Adam recently interviewed experienced passive investor Jeremy Roll on the Creative Real Estate Podcast. He had so many good tips about investing that we turned them into a blog post.
First, a little about Jeremy:
Jeremy Roll, a real estate and business investor for over 16 years, left the corporate world in 2007 to become a full-time passive cash flow investor. He is currently an investor in more than 70 opportunities across over $500 Million worth of real estate and business assets. As Founder and President of Roll Investment Group, Jeremy manages a group of over 1,000 investors who seek passive/managed cash flowing investments in real estate and businesses. Jeremy has an MBA from The Wharton School, is a licensed California real estate broker (for investing purposes only), and is an advisor to RealtyMogul, the largest real estate crowdfunding website in the US. Jeremy welcomes e-mails (firstname.lastname@example.org) to network with or help other investors and to discuss real estate or business investments of any size.
On to the questions!
1. Does this investment fit your risk profile? Typically the highest risk is new development, and the lowest is stabilized multifamily of at least 90% occupancy. Value-add properties fall in the middle. Returns correlate with risk — higher risk, higher return — but there is also higher risk that you will lose money too. Tip: a portfolio strategy might include spreading your money across all three, giving different weights based on the market cycle
2. Is the management team qualified to manage this asset? A “no brainer” deal means lots of brains and experience on the management team. Ask for their bios, check their LinkedIn profiles and ask for references. If you do not already have a relationship with them, you will want to do a background check as well (see number 8 below).
3. Is there a preferred return? The preferred return is the threshold that investors must receive before the general partner receives compensation. In the case that the preferred return is not met, it usually accrues and must be repaid in the future. For example, if there is a 7% preferred return, but the project only returns 6% to investors in the first year, then in the following year the investors are entitled to 8%. Most opportunities offer a preferred return, so Jeremy considers it a negative if it’s not.
4. What is the profit split? The profit split is the ratio of profits that go to investors relative to the general partner. These range from 80/20 to 50/50. There is no exact formula, but the basic drivers are experience level of the operator, profitability of the project and how much work the operator will need to do to (i.e. major construction is obviously more work than overseeing a stabilized property).
5. Are the assumptions and projections conservative? Look for operators who under-promise and over-deliver. Aggressive projections would be 5% annual rent increases and 1% annual expense growth, which translated to a net 4% compound growth. A more conservative view would be 2% growth in rents and expense, which basically matches inflation. [Editor’s note: we once passed on a deal because we thought the projections were unrealistic (20% rent increase in year one). Then we found a good deal that we put in front of investors. Some investors had seen the other deal we passed on and it made our deal look weak in comparison. If you see something like this, it’s not necessarily a scam, but it has no margin for error and/or might reflect a less-experienced operator who’s overly optimistic.]
6. Is the business plan realistic? A big rent increase (even just to market level) could drive a lot of tenants off and give a bad reputation. Worst case scenario: an operator of one of Jeremy’s investments raised rents so high that tenants started protesting. The media picked up the story and the incident led to changes in state law!!!
7. Are the location and demographics favorable? As the saying goes, “A rising tide lifts all boats.” It’s better to invest in an area that’s growing than one that’s shrinking. Learn as much as you can about the economic drivers and try to think a few years ahead. For example, a high concentration of jobs in the online business sector is preferable to retail. The ideal is predictable, steady growth such as one finds in the midwest, not crazy growth like Seattle and Denver, which has lead to high asset prices. Dallas and Texas in general are good because of job and population growth, and also because people tend to retire in the south
8. Did you perform background checks? If possible, use TLO, owned by TransUnion and which is used by many police departments, or Accurint, owned by LexisNexis. You can also hired a private investigator for $100-400 per search. To avoid asking for a social security number, you can usually get a reliable record on someone using their name, home address and ideally you date of birth. Say to the operator: “just so you know, I’m going to do a background check. Is there anything you want to tell me about before I do that?”
9. Did you review ALL of the legal documents? The operating agreement is the rules of the game, and should cover such things as:
- How do you remove management team? Unanimous vote? Majority?
- Same for selling the property
- Are there any rules around capital calls? For example, Jeremy once reviewed an opportunity where if there were a capital call, the investor had to provide the cash within five or days or get diluted by 50%. This is unusual and borderline egregious. Never trust an operator who inserts this kind of provision.
- If you see something unusual, ask the operator about it, and have your attorney review it as well.
10. What does your gut tell you? Ultimately, if everything checks out, it comes down to your comfort level with the management team. Do they shoot straight with you? Do they use conservative projections? Are they transparent? Do they answer all your questions in a forthright manner? Do you have a personal rule, such as only investing with people you’ve met personally? Then follow that rule! After all, it’s your money.
DJ has been a serial entrepreneur for over 20 years, founding multiple companies in the software and media industries. He began real estate investing in 2016 and loved it so much that in 2017 he decided to focus on it full time.