The Biggest Misconceptions About Real Estate Syndications
Part 1 in a 3-Part Series
When it comes to syndication investing, I encounter a lot of myths that either deter investors from participating in what could be a great deal for them or cause issues down the line due to a disconnect between reality and their expectations. In this series, I’ll address the most common misconceptions I hear on a regular basis and provide insights from my experiences working with experts across multiple syndications.
If you’re new to syndications, I recommend you read this primer on the topic before continuing with this article.
MISCONCEPTION #1: Syndications Are Completely Passive for a Limited Partner
Stop me if you’ve heard this one before: You can invest with an operator, and they will take care of everything (after you wire the money, of course). In other words, this is a 100% a passive investment. Nothing could be further from the truth. There is a lot of “active” legwork required in order to vet deals to ensure that they are the right match for you and your investing goals. It’s important to understand that the actual investment is often the last step in the process—not the first. And in most cases, given how syndications are legally structured, there is very little recourse a limited partner has against a general partner once the deal is in motion. So in a way, yes, a limited partner’s investment is completely passive after the investment is made similar to how you can be a completely passive passenger in a car moving that has no brakes. By the time the car gets going, it’s already too late.
Let’s take a look at the “active” steps that are required in any proper syndication investment.
Learn the Language of Investments
Just as with learning any new language, becoming fluent in investing take time. If you read these other articles we’ve written, The Language of Real Estate Investing and The Language of Alternative Investment, you’ll see that learning goes beyond terminology; it also extends to the context behind the words that provide meaning to you as an investor.
To go back to the car example, if you go to a mechanic and are told that your brake pads need replacing, you may not dig any deeper, pay the person, and move on with your life. In this case, you passively changed your car’s brakes and have left the mechanic’s shop with the same amount of knowledge as when you walked in with your squeaking brakes.
But if you are a car aficionado, you might ask a series of follow-up questions based on your existing knowledge of brakes. Depending on the answers to those questions, you may make the same decision as the first example or a completely different decision. In this scenario, the procurement of the knowledge required to ask those questions is an active investment of time, which allows you to make a more informed decision about your brakes. Even though the end result may be exactly the same, learning the language is critical to your ability to make informed decisions.
If there was one thing I wanted readers to get out of my book, The Alternative Investment Almanac: Expert Insights on Building Personal Wealth in Non-Traditional Ways, it was the importance of networking. You simply cannot achieve sustainable positive results in the alternative investing space without mastering this skill.
Investing in syndications is not cheap; investing in your network shouldn’t be, either. Throughout my investing career, a dollar spent on networking has saved me literally hundreds of dollars of potentially bad/fraudulent/disastrous investments. In fact, I am such a proponent of networking with other investors that if this is a deal breaker for you, I would advise you not to invest in alternative investments. Alternative niche assets like these are not covered by scores of Wall Street analysts, and many times, other investors are your only source for current relevant information.
Whether or not you need to finish Step 1 before moving on to Step 2 is debatable. You at least want to start learning the basics of alternative investments prior to seriously networking. The reason is because without any familiarity of the language and concepts, you may send the wrong message about your credibility or level of professionalism. The purpose of networking is to help each other, but if the other person on the phone feels like they’re teaching you how to take your first step, the relationship won’t last.
Perform Due Diligence
Now that you learned the language and built a small network, you are ready to move on to the due diligence phase. Learning how to perform due diligence is the most critical step in becoming a passive investor. This is where the rubber meets the road. By this step, you should know how to constructively analyze a deal and have a network that can help you if you get stuck. If you don’t feel comfortable for whatever reason, don’t be scared to repeat the steps again and again. The trick to truly become a passive investor is to put in the time—it sounds contradictory, but it’s true.
A great place to start is with your network by seeking referrals to the best operators with whom they have previously invested. After that, you’ll need to do your own homework on them. If you open your door to new operators without being selective, you’ll quickly become inundated with requests. It’s far more effective to properly vet a few operators and keep your operator list small than to vet poorly using a large operator list.
Learning how to conduct due diligence is a skill that requires patience, and I recommend starting by obtaining one of the many comprehensive checklists that have been created by other experts in the field. There are many out there, but my favorite was created by Brian Burke, author of The Hands-Off Investor: An Insider’s Guide to Investing in Passive Real Estate Syndications. As a newer investor, you may not be able to ask the operator every question you would like to, but with a checklist, you can at least ask enough questions to give you a sense of what it would be like to invest with them.
Here’s a pro tip:
Before making contact with an operator that has been referred to you, make sure you Google them and listen to any podcast they may have been on. Many times, a question you had was already asked and answered. After a few podcasts, you should be able to cross off several due diligence questions and know how to steer your communication with the operator.
Pay attention to response times to any questions you might have. Usually, an operator is most responsive during those initial interactions. So if anything doesn’t sit right, this is the best time to walk away.
The good news is you’ll have no shortage of investment opportunities to consider. If you end up hating the due diligence part, you might want to consider a fund, which only requires you to perform due diligence one time. If you like the process, then you can perform due diligence on individual deals. And if you develop a skill at it, someone in your network will notice. Some of the most well-known investors have reputations of performing “painful” due diligence on operators and are in considerable demand.
Yes, the actual investment in a syndication is very passive, but the amount of work that goes into networking, learning about the investment, and conducting due diligence beforehand is anything but passive. To make this a viable long-term option, you need to put in the work up front to reap all the benefits syndications have to offer.
If you liked this article and wish to continue on your path in learning about alternative investments, please make sure to check out my other educational articles as well as my book, The Alternative Investment Almanac: Expert Insights on Building Personal Wealth in Non-Traditional Ways.
Disclaimer: The information presented in this article is for informational purposes only and does not constitute professional financial or investment advice. The author does not make any guarantees or promises as to the results that may be obtained from it. You should never make any investment decision without first consulting with your own financial advisor and conducting your own research and due diligence. Even though, the author has made reasonable efforts to ensure that the contents of this article were correct at press time. The author disclaims all liability in the event that any information, commentary, analysis, opinions, advice and/or recommendations contained in this article results in any investment or other losses. Your use of the information in this article is at your own risk.