By Dr. James M. Dahle, WCI Founder
The most important book I read this year is somewhat niche, but it's well done and clearly the best book that has yet been produced on the topic of private real estate investing (syndications and funds). It is titled The Hands-Off Investor: An Insider's Guide to Investing in Passive Real Estate Syndications and is written by Brian Burke, the CEO of Praxis Capital, and published through BiggerPockets Publishing.
Despite the obvious conflict of interest (and to Mr. Burke's credit), the book surprisingly doesn't contain a plug to invest with Praxis the way most books written by financial professionals do.
The Hands-Off Investor is dense. This is not a quick, easy read nor is it particularly entertaining; it took me most of the year to get through it. It has 358 pages, and there is something useful on every one of them. Perhaps the best way to think about it is that it's the equivalent of an online course compressed into a far less expensive book (it was < $15 on Amazon the last time I looked). If you are considering investing in private real estate investments, particularly individual syndications, you should probably read this book first. If you can't get through the book, well, you should probably stick to the Vanguard REIT Index Fund as your chosen real estate investment.
The introduction and first section lay out the case for real estate and particularly private real estate syndications. It will introduce you to the basic terms in this space and do as good a job as anyone to convince you to include these investments in your portfolio. Like most real estate books, the argument for real estate is a little over-exuberant to the point of being misleading.
For example, he includes a table suggesting that real estate has tax advantages and can be leveraged but stock investing does not and cannot. Plus, the first category in that table is “hard assets.” Well, let's be honest. When you buy into a syndication, you don't have any more of a hard asset than when you buy into Amazon or Apple. You just have papers describing what you bought (which includes properties, machines, and other “hard assets”). There is also far too little discussion in the book about the use of retirement accounts. Both are classic mistakes that lots of real estate-focused investors make all the time, and this book is no different in that regard.
The second chapter in the first section and the entire second section (two more chapters) are where the book really begins to shine. The first thing to evaluate with a private real estate investment (and I'm in complete agreement on this point) is not the investment. It's the sponsor/manager/operator. A great sponsor can make lemonade out of a lemon investment. A bad one (or worse, a fraudulent one) can ruin even the best deal on paper. You want to know what you should know about a sponsor before investing with them? This book contains a comprehensive list. Most importantly, Burke tells you what the right answers should look like. He advises:
“No airline passenger would ever board a plane that hadn't proved in the real world that it can both take off and land. The only people allowed on untested aircraft are test pilots. Investing with an untested syndicator makes you a test pilot. There's nothing wrong with that as long as you're aware that's what you are signing up for and willing to accept the extra risk. Just don't confuse being a test pilot with being a fare-paying passenger flying on a fully tested plane.”
The third section of the book describes how to evaluate properties. Should you buy into this property or not? What is your return likely to be? This goes on for 134 pages. In a straightforward, logical manner, he goes through the basics, bottom-up analysis, discussion of both gross and net income and the typical ways they are presented, performance indicators, debt structure, capital improvements, cap rates, and valuations. Dozens of pearls are contained, such as this one:
“Common area maintenance (CAM) charges are amounts charged to tenants of a commercial property under triple-net leases to pay for common area maintenance, including landscaping, insurance, common area utilities, and such. You don't typically see CAM charges in multifamily properties but they are common in office buildings and retail centers.”
I remember the first time I learned about CAM charges. I was pretty excited (remember I'm on a board that manages an office building syndication where our physician partnership is housed) because it boosts the income and return of the property. But if you've only been involved in apartment buildings, you might not think to add that to your contracts.
The fourth section is about the investment. It discusses various investment structures, underwriting, where projections come from, where the money to pay for it all comes from, waterfalls, and fees. Here's an example from that section:
“A sensitivity analysis is a table or tables that show the projected return for various alternative performance scenarios. This might be exit cap rates that are higher or lower than forecast, or income that is higher or lower than forecast, or vacancy that is higher or lower than forecast. The best sensitivity analysis will show a variety of combinations of all those factors, and even show variances for different hold periods, in case the property is held for more or less time than forecast. The benefit of a sensitivity analysis is that you can see where the deal really starts to get stressed, and perhaps even discover ways to maneuver around that stress. You can also see some best-case versus worst-case scenarios.”
Then he provides a couple of tables demonstrating sensitivity analyses.
This section runs another 100 pages. By the time you have finished sections two through four, you will understand all the terms used in this space. You will speak the language of private real estate, and you will have a good sense for just how much due diligence should be done prior to investing. If reading through a 100-200 page Private Practice Memorandum seems like a lot to you, that is only one small part of due diligence.
The last section is shorter and discusses the process of putting money into the investment, what happens while you are invested, and getting money back out of your investment. There's also a nice appendix with the legal definition of an accredited investor, which hopefully won't be new to you if you've been involved in these investments for a while.
There is no reason to read this book if you have no interest in private syndications or funds comprised of those syndications. But if you are interested in those, I know of no better book out there on the subject (and I've looked at every one I could find over the years). I'm adding this book to my recommended book list.
While you're at it, don't forget to sign-up for the free White Coat Investor Real Estate Newsletter that will alert you to opportunities to invest in private real estate syndications and funds, including most of those where I invest.
What do you think? Have you read this book? What is your favorite resource to learn how syndications work? Comment below!