What first attracted you to the world of investing in real estate syndications? My guess is that you saw the potential to put your hard-earned money to work for you and build your wealth over time. Most investors are interested in investing in syndications for that exact reason.
As a busy ER physician, I work long, last-minute shifts and it’s music to my ears that I can have an investment producing excellent returns in a hands-off way while I sleep, work, hang out with family, and do whatever else I want! No matter where you are in the medical field, I’m betting you feel my pain – as much as I love medicine, I’m not sure I want to practice this way for my entire life.
I’d love to travel more, volunteer, and practice medicine in an altruistic way… but funding that lifestyle felt like a big barrier for a long time – until I discovered syndications, of course! The number one question I get asked by would-be investors is how much money they could expect to make if they were to invest $100,000 in a syndication deal.
After all, to build wealth, all you need to do is simply invest in deals that will earn great returns, right? Not so fast. While I love healthy returns, there’s another factor that’s even more important for me to consider when evaluating potential real estate syndication deals.
Although it’s not exciting, capital preservation is the most important thing I focus on in a real estate syndication. That means I focus on making sure that the deal has multiple plans in place to protect from any loss of investor capital. As dull as it may be, that’s my number one priority.
Why Capital Preservation is Crucial to the Success of a Deal
Capital preservation isn’t the most exciting part of investing in real estate syndications, but it’s one of the most critical factors to consider as a passive investor.
While it’s easy to focus on the flashy aspects of investing in a real estate syndication deal, capital preservation is how your investment is protected when unexpected issues arise. When evaluating a potential deal, of course, you should check out the projected cash flow returns, potential earnings, and brightly colored marketing packages. Still, ultimately it’s most crucial to have a sponsor team that gives capital preservation the attention it deserves.
Capital preservation is all about mitigating risk and protecting your investment. According to financial guru Warren Buffett, there are two rules to investing. The number one rule is never to lose money, and the number two goal is never to forget rule number one.
Regardless of what company or deal you decide to invest in, be sure you know what questions to ask and what to look for so you can invest confidently with a team that will uphold your best interest.
The 5 Pillars of Capital Preservation
I keep capital preservation as my number one priority in every investment I participate in. Five building blocks make up my capital preservation strategy and are at the core of every deal.
#1 – Raise money to cover capital expenditures upfront
Problems can accumulate quickly when capital expenditures are funded solely by cash flow. For example, if the property has a sudden plumbing emergency requiring an expensive repair, that sudden cost would have to be covered by the cash flow instead of the planned unit renovations. This would cause the business plan to fall behind schedule, leaving units not ready and contributing to continued vacancy.
To avoid this issue, I ensure the funds for capital expenditures are set aside upfront. So, for example, if I need $2 million for the down payment and $1 million for renovations, I’ll raise $3 million upfront. To put it simply, I’ll make sure $1 million cash is reserved for renovations, and I’ll never have to rely on monthly cash-on-cash returns to keep the business plan on track.
#2 – Purchase properties already cash-flowing
Another excellent method I use to preserve investor capital is to purchase properties that produce cash flow immediately, even before improvements. Cash-flowing properties are a safeguard if units don’t fill as planned or the business plan hits a bump in the road. Simply holding the property would still allow for positive cash flow.
#3 – Stress test every investment deal
I ensure the viability of every syndication deal by performing a sensitivity analysis on the business plan before investing. Then, I adjust various aspects of the business plan to ensure the investment can weather the worst conditions. For instance, what if vacancy rose to 15%, or what would happen if the exit cap rate was higher than expected?
It’s easy to make a property look attractive if you’re only diving as deep as fancy marketing brochures and idealistic projected budgets. My job is to stress test those numbers and get a realistic view of how the performance of the investment may adjust based on potential variability in variables.
#4 – Multiple exit strategies are in place
In case of any disaster or emergency, it’s wise to have a plan, notably an exit plan, so you’ll be able to escape the problematic fate that awaits you. Real estate syndication deals are no different.
Real estate syndication deals typically hold properties for around five years, but no one can predict the market at the five-year mark. Therefore, your sponsor needs to have a solid contingency plan in place. Back-up plans can include holding the property for a longer time or preparing the property for a different type of end buyer.
#5 – Put together a team with a solid track record of valuing capital preservation
One of the most critical pillars of capital preservation is to have a team that values protecting investor capital above all things. This includes both the sponsor and operator teams and the property management team. In addition, every team member should be passionate about their role and display a strong track record of success.
The more experience the team has in navigating challenging situations successfully, the more competent they’ll be in protecting investor capital.
How getFREED Protects Investor Capital
While capital preservation may be boring and not nearly as exciting as double-digit returns, it is undoubtedly one of the most critical building blocks of a solid deal. In a real estate syndication, every decision and initiative made by the sponsor team should be rooted in preserving the investors’ capital.
Here are the five capital preservation pillars I use in real estate syndication deals I participate in:
- Raise money to cover capital expenditures upfront
- Purchase properties already cash-flowing
- Stress test every investment
- Multiple exit strategies are in place
- Put together a team with a solid track record of valuing capital preservation
I utilize these five pillars to minimize investor risk as much as possible. By keeping capital preservation at the forefront of every decision I make, I can ensure I’m protecting your money, first and foremost.