As a professional passive real estate investor my job is to find great deals to put my money into. Once my capital has been placed in an asset I have almost no control to influence the return so all of my work comes on the front end. The most important thing I can do to ensure that I am achieving the returns I desire is having a thorough system of due diligence and looking at lots of deals. Here are some of the items that I look at when reviewing a deal.
1. The Operator- The number one thing you need to be 100% confident in when investing passively is the operator. They are the decision makers and ones in control of the return. Although trust comes from developing a relationship you can start by asking these questions:
What is their track record? How long have they been doing this? How did they fair through the last recession?
Do they have a local presence? If they have another local asset you can be confident they have a team of qualified service providers in place.
What is their competitive advantage? What makes their deals or process unique? Are they getting deals that no one else has access to or do they have a unique management strategy to drive down expenses?
Have they ever lost investors money? If they have, there better be a very compelling reason and proof that they did everything in their power to make those investors whole.
2. Asset Class- Do you believe the asset class (multifamily, retail, industrial, etc.) has significant tailwinds or currently very popular and possible overpriced?
3. Strategy- What does the operator plan to do to to hit their proposed returns? Is the asset already performing or are they implementing a value add strategy to increase the value of the property.
4. Risks- All investments come with some sort of risk. Make sure you understand the risks associated with each deal and that you would survive a worst case scenario. Each station in life brings with it a different tolerance so be aware of how much risk you are currently okay with.
5. Return- Find out the expected return on your investment. They can show it is ROI, IRR, or equity multiple. Know the difference between each of these and what you desire to achieve your goals.
6. Payout Structure- Some investments give you good steady cashflow where others could have a better overall return that doesn’t get distributed until the sale of the asset. One is not universally better than the other; it is dependent on the goals of the investor.
7. Incentive Alignment- How and when do the operators get paid? An operator’s incentives are highly aligned with the investors when they do not get paid until the investors get a good return. Does the operator have any of their own money invested? You want to feel like the operator will do everything in their power to get you the highest return.
8. Conservative Underwriting- How conservative do you feel the executive summary and pro forma are? You should be confident that the operator can hit their numbers even with a few hiccups. Were they conservative with their expected occupancy, reserves, exit cap rate, etc?
9. Demographics- Look into whether population, income, employment, etc. are increasing. Do you see an increase in demand for the asset over the next 10 years from the current demographic?
10. Financing- Having good, conservative financing can make or break a deal. What is the spread between the cap rate and the interest rate? Are they using interest only options to juice cash flow or just to make sure they have reserves? Having a high debt service coverage ratio ensures that debt payments will be able to be made even if something goes wrong.
11. Exit Strategy- How and when do you get your money out? The operator should have a clear plan of how and when you receive your money back. Make sure that there are buyers for this type of asset. Be clear on the strategy and know that the game plan can change; trust that the operator will make decisions along the way that are in your best interest (see #1).
The skills to analyze these details are gained through lots of study and experience. Many people do not have the time or desire to go into this amount of depth. I am happy to help you analyze deals your deals, teach you some insights, or just bring you along on the deals that I invest in.
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