What first intrigued you about real estate syndications? Our guess is it was the chance for you to create a steady passive income stream and build your wealth for the future.
The question we get asked the most by would-be investors is, “If I invest $100,000 in real estate syndications with you, how much money can I make?”
We love investing in deals that generate healthy returns. That’s a big reason why we do what we do, but the returns aren’t our top priority. Yes, passive income and tax write-offs are a beautiful thing, but there’s something else that’s even more important to us.
The main objective for us in a real estate syndication is preserving your capital. That means we’ll go to great lengths to ensure your investment is protected from loss. It may not sound very exciting, but it’s our top priority.
Why Is Capital Preservation So Important?
We know capital preservation sounds a bit boring, but it is one of the most important parts of real estate syndication investments.
It makes sense for investors to focus their attention on the opportunities for cash flow returns, and profits. After all, that’s one of the main reasons they decided to invest in real estate syndications in the first place. BUT, when unanticipated situations happen, investors can rest easy knowing that they have a team of sponsors dedicated to preserving their capital.
Capital preservation reduces risk, and Warren Buffett’s rules for investing say it best:
Rule #1: Never lose money
Rule #2: Never forget Rule #1
It’s important to ask the right questions and know what to look for, no matter what you invest in, or who you invest with. You want the security of knowing your money is in good hands.
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.
We Told You It Wasn’t All That Exciting…
As you can see, capital preservation isn’t the glamorous part of investing in a real estate syndication, but it is one of the most vital parts of a solid investment deal. As your sponsor team, we’re there to preserve investor capital.
We incorporate these five capital preservation principles in our real estate syndication deals:
- 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
By establishing these five principles, we reduce risk in every way possible. You can have peace of mind in knowing that every decision we make involving your investment is keeping your money secure.