Time for some proper due diligence/ independent auditing in our communities

[dm123]

Eli Fried chiming in on LinkedIn:

https://www.linkedin.com/posts/activity-7069656339920080896-Rpxv

Most investors don't belong in real estate  deals/syndications.

This is as controversial as saying most skiers don't belong on black diamond ski trails. (i.e advanced level)
_____________________________________
Now, let me explain.

I am a huge fan of real estate and have friends, family and clients in the RE business.

Direct ownership of real estate offers the potential for tremendous returns and unparalleled tax benefits.

My knowledge and opinions are coming both from general research on RE fundamentals and having "at the table" knowledge of many successful RE transactions.... and a few that did not turn out well.

Many real estate syndicators do a fine job for their limited partners. Some are masters at the craft. But there are a LOT who aren't. And it is very difficult to sort them out with foresight.

Amateur investors don't have what it takes to properly analyze, structure, oversee, and diversify into real estate syndicates/deals.

I know plenty of bruised up RE investors, both from this cycle and last cycle. Amateurs AND pros. Of course many also do well and some have done fantastically.

Bottom line, direct real estate is not for amateurs.....i.e. the vast majority of investors.

Neither are hedge funds, VC, PE, crypto, stock picking, options etc. but I know very few amateurs putting their life savings into those vehicles but plenty who do that in real estate syndications.

Amateur investors should stick to "green circle" investments. Index mutual funds.

With a bit of training and experience, they can graduate to "blue square" investments if they choose to. (eg. active mutual funds, blue chip stocks, renting out RE  they know well and control. etc.)

Long run, by staying within their capabilities, investors end up with better returns with much less work and angst.

Handing over your money to a real estate syndicator is Black Diamond.

If you don't know what you are doing, you will probably break limbs.

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This is just my opinion, of course. Feel free to voice your opinion below.

Professionally, please. =)

I understand this may be your living and you may fundamentally disagree.

And I don't begrudge anyone tremendous returns/ wealth. I hope and pray that everyone reading this makes tons of money, quickly and easily.

But a shocking number of amateur investors in my orbit have gotten sucked into RE deals and burned.

In my opinion, which I voiced on the way up too, they don't belong in this space.



(BTW, if you are truly a master of the craft I'd love to speak tachlis with you, if you are willing after reading this post. =) Message me via LinkedIn.)

[yuneeq]

For example, if a $10 million property was producing net operating income of $35,000 or a 3.5 cap and you can raise the income to $70,000 over a few years, as long as cap rates remain at 3.5 that property would now be worth around $20 million. Additionally, cap rates were actually coming down over much of the list decade which would increase the value of the property, even if income stays the same. This was largely a function of interest rates continually going lower.

Additionally, if you could borrow 80% of the purchase price of a 10 million dollar property at 2 1/2% then you are leveraging the cash you are putting in because the 8 million you are borrowing at 2.5% is yielding 3.5% so that magnifies the return on the 2 million cash portion of your investment To far more than 3.5% (this is a simplification ignoring many other expenses and factors.)

Fast forward a few years and that 3.5 cat property now requires a loan at 7%. This means that all things being equal every dollar of the 8 million that you are borrowing at 7% is only yielding 3.5%. That is actually hurting your return. Your cash portion is yielding 3.5% but your loan portion is losing money And could even be wiping out any yield from the cash portion to buy the property at that price you had better you have a very good Gabe plan or unusual opportunity, such as rents that are way below market or some other factor that will make it worthwhile despite the lousy numbers . In general, the higher rates are going to Nashly put pressure on the cap rates for the reasons above.


To put things another way the bank is getting 7% on its money with relatively little risk. They have first dibs on the property in the event of a default. Granted, they may not recover the entire value of the loan because they’re only lending out a percentage of the full value, even if valuations go down, they stand to recoup most of their money, even if the investment is a flat. The investor on the other hand is taking the risk of losing all his capital and only getting a yield of 3.5% on his money, even less when considering the negative leverage. In theory, the greater the risk that is taken the larger, the return or to be , this illustrates that the market is not where it should be and prices need to come down significantly (cap rates need to rise .) there will always be exceptions and niche opportunities but in general the numbers out there today do not support current market valuations, and something is going to give.

In the 10mm example, 3.5 cap would mean 350,000 not 35,000, and so on.

[liosac]

Yes . Corrected.

[avromie7]

Eli Fried chiming in on LinkedIn:

https://www.linkedin.com/posts/activity-7069656339920080896-Rpxv

He has a fair point, but there was a great response in the comments

building wealth is a game of how quick you can double your money and compound your returns. Putting money in mutual funds and making 8-10% annually is a very long game. With real estate, of course it is riskier but it affords someone the opportunity to get there a lot quicker (or not get there at all if it goes bust). You need to be aware of that risk before entering. Anytime there is leverage involved, there is inherent risk that is not so by mutual funds.

[dm123]

He has a fair point, but there was a great response in the comments

Yep. And double black diamond is much more thrilling than bunny hills. Doesn't mean stay at bunny hills your whole career, just use good judgement about when you should move on to the next level. Think they're saying the same thing.

[yuneeq]

He has a fair point, but there was a great response in the comments

That doesn’t detract from the post. Real estate is a fast way to build wealth, but like other wealth-building investments it come with more risks that aren’t well understood by amateur investors. And the less they know, the riskier the investment becomes.

If they do proper due diligence and can identify good opportunities then it can make sense to take risks, but then again they wouldn’t be amateurs at that point.

[knowitall]

That doesn’t detract from the post. Real estate is a fast way to build wealth, but like other wealth-building investments it come with more risks that aren’t well understood by amateur investors. And the less they know, the riskier the investment becomes.

If they do proper due diligence and can identify good opportunities then it can make sense to take risks, but then again they wouldn’t be amateurs at that point.

RE is a fast way to build wealth, or WAS a fast way over the previous few years?

RE has always been a long and slow game. The past few years were an anomaly.

[dm123]

RE is a fast way to build wealth, or WAS a fast way over the previous few years?

RE has always been a long and slow game. The past few years were an anomaly.

Isn't it in cycles? It wasn't a fast way pre-2008?

[avromie7]

RE is a fast way to build wealth, or WAS a fast way over the previous few years?

RE has always been a long and slow game. The past few years were an anomaly.

It was always a fast way. The idea is to do a cash out refi within the first couple of years. The investor gets his money back, while the property continues generating income. He can then put the same cash back into a new deal, rinse and repeat.

[liosac]

It was always a fast way. The idea is to do a cash out refi within the first couple of years. The investor gets his money back, while the property continues generating income. He can then put the same cash back into a new deal, rinse and repeat.

Try doing that in the next couple of years with cap rates expanding and available credit and lending standards tightening. It’s a cyclical strategy unless you are really good at identifying inefficiencies or overlooked opportunities that allow you to substantially add value even in a down market.

[knowitall]

It was always a fast way. The idea is to do a cash out refi within the first couple of years. The investor gets his money back, while the property continues generating income. He can then put the same cash back into a new deal, rinse and repeat.

Until a few years ago, it usually took 3-5 years for a deal to grow NOI enough to do a cash out refi.
In 2020/2021, there was unprecedented rent growth coupled with rock bottom rates that made it possible for anyone without talent do refi/exit very quickly.

[avromie7]

Until a few years ago, it usually took 3-5 years for a deal to grow NOI enough to do a cash out refi.
In 2020/2021, there was unprecedented rent growth coupled with rock bottom rates that made it possible for anyone without talent do refi/exit very quickly.

3-5 years to cash out while making 10% or so in the interim is way faster than 8-10% mutual funds.

[liosac]

3-5 years to cash out while making 10% or so in the interim is way faster than 8-10% mutual funds.

If you invest with the right people. Historically speaking, excluding the last decade, average annual appreciation of both rents, and real estate is only a couple of percentage points ahead of inflation. Unless you have a knack for picking undervalued areas or adding value consistently over the long term, it is not a given that over the long term you will beat 8-10% in the stock market with a generic strategy of buying and re-financing.

Over the last decade a guy who had no eye for value and thought “negative leverage” was Chinese could handily beat the stock market.

[avromie7]

If you invest with the right people. Historically speaking, excluding the last decade, average annual appreciation of both rents, and real estate is only a couple of percentage points ahead of inflation. Unless you have a knack for picking undervalued areas or adding value consistently over the long term, it is not a given that over the long term you will beat 8-10% in the stock market with a generic strategy of buying and re-financing.

Over the last decade a guy who had no eye for value and thought “negative leverage” was Chinese could handily beat the stock market.

There is (almost) always room to add value. That's always where the money was.

[yuneeq]

RE is a fast way to build wealth, or WAS a fast way over the previous few years?

RE has always been a long and slow game. The past few years were an anomaly.

Always has been a quick way to grow wealth, even if ignoring the last few years.

If you invest with the right people. Historically speaking, excluding the last decade, average annual appreciation of both rents, and real estate is only a couple of percentage points ahead of inflation. Unless you have a knack for picking undervalued areas or adding value consistently over the long term, it is not a given that over the long term you will beat 8-10% in the stock market with a generic strategy of buying and re-financing.

Over the last decade a guy who had no eye for value and thought “negative leverage” was Chinese could handily beat the stock market.

If the property appreciation is pacing inflation, but your leveraged 5x, if property goes up 20% over 5 years and gets sold, you just doubled your money. Obviously any leveraged investment will be a faster - yet riskier - method of building wealth than an unleveraged investment.

[liosac]

Always has been a quick way to grow wealth, even if ignoring the last few years.

If the property appreciation is pacing inflation, but your leveraged 5x, if property goes up 20% over 5 years and gets sold, you just doubled your money. Obviously any leveraged investment will be a faster - yet riskier - method of building wealth than an unleveraged investment.

True. Some asset classes in commercial RE have recently fallen close to 20% by some estimates. If you were in at 80.% LTV you lost 100% of your money. If you like living on the edge you could buy a triple leveraged ETF for that matter too and double your money on a 33% unleveraged return.

[aygart]

That doesn’t detract from the post. Real estate is a fast way to build wealth, but like other wealth-building investments it come with more risks that aren’t well understood by amateur investors. And the less they know, the riskier the investment becomes.

If they do proper due diligence and can identify good opportunities then it can make sense to take risks, but then again they wouldn’t be amateurs at that point.

Another option is for them to get avise from someone who is not an amateur similar to hiring an investment advisor.

[liosac]

Either way, assuming no foul play involved, what due diligence would have helped the investors, (if its a healthy property, cash-flowing, 1031-ing, refi-ing again n again, getting monthly distributions, getting some capital back, keep the good times rolling....) -

If someone is in his mid 20’s with no long term track record of stability and healthy management practices that ought to make investors think twice. 
If the property is being purchased at so steep a premium that bridge loans are needed to finance the property because there is no way DSCR will allow it to  qualify for  a conventional loan that ought to be a flag. Investors have looked the other way at their own peril as we have recently seen.

[Shmobaum]

Ok enough with 99% of us guessing who’re the guys that went bust.
As per forum rules:
A. Please state name of guy/s who went bust.
B. USD amount of loss.

[avromie7]

If someone is in his mid 20’s with no long term track record of stability and healthy management practices that ought to make investors think twice. 
If the property is being purchased at so steep a premium that bridge loans are needed to finance the property because there is no way DSCR will allow it to  qualify for  a conventional loan that ought to be a flag. Investors have looked the other way at their own peril as we have recently seen.

It's always a good idea to do your due diligence, but CCIIW, I think it's commonplace in Value-add deals.