What attracts most people to real estate syndications is the potential to put your money to work for you, create a substantial return, and the ability to see tax-efficient stable consistent growth.
When you evaluate possible investment opportunities, in addition to looking for a simple to manage, pay-and-play investment, you need to consider how much risk is involved in the investment, and if it is a risk you are willing to make.
As part owner of a large multifamily property, you need to know your capital is protected in addition to evaluating the likely return on investment. Our deals have multiple plans in place to help protect you from any loss of investor capital, so you can be confident that your wealth is building and not declining.
Research Capital Preservation Strategies
Capital preservation is one of the most critical pieces of evaluating whether a deal is right for you. Don’t be distracted by cash flow returns and potential earnings without giving capital preservation the attention it deserves in your research process.
5 Ways to Mitigate Risk
At the core of every investment in which we participate, capital preservation is our number one priority. There are 5 building blocks that make up our capital preservation strategy.
#1 – Cover capital expenditures first
Imagine the avalanche of problems that can accumulate when capital expenditures (like renovations) must be funded purely by cash flow. In this case, cash-on-cash returns, which vary based on occupancy and maintenance costs, would have to fund sudden HVAC repairs instead of unit renovations according to the business plan. In this case, the business plan falls behind schedule, units aren’t ready as planned, and vacancy persists.
Instead, we ensure the funds for capital expenditures are set aside upfront. As an example, if we need $2 million for the down payment and $1 million for renovations, we will raise $3 million upfront. This means we have $1 million cash for renovations and won’t have to rely on monthly cash-on-cash returns.
#2 – Plan for Positive Cash Flow
One great option to preserve capital is to purchase properties that produce cash flow immediately, even before improvements. If units don’t fill as planned or the business plan isn’t going smoothly, just holding the property would still allow positive cash flow.
#3 – Perform a Sensitivity Analysis
Performing a sensitivity analysis on the business plan prior to investing allows us to see if the investment can weather the worst conditions. What if vacancy rose to 15% and what would happen if the exit cap rate was higher than expected?
Properties look wonderful when they’re featured in fancy marketing brochures with attractive proformas (i.e., projected budgets), but stress testing those numbers helps us take a look at how the performance of the investment may adjust based on potential variability in variables.
#4 – Have contingency plans
In any disaster or emergency, you want to have several ways out. In case of a fire, you want a door and window. The same goes for real estate syndications.
Even if the plan is to hold the property for 5 years, no one really knows what the market conditions will be at that 5-year mark. So, it’s important to account for contingency plans, in case you need to hold the property longer, and the possibility of preparing the property for different types of end buyers (private investors, institutional buyers, etc.).
#5 – Pick your team wisely
Possibly the most critical pillar of all is to have a team that values capital preservation. This includes both the sponsor and operator team(s) and the property management team. All of these people should be passionate about their role and display a strong track record of success.
The more experience they have in successfully navigating tough situations, the better and more likely they will be able to protect investor capital.
Minimizing Risk to Capital
Capital preservation is the foundation of a solid real estate syndication deal. This is why ensuring that investor capital is as safe as possible is a key factor in each and every decision that the sponsor/operator team makes.
We always put in place these five central pillars to ensure our deals are as risk-free as possible:
- Cover capital expenditures upfront
- Plan for positive cash flow
- Perform a sensitivity analysis
- Have contingency plans in place
- Pick a team wisely to ensure they have the same values as we do
In doing so, we minimize risk and maximize the chance of protecting capital for our investors, providing a streamlined experience with your needs top of mind.