When you step back and look at the big picture, what is it that initially attracted you to real estate syndications? You aren’t alone if it was the opportunity to put your hard-earned money to work and the chance to create significant returns and steadily grow your wealth over time.
There’s such a strong alignment about this desire. That’s the number one question we get from investors when they first consider investing in a real estate syndication. They want to know if they were to invest $100,000, how much money they could stand to make?
And believe me, we love good returns, and those returns are a big part of why and how we are creating a community around multifamily investment opportunities. However, even though returns are undoubtedly significant, there’s an even more critical aspect that we focus on when evaluating potential deals.
I’ll give you a hint. It’s not nearly as exciting as passive income and double-digit returns. It’s more boring than taxes and K-1s.
The most important thing we focus on in a real estate syndication is capital preservation. In other words, we focus on making sure that the deal has multiple plans in place to protect it from any loss of investor capital. That’s our number one priority, as dull as that might sound.
Why Capital Preservation is Our Number One Priority
Sure, capital preservation isn’t the most exciting part of investing in real estate syndications, but it is one of the most critical pieces. You don’t want to lose anything, and neither do we, so the most significant portion of our focus is on capital preservation in favor of our investors’ trust and livelihoods.
As an investor, and even as a syndication lead, it’s easy to just focus on cash flow returns, potential earnings, and brightly colored marketing packages. Still, when an unexpected situation arises, you’ll be praising Providence for a sponsor team that gives capital preservation the front-row seat it deserves.
Capital preservation is all about mitigating risk, and as Warren Buffett puts it, there are two rules to investing:
Rule #1: Never lose money!
Rule #2: Never forget Rule #1!
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.
The Five Capital Preservation Pillars
At the core of every investment in which we participate, capital preservation for our passive investors is our number one priority. Five pillars shore and support our capital preservation priority.
#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. According to the business plan, cash-on-cash returns, which vary based on occupancy and maintenance costs, would have to fund sudden HVAC repairs instead of unit renovations. In this case, the business plan falls behind schedule, units aren’t ready as planned, and vacancy persists.
Instead, we set aside the funds for capital expenditures upfront. So, for example, if we need $2 million for the down payment and $1 million for renovations, we will raise $3 million upfront. Setting aside upfront capital means we have $1 million cash for renovations and won’t rely on monthly cash-on-cash returns.
#2 – Purchase cash-flowing properties
One excellent 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
A sensitivity analysis performed on the business plan before investing allows us to see if the investment can weather the worst conditions. What if the vacancy rose to 15%? What would happen if the exit cap rate was higher than expected?
Properties look lovely when featured in fancy marketing brochures with attractive proformas (i.e., projected budgets). Still, stress testing those numbers helps us 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. For example, 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 five years, no one knows what the market conditions will be at that 5-year mark. So, it’s essential 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 team includes the sponsor, operator, and property manager. All should be passionate about their role and display a strong track record of success.
The more experience they have in successfully navigating challenging situations, the better and more likely they will protect investor capital.
Protecting Your Investment With Capital Preservation
While capital preservation may not be very exciting, it certainly is one of the most critical building blocks of a solid deal. You have two requirements in mind when considering an investment opportunity. First, your investment must have some level of reassurance or stability and, second, your investment must have the potential to create the desired financial result.
With investments, preserving investor capital should be at the root of every decision and initiative by the sponsor/operator team. In addition, capital preservation is the only way that you may achieve your other goals.
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
By putting these five pillars in place, we minimize risk as much as possible and ensure that every decision we make around the property stems from making sure that we are protecting your money, first and foremost.
As an investor with Starboard Equity, you are important to us, no matter how actively you invest or how much you invest, and it’s important to us that you know we take your core desires to heart. Therefore, we expect that we will assist you in mitigating risk for your investments using these five guiding principles.