When the market is good and investors are doing well, we sometimes tend the forget the basics of investing – or sometimes things were so good investors never had to learn them. Sometimes (like with crypto and Bitcoin) a bit of fomo creeps into our minds and we don’t do as much homework as we normally would.
When the market turns and goes poorly – deals go belly up and some investors will lose money. In the days of social media and online presences – there is always blame quickly tossed around, and in some case deservingly so.
Everyone gets to play Monday morning quarterback – and identify problems or fault that both may have been obvious or that may not have been as noticeable before a market decline.
I’d like to start the year fresh and get back to basics – identifying steps that I think all investors should take on any new investment. And what not to do…
What some sponsors don’t tell you about investing……
1. Don’t believe everything you read. Do you own homework, learn about how to understand an offering, and become an accredited investor if you can.
Anyone can invest in stocks, bonds, and mutual funds, but there’s a whole range of assets that are off-limits to everyday investors. These are private market investments like real estate. You must be an accredited investor to put your money in unregulated or private investments. Being an accredited investor means you have either the money or the know-how to cope with the greater risks involved.
An accredited investor is a person that meets certain requirements the US government declares are required to purchase private investments, which are reserved for sophisticated investors.
2. Work with a sponsor that has been in business for a while. Preferably one that has seen various market cycles and who worked through 2008 and the Lehman crisis – or earlier. While we all want to support new sponsors – that comes with a lot more risk. Understand that any investor or sponsor that has been in real estate for a while and has gone through several full market cycles will have some projects that do not turn out well as planned.
Once you find a sponsor – ask how the sponsor performed in various parts of the market cycle – in times like the crash of 2008 or during Covid.
It’s much more likely that an experienced sponsor will be successful or better protect capital when the market is volatile or is in a downturn.
Real estate funds and syndications seek high annual returns, and as a result are riskier than buying an index mutual fund. True real estate investments take careful planning to reposition or develop at asset to create value. Be weary of the sponsor selling riches with a ‘lipstick flip’ renovation.
3. Avoid pitches that suggest you can get rich and retire overnight. Real estate is not a get rich scheme. It is a process with key principles and fundamentals built around slow growth and compounded gains over time.
4. Look to understand the capital stack and how a sponsor uses mezzanine debt or bridge loans. If mezzanine debt is secured against a property that falls on hard time, a secondary lender will most likely default the borrower before the senior debt does – and these are significantly harder to navigate and usually result in a loss of capital.
5. Ask about a sponsor’s liquidity and cash reserves. When the markets tighten cash is king. A sponsor must have adequate liquidity to help protect against capital calls or lender defaults that can bankrupt an investment.
6. Define your goals. Many investors define their strategies via one of these three –
A. Capital appreciation: A focus on growing your savings or retirement money. Appreciation is the return on invested capital resulting from the growth in value of an investment relative to the amount of capital used to purchase and improve the real estate. Using 401K or retirement funds via Self-Directed IRA’s are also a popular trend to grow savings.
B. Tax Incentives: Whether its bonus depreciation, 1031’s or Inclusionary Zones – real estate investors can take advantage of numerous tax breaks and deductions that can save money at tax time or offset salaried income. There is also the ability to deduct interest expense and depreciation (non-cash deductions).
C. Passive Income: The steady flow of cash earned in the form of quarterly payments. Conceptually the idea of making money while you sleep.
In closing – the important part of investing is diversity, having a blended portfolio of mixed investments, spreading risk, being conservative, and patient. The turtle always wins the race…
Best of luck to everyone on their investment journeys in the new year!
————————————————