Real estate has always been regarded as an equal-opportunity wealth creator. However, the caveat emptor: real estate historically has been full of scams. And, based on my experience managing distressed real estate funds, that’s the No. 1 reason smaller investors don’t invest and the final reason all real estate deals fail. It’s been close to six years since the first portion of U.S. equity crowdfunding laws went into effect in September of 2013. This means that the barrier to entry has never been lower for unsophisticated non-accredited investors to invest into deals they know little about.
Adding fuel to the desperation, the perpetually low interest rates that have existed for over a decade have acted as an implicit tax on savings. This means that most investors have been forced to take risk into unknown investment waters that are not as regulated as the public stock markets.
These essential questions will teach you how to cleverly identify the strategic risks and rewards associated with any real estate-related investment.
How much is the operator (the person managing the deal) investing personally?
When someone comes to you promoting an investment opportunity, ask them how much the prospective fund managers are investing personally. If they don’t have a stake in the deal and things go wrong, they are likely to walk away from it. If your operator has no stake in the deal he has sold you and others, he also doesn't really care if he overpays. This is one of the biggest dangers in the industry.
Is there a huge upfront fee or load?
Never take your eyes off the fees. Is there a huge upfront fee or load? The response you get will reveal the sophistication of the operator you are dealing with. Fees are appropriate, but immediately taking 10% off the top of your investment is not. If they are looking to take fees right off the top of your $1,000 investment now, you'll only be left with a $900 investment. That’s a bad deal.
How will you get taken out? What is the exit strategy?
Do not invest in any real estate funds that present no clear-cut exit strategies for their investors. There are only two ways investors can get taken out of any commercial real estate deal: one is a refinance and the other one is a sale. Make sure you are getting on board with an investment group that is either capable of successfully closing a sale or qualified to get the property refinanced so as to get its investors taken out.
How many smaller investors do they have?
Usually, when managers or operators say, "Well, we were taking $50,000 as a minimum, but I'll let you in for $10,000," it usually means that they are desperate. They are raising a lot of money, pulling the wool over people’s eyes and yours, too. That should make you sit back and think: It seems there is some trouble somewhere and the smarter money has walked away from the deal.
Where does your money go?
Following the money is a piece of sound investment advice. Therefore, some of the questions the investors should be asking their prospective fund managers are: How do I see where my dollar is going? Another way to rephrase this question is to say, "Where in the capital structure will my money go?” If your prospective fund manager appears clueless, then think twice before you proceed with that investment plan.
What is your operator’s experience?
Many potential real-estate investors buy on emotion and won’t ask questions about their operator's experience(s). Did the operators ever do anything tangible with real estate? Were they an entrepreneur beforehand? Have they ever laid in a pool of their own sweat to manage a property? What kind of financial backing do they have? And where is the asset located -- within an hour drive or two time zones away?
How much leverage are they using?
Leverage can be good. But if your operators are using too much of it, they're probably trying to use it to make a marginal deal look like a home run. This can lead to you potentially paying higher prices for property that may otherwise have cost less. It will be problematic to sell such as an asset in the future and you may not be able to ever recover your initial investment.
What other assets does your operator currently have?
Asking your potential fund managers about the other assets they currently have under management to determine their level of expertise. Ask to know the intention of your operator’s crowdfunding exercise. Are they raising money for you to pay off legacy assets that are not that good, not as desirable and perhaps not performing that well? Are they paying off their previous bad investments with the new money they have raised from you and others? These questions are critical.
Do they have partners?
Don’t hesitate to probe until you get a satisfactory answer concerning these questions: Do you have partners? If yes, do you have a partnership agreement or a document that clearly defines your working relationship? The best-case scenario is a couple of experienced operators working together after a long time off. The last thing you want is a bunch of folks who haven’t worked together before. And husband and wife teams are red flags too.
