By Dr. Peter Kim of Passive Income MD, Anesthesiologist, WCI Network Partner
Investing in real estate syndications is a fantastic way of creating passive income without having to deal with the day-to-day operations of being a landlord. It does require time and effort up front to figure out what to invest in, but the rest is as passive as can be.
If you're considering investing in a syndication, you might have several questions, such as where you should begin, how do you make money on a deal, what if this doesn't work, etc.
Like any other investment, investing in syndication also has a learning curve, and along the way, there is the potential to make some expensive mistakes. But if you want to accelerate your learning and minimize the pain, focus on learning from others' mistakes.
So, in this post, I want to discuss five big mistakes when investing in real estate syndications.
Mistake #1: Not Doing a Deep Dive on the Sponsor and Their Track Record
Many investors out there make the decision to invest mainly on the numbers. They look at the hold period, the returns, the equity multiple, etc. These details are plastered on the front of every offering memorandum, but they forget that real estate investing is a human game. The competitive edge of one sponsor over the other lies in their network, track record, skill set, and their ability to operate a deal well.
For instance, a sponsor might have an excellent deal, but if the team managing that deal is inexperienced or ill-equipped, then you could possibly lose money on that deal. But say a sponsor has a reasonable deal, but their experience, industry know-how, and strong operating team could take that ordinary deal to the next level and fetch you better returns.
Most of the time, you're investing in the sponsor more than the deal itself. Anyone can make up numbers to put on a sheet, but only a few can actually execute things well.
So, spend a good deal of time getting to know your sponsor, their track record, and their ability to make things happen.
Mistake #2: Investing Out of FOMO – Fear of Missing Out
I can't tell you how many times I missed out on a deal early in my investing career because I was too late to hear about them. After a while, I was so determined to invest in a deal that I jumped at the next available opportunity without thoroughly looking into it. As fate would have it, I lost a good portion of my investment on that deal which I could've easily avoided by doing even basic due diligence.
I'm sure that at some point on your investment journey, you’ve come across a deal that you wanted to invest in, but the deal closed before you could get in. At the time, you might’ve regretted missing out, but trust me, it’ll happen quite a bit.
There’s nothing wrong with a deal going by. I promise you there will be more. I’d rather miss a deal than invest in a poor deal that I could’ve avoided by simply doing a little more due diligence.
There's nothing worse than getting in a deal that you're not fully comfortable with. You’re committed to most of these deals for years, so why rush to invest?
Mistake #3: Not Understanding the Lack of Liquidity in Real Estate Syndications
A real estate syndication is more of a longer-term investment strategy. You likely won't see significant returns in a few months, so don't obsess over it.
Focus on the big picture and talk to your sponsor about the realistic timeline for your returns.
Generally, your funds are locked in for three to five years or more, depending on your sponsor's plan, and it's their decision when to refinance or sell the property. That’s why these types of investments are considered more of an “illiquid” investment. You can’t easily convert your investment to cash like you can for a stock or mutual fund.
However, you will be receiving some cash flow along the way, and you might get a portion or all of your initial capital back in case they decide to refinance.
I tell people to assume you won’t be able to access it for 3-7 years.
This might seem like a bad situation, but the outsized returns you receive are part of the trade for this lack of liquidity.
If you need access to this capital quickly, I wouldn’t put it into one of these types of investment.
Mistake #4: Not Diversifying and Only Investing in One Deal
Investing in syndication is a great way to diversify your earnings, but it's equally important to invest in more than one deal at a time. Diversifying across different asset classes can help an investor manage risks and minimize the impact of market volatility. Investing in more than one deal offers several benefits. It can enhance your earning potential and stabilize your returns.
Actually, this is the reason why I invest heavily in real estate funds. With one investment, you’re automatically invested in multiple properties.
There are some things that happen that are out of the hands of even the most experienced sponsor, so it’s smart to spread your bets.
Mistake #5: Not Asking More Questions
Before investing in a syndication, you’re likely to come across an offering memorandum or deal summary. It’ll provide the highlights of the deal and make it look amazing. In fact, on first glance, every deal seems good.
Only upon digging and asking more questions will we find out what we want to know.
For example, once you learn how to spot aggressive assumptions, you’ll be able to ask why an expense ratio seems unrealistic. Once you do see it, you should definitely ask a sponsor how they plan to make it a reality.
Also, if fees aren’t stated explicitly on the offering memorandum, you should ask about them.
Just remember, they’re looking to create a relationship with you and your hard-earned money, and it’s your right to ask whatever questions necessary until you’re comfortable investing thousands of dollars.
So please learn how to read a summary and what questions are helpful to ask.
Investing in real estate is one of the most effective and powerful ways to generate multiple income streams. Sure, there will be mistakes along the way, but the end goal of achieving financial independence is worth the experience.
However, there's no substitute for proper due diligence; it's the only way to feel good about investing in any deal. If everything looks great and the math checks out, then pull the trigger with confidence.
If you'd like to learn more about how to confidently invest in passive real estate investments, feel free to check out our Passive Real Estate Academy Course. It's happening this September!
Are there any other big mistakes you've made investing in syndications that others should watch out for? Comment below!