What first interested you in real estate syndications? It may seem like a trick question, but there is normally one answer we hear from new investors. “To make money.”
The number one question we get asked when a new investor is considering investing in a real estate syndication is “How much could I make if I invest $100,000 with you?”
Making money is one of the biggest motivators for investing in real estate, and we love a good return! However, returns are actually not the most important aspect we focus on when evaluating potential deals.
Passive income and double-digit returns are pretty exciting, but what we really focus on is actually more boring than taxes and K-1s.
We focus on capital preservation first and foremost. This means we make sure the deal has multiple plans which will help protect investor capital loss. That’s our number one priority throughout the lifecycle of every deal.
Why It’s Important to Talk About Capital Preservation
Capital preservation is in no way the most exciting part of investing in real estate syndications, but it is one of the most critical pieces.
It’s easy to just focus on all of the exciting stuff like cash flow returns, potential earnings, and brightly colored marketing packages, but when an unexpected situation arises, you’ll be thankful (for this article and) for a sponsor team that gives capital preservation the attention it deserves.
Capital preservation is all about mitigating risk, and you never want to lose money!
No matter what you invest in or who you invest with, you should know what to ask and what to look for so you can invest confidently with a team that holds your best interest.
5 Capital Preservations Pillars
At the core of every investment in which we participate, capital preservation is our number one priority. There are 5 building blocks that make up our capital preservation strategy.
#1 – Raise money to cover capital expenditures upfront
Imagine the avalanche of problems that can accumulate when capital expenditures (like renovations) must be funded purely by cash flow. In this case, cash-on-cash returns, which vary based on occupancy and maintenance costs, would have to fund sudden HVAC repairs instead of unit renovations according to the business plan. In this case, the business plan falls behind schedule, units aren’t ready as planned, and vacancy persists.
Instead, we ensure the funds for capital expenditures are set aside upfront. As an example, if we need $2 million for the down payment and $1 million for renovations, we will raise $3 million upfront. This means we have $1 million cash for renovations and won’t have to rely on monthly cash-on-cash returns.
#2 – Purchase cash-flowing properties
One great option to preserve capital is to purchase properties that produce cash flow immediately, even before improvements. If units don’t fill as planned 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 15% and what would happen if the exit cap rate was higher than expected?
Properties look wonderful when they’re featured in fancy marketing brochures with attractive proformas (i.e., projected budgets), but stress testing those numbers helps us take a look at how the performance of the investment may adjust based on potential variability in variables.
#4 – Have 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 at 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 – Put together an experienced team that values capital preservation
Possibly the most critical pillar of all is to have a team that values capital preservation. This includes both the sponsor and operator team(s) 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.
Capital Preservation = Peace of Mind
Capital preservation is not exciting, but it is one of the most critical building blocks when developing a solid deal. It allows the investors to have peace of mind and know the sponsor/operator team is always working on their behalf to preserve investor capital.
The five capital preservation pillars used in real estate syndication deals we do include:
- Raise money to cover capital expenditures upfront
- Purchase cash-flowing properties
- Stress test every investment
- Have multiple exit strategies in place
- Put together an experienced team that values capital preservation
Since we use the same 5 pillars for every deal we take on, we minimize risk as much as possible and make sure every decision made about the property is protecting investor money (your money), first and foremost.