For those still wondering whether or not passive investing in multifamily real estate is right, take a moment to reflect on what the famed political economist and philosopher John Stuart Mill once said:
“Landlords grow rich in their sleep.”
And this is true. Owning real estate continues to be one of the best ways of generating long-term wealth.
Now, passive investors want to skip what I call the tenants, toilets, and trash challenges of real estate, or the day-to-day management. Passive real estate investing appeals to investors who want exposure to real estate, but who want to focus on selecting the best investment, leaving the management to others.
I’m writing this post so you have an idea of how I think about passive investing in multifamily properties. Below are 12 rules taken from my years of investing and real estate experience. Now, these rules aren’t hard and fast, but they are a good guide. These rules will help you avoid some of the mistakes of being a new investor.
Rule #1: Be ready to do the upfront work
The bulk of the work of a passive investor is selecting the best investment. This is a challenging process. Not only do you have to find the best market, but you have to find the right sponsor, the right investment strategy, the right property, and the right property management company. 95% of the work you do happens before you invest. Your sole goal is to select the best investment. Compare this to sponsors or owner-operators, who have to find the right property, manage the property, and eventually sell the property.
Rule #2: Do your homework
This rule follows from the first rule. You have to do the upfront work, and that means doing extensive research on every aspect of the investment: the market, the neighborhood, the sponsor, the strategy, the property, and the property management firm. I tell new investors to dig into every nook and cranny of the property. Don’t take a sponsor’s word for it either. Start with historical data, found at the National Association of Realtors (NAR) or Zillow. Track down property value estimates, research neighborhood quality and amenities, conduct a market analysis, evaluate the property, and compare with similar properties.
Rule #3: Internal rate of return (IRR) and equity multiples don’t tell the entire story
It’s easy for investors to get stuck on IRR and equity multiples when considering an investment. As with rule #2, make sure you are not giving too much weight to these numbers. Investments can change over time and today’s predictions might not be accurate. Now, that doesn’t mean ignore IRR and equity multiples – they are powerful tools and important for comparing deals.
Rule #4: Ask difficult questions
As a rule of thumb, it is good to be critical of any property. Just like IRR and equity multiples not telling the entire story of a property, what you read and learn about the property should always be taken with a grain of salt. Good investments do exist, and your job as a passive investor is to sift through the countless investments looking for the best one for your portfolio. Asking hard questions will help to expose the realities of the property. Here are a few questions I use:
- How can this property lose money?
- What are the local and regional vacancy rates?
- What are the local and regional rental rates and which ways are they trending?
- What competitive advantages does this property have?
Rule #5: Watch out for market hype
Asking probing questions about an investment will help you to identify any potential hype in the market. Don’t get sucked in. Bubbles happen and wipe out investors unprepared for a market turn.
Rule #6: Speak face-to-face and visit the property
This is a simple rule I have. Visit the property. In the age of online investing, many investors are skipping this and are taking huge risks. You would be surprised how the feel of a property, the neighborhood, and the property management team can transform how you view an investment. Walking through the property, or around the neighborhood, can reveal information not present in photos and videos. If you can, always visit the property and talk to whoever you can.
Rule #7: Check references
The past is (often) a good indicator of success. Good sponsors and good property management companies often have a wealth of positive references. Don’t be afraid to ask. Listen to what references say and what they don’t say. Ask if the sponsor was fair, responded timely to inquires, and if they met past targets. If the sponsor did a poor job in a past investment, ask them why this time will be different.
Rule #8: Justify your investment
I use this rule as a way to gather all the information and to explain to myself exactly why I am investing in a particular property. You need to make a case for why one investment is better than another. I also recommend investors find a partner, counselor, friend, or an unbiased third-party who will listen to the rationale for the investment. They can ask the questions you can’t think of.
Rule #9: Good investments follow from good research
This rule captures what most of these rules are saying: the quality of your investment relates directly to the quality of your research. While you can’t know everything about a property, nor the future, you can certainly discover what makes one property better than many similar properties.
Rule #10: Think long-term
This rule, and the following two rules, are far broader. Good passive real estate investing happens over the long-term. True, many investors are attracted to the excitement of fix and flip properties. This isn’t passive investing in multifamily properties. Think two or three solid deals held for five, 10, or 15 years.
Rule #11: Diversify – because markets turn
This speaks to rule #5. To avoid the hype you need to make sure you are prepared for markets to turn. The best way to do this is to make sure your deals are sufficiently diversified.
Rule #12: Be flexible
Part of the fun of passive investing in multifamily real estate is discovering a stellar property. Make sure to let your research guide you and not the other way around. If you are stuck on investing in fourplexes, you may miss the opportunity to invest in a mobile home park.
Reach Out To Learn More
Now that you have 12 rules to get you started, click over to my ten-step article, which offers a more practical plan for how to get started.