Why Capital Preservation Should Be Your KEY Focus...
/
Real estate is a very unique investment compared to other more aggressive investments. For instance, it’s highly unlikely that investors will see a 20X return in real estate. Unlike venture capital and cryptocurrency, real estate moves slowly.
However, that slow and steady growth provides stability and predictability that is difficult to recreate with other investment strategies.
In addition to regular cash flow, steady appreciation, and enormous tax benefits, there is ONE primary focus to our investment strategy: Capital Preservation. In other words, we focus on how NOT to LOSE money.
Warren Buffett once said there are two rules to investing:
Rule #1: Never lose money
Rule #2: Never forget Rule #1
If you are investing as a passive investor, you should know what to look for so you can invest confidently with a team that holds your best interest.
At the core of every investment, capital preservation is our number one priority. Here are 5 key things you should look out for…
#1 – Plenty of Capital Reserves
It’s imperative that the sponsor raise enough capital for expected and unexpected capital expenditures. These can be for planned renovations such as improving apartments or replacing the roofs. Or it can be for unexpected variables such as high vacancy or a broken pipe.
An experienced sponsor knows to keep plenty of capital reserves to protect against any issues.
#2 – Purchase Cash-Flowing Properties
One great way to preserve capital is to purchase properties that produce cash flow immediately, even before improvements. If units don’t fill as projected or the business plan isn’t going smoothly, just holding the property would still allow positive cash flow.
#3 – Stress Test Every Investment
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 25% and what would happen if the exit cap rate was higher than expected?
It’s not enough to simply underwrite a deal. Make sure your sponsor stress-tested the project and understands just how bad things could hypothetically get before losing profitability.
#4 – Multiple Exit Strategies in Place
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 upon 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 – An Experienced Team
Possibly the most critical pillar of all is to have a team that values capital preservation. This includes both the sponsor 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.
Conclusion
When browsing for your next real estate syndication investment, there’s nothing wrong with getting excited about the projected profits and feeling confident that your business plan will go smoothly.
But remember to go back and look at the data with an investigative eye. Make sure capital preservation is as important to the sponsor team as it is to you.