So far in our series, Passive Investing Made Simple, you’ve learned a few definitions and key concepts, the framework for a typical deal structure, and what to look for in a sponsorship team. Part 4 of our series is going to help you evaluate deals once you start receiving them.
Your specific investment criteria should depend on your investment goals, risk tolerance, desired liquidity, as well as a number of other variables. The exact target metrics that should be used can vary depending on many factors, so we will provide a few rules-of-thumb but you will need to make your own informed decisions on what to strive for.
There are many factors to look for in an investment opportunity, but here are the four key components to consider before you invest.
- Market (and Sub-market) Fundamentals
- Comfort with Sponsorship Team
- Business Plan
- Metrics
Market Fundamentals
You’ve heard it many times, but “location, location, location” is still solid advice to consider when evaluating real estate. Buying a property in an area with high rental demand not only increases your chances of achieving strong returns, but it helps limit your downside on an investment as well. Just remember, the value of an apartment building is based on the Net Operating Income (NOI) and the best way to maximize your revenue is to collect consistent rent checks. So how do you evaluate market demand? You can start by looking at economic factors like population growth, job growth and job diversity. You can find these statistics and many more at https://www.city-data.com/. You also want to consider things that attract people to a location such as cost of living, climate and good schools. Are there new companies moving to the area? Are there hospitals or universities nearby? Are there popular coffee shops, breweries or restaurants moving into the neighborhood? These are all factors that can drive rental demand and are great topics to discuss with the sponsor.
Sponsorship Team
In Part 3 of this series, we discussed how to evaluate a sponsor, so please read that article if you haven’t. You may feel comfortable with an individual sponsor after going through the vetting process, but you still need to evaluate the entire sponsorship team in terms of their ability to succeed in a particular investment. Multifamily investing is a team sport, so many times there will be people that you may be unfamiliar with brought onto the team to help with various aspects of the business. You may not be able to personally meet all team members, but you can make sure the team checks all the necessary boxes. They should have experience doing deals of similar size and structure, knowledge of the market and sub-market, complimentary skill sets and should present a strong business plan. That brings us to #3, the Business Plan.
Business Plan
The sponsorship team should have a detailed and realistic business plan for the property. There should be a clear plan for the property from the day of closing through disposition. If the investment is a value-add play, you need to find out how the team plans to add value and make sure they are approaching it with reasonable expectations. To understand what that plan is, you can ask questions such as:
- Is there work needed to maximize rents?
- Is there deferred maintenance?
- Who will manage the property?
- Will there be staff on-site full time?
- Have you evaluated rent comps?
- What is the holding period?
- What are you using for a cap rate at disposition?
Metrics
Once you feel comfortable with the market, the team, and the business plan, now it’s time to take a look at the projected returns. I start with three metrics during my initial evaluation of a passive investment, Internal Rate of Return (IRR), Equity Multiple (EM), and Average Annual Return. There are plenty of resources out there to help explain what these are, so I won’t bore you with the definitions, but Investopedia is a good place to start if you are unfamiliar with these metrics. What to look for in these numbers will depend on your investment criteria but I’ve listed ranges for a typical real estate syndication below.
- Internal Rate of Return (IRR) 12%-18%
- Equity Multiple 1.7x-2.2x
- Average Annual Return 14%-20%
Please take these numbers with a grain of salt and understand that when you are presented a deal, the metrics shown will be projections and not guarantees. It is important to find a sponsor that runs realistic and conservative projections, because it is very easy to show unrealistically high projections by simply modifying a few assumptions. If you’re interested in learning more, head over to https://goldribboninvestments.com/ to download our free sample deal package.
We hope you have enjoyed this article. In Part 5 of our Passive Investing Made Simple series, we will discuss what you can expect when you invest in a deal as a limited partner (LP).
If you’ve found this helpful, visit https://goldribboninvestments.com/ to learn more about how we help others invest in real estate without the headaches of becoming a landlord. We genuinely hope you start your journey for financial freedom today. You and your family deserve a life filled with Freedom, Wealth and Impact and real estate investing is a great vehicle to take you there.
Adam Lacey
Managing Member at Gold Ribbon Investments
