Preview 3) Diversify & Power of Commercial REI
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Below is a sample of the Full Syndication For Passive (LP) Investors eCourse
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Four ways Sophisticated investors diversify in syndications:
- Different leads/operators
- Asset classes such as MFH, self-storage, mobile home parks, assisted living
- Geographical markets
- Business plans (5-year exits vs legacy holds)
*Usually I see investors place no more than 5% of their net worth into any one deal
The biggest reason as my net worth went above $500,000 I made the move to commercial real estate via the syndication/private placement was how I learned how residential real estate values are based on emotion or comparable sales. Where commercial real estate values are dictated by numbers or a by product of the net operating income and cap rates (see glossary).
See below on how the power of a little of value add (rehab) times a few hundred units can create legacy wealth!
Capitalization Rate = Net Operating Income / Purchase Price
An apartment community purchased for $8,300,000 which returns a net operating income of $500,000 has a 6.02% capitalization rate. If the purchase price was $9,000,000 the capitalization rate would drop to 5.55%.
Now back to our example: We spent $4,000 to upgrade an apartment and now it earns $900 more annually. At a 6% cap rate this $900 would increase the property value by $15,000! At a 5% cap rate the $900 would result in the property value increasing by $18,000.
Let’s take it 1 more step…
Let’s assume that ½ of the units at our 300-unit apartment community are outdated and can achieve on average $75 more per month after a $4,000 renovation.
Let’s assume we have an amazing team in place that can renovate 5 units every month, to renovate 150 units would take 30 months and it would cost $600,000.
The result after 2.5 years would be $900/yr/unit x 150 units = $135,000 increase in income.
At a 6% cap rate the annual $135,000 increase income would result in an increase in property value of $2,250,000!
Question: Is there a disadvantage to a legacy hold in a syndication?
Answer: The opposite of a legacy hold is a 3 to 6-year business plan to force appreciate a property and sell it. Or 5-year pump and dump. Sometimes certain properties line up better for a long term play (higher grade properties such as B or higher, also what type of location). And the conditions of the market always change. I think of it as going with flow and taking the best exit strategy at a time.
On this past deal the operator lived there and saw it as an opportunity to pick up the 2% asset management plan. That’s a real retirement plan! Personally I try to align myself with the operator as much as I can and nothing makes me feel more comfortable that in the lead investor has a long term outlook.
Legacy can mean anywhere from 5-20 year hold. In MFH/Commercial anything longer than 5 years is a really long time. Think of it like dog years.
In the end it’s all a personal portfolio question. If you have a lot of 2 year developments or 5-year pump and dump investments, you might want to think of diversifying in terms of hold lengths too.