#146 5 Things To Reduce Risk In A Passive Real Estate Deal

Hey everyone. Today we're going to be talking about that four letter word that everyone's worried about. Yep, it's risk. R, I, S, K. We're trying to find ways to minimize it. We're always trying to do that, especially when it comes to passive real estate investing. And we're going to be talking about the ways to minimize risk when it comes to this type of investing. So stick around. Welcome to the Passive Income MD podcast where we talk about creating your ideal life through multiple streams of income. I'm your host, Peter Kim. If you enjoy hearing about this stuff, make sure to hit subscribe so I can bring it to you every week. Now let's get on with the show. If you've been in my world long enough. You know, one of my favorite sayings is by a guy named Warren Buffett, you might have heard of him before. Pretty smart guy. He says the first rule of investing is to not lose money. And the second rule is to remember the first rule and that's all there is. But that might be easy to say and not easy to do, right? Because real estate investing, it comes with risk. Any sort of investing comes with risk. Walking across the street comes with risk. That's why research and careful due diligence, it's essential. Now, it's impossible, I'd say, to never lose money. If anybody's ever had a long investing career, I, I'm going to say that you've likely lost at least a couple things in your life. But again, we're trying to make a situation where we win far greater than whatever we lose. As physicians, we're used to taking calculated risks. We talk about the risk benefit ratio all the time. I talked about whether physicians are risk averse or not. In fact, we're great under pressure. We're great assessing risk and figuring out the decisive action necessary to accomplish a goal. We take risks day to day. And honestly, it took a lot of risk to, to end up where we're at. While so many of our friends were going out into the workplace, they were making money, many of us delayed gratification. We took on huge student loans. That's an investment. And we hoped at the end of this, at the end of a residency training and all of that would be this great life, at least a career that was fulfilling and would be able to support us financially and our families and be able to pay off those six figure loans. So when it comes to passive real estate investing, and I'm talking about investing in things like syndications and real estate funds, it's absolutely essential that you identify what the risks are and and then take steps to mitigate each of those risks. And at a time like today when there seems to be a ton of risk in the marketplace, it's more important than ever to understand all of these concepts. So we're going to be talking about them today. The first thing you have to do to minimize risk in any transaction, in any investment opportunity when it comes to passive real estate investing, is to understand who is doing the deal. You've got to know the track record of the sponsor, operator, general partner. Whoever the person is you're investing with is in your right to ask for that in full completion, in full glory. It's been said that a bad sponsor or poor sponsor can tank any deal. But a good sponsor can pull a deal maybe that's not performing as well and help you get through it with a favorable outcome. I think the same thing can be said for undergoing surgery. When somebody, either yourself or loved one, is undergoing the knife, you want to know who's holding that knife. Not only what is their training, what have they done in the past, but how well their outcomes have been. You want the best surgeon in charge to make sure you get a great outcome. So what are some of the questions that you want to ask about this track record? Number one, how many deals have they been in? How many deals have they exited, meaning they've gone maybe full cycle? What were some of their best and worst deals? Meaning how did these deals perform? Did they ever lose money? And what happened in that situation, Just so you know, that's not a red flag for me and completely, if they've lost money, like I said, it's possible that some company loses money. Not everything goes perfectly. But what did they learn from it? How did they resolve it and what are they doing now to minimize the chances of that happening ever again? Sometimes I'd rather be with somebody who's had a difficult time, learn from it, and I'll be able to take advantage and leverage that past experience, those past mistakes to really achieve my outcomes, to get good performance at the end of the day. The other question I ask is considering the market today, what are you doing to mitigate risk? Meaning what are you putting in place to, to make sure that people don't lose money in this economic environment? Now I'll tell you, if you don't get these questions answered in a way that's satisfactory to you, that you feel comfortable, that you feel that you could plunk down, give your hard earned money to them and trust them with it. If there's a level of doubt in there, I'd say move on. There are tons of these syndicators, these operators, and there are people out there that you can find that would be a good fit for you, that you can trust with your money to help you and your family get where they want to be. Okay, I want to take a moment to talk about SEP for Life Insurance. They're a nationally recognized independent insurance brokerage specializing in life and disability insurance for physicians and high income professionals. As brokers, they work on the client's behalf to shop around, find the most suitable products at the most cost effective rate. I know that's really important to all of you because the volume and exceptional reputation of Set for Life as well as the relationships that they have developed with companies over the years, their clients, they have access to special services not available elsewhere in the industry. These include special discounts, priority underwriting, handling and on some occasions exceptions in the underwriting process. So if you want to check these out, find out more information, make sure to contact SEP for Life Insurance today and let them know we sent you. Thanks so much. Next, you want to find out how this deal is financed. Many of you remember 2008. A big recession happened at that point, right? You've heard about the real estate crash, the stock market crash, a lot of that happened. And it was started in terms of the crash because of real estate, meaning that the loans went bad. There's so many bad loans out there that these deals fell through. Foreclosures happen, bankruptcies happen. The biggest risk in any deal is the debt, the financing, the leverage you might call it. So it's absolutely important for you to understand what that debt is. Is it short term, is it long term, is it fixed, is it variable? What are some of the clauses or expectations for the bank in terms of making sure that they can refinance in the future? All of these things are things you have to understand because at the end of the day we need to know what's going to happen at the end of this deal. If things don't go perfectly well, is the deal set up to withstand a big drop in their income? For example, maybe there's low amount of leverage. Many people, they're excited by a high amount of leverage because it might result in higher returns. The problem is it's double edged short. With higher returns come higher risk. Now you might look at a deal that maybe doesn't advertise as high returns, maybe it's a little bit lower, but maybe the risk has been Taken out of that deal, there's a lot less risk, and that's why you get the low returns. That's not necessarily a bad thing. Maybe loan is interest only or it's amortized over a long period. Whatever it is, that loan can be set up in so many different ways. What you want to make sure is that when bad times come, and they inevitably will, or the market changes, that the property is set up for success, that you don't go through what happened in 2008 where properties were foreclosed on, banks had to call loans, and then properties were ultimately and investors were shut out. That's a losing situation. So I'll say this again. If you're looking at any investment opportunity, you have to look at the loan and understand it. So don't move ahead with any sort of investment unless you really have a deep understanding of where those pitfalls are when it comes to the financing. Next, you have to understand the market that it's in. When I mean the market, that can mean a lot of things. It could be the neighborhood it's in, it could be the city, it could be the state, it could be the side of the country, the west coast, whatever it is. I think we all intuitively understand that properties in different areas perform differently. For example, I live in California. I'm not sure where you live. Depending on where you're listening to this or watching this, you know that our properties are different now. Certain properties go up in value faster, they go down in value. Rents are different. Certain states are landlord friendly. Certain states are boom and bust with the economy a lot more. Whatever it might be, it's really important for you understand the market at a high level. Meaning that what will cause that property over time to continue to do well? Are there market drivers that are set up for you to find success? Meaning that is the wind at your back. Now, if you're looking at an apartment building, you want to find an area that, that has a good amount of migration in that area. You want population growth, you want people living there. Why do people move to certain areas? Because maybe the standard of living is better. Maybe there are jobs in that area. So you want to look at the local economy. You understand, is there a considerable amount of job growth? Are there big industries moving in certain areas? I'm looking at big companies are leaving maybe somewhere like California and moving to those areas. And it's nice to actually catch those properties while they're on the upswing. Now, that's for apartment buildings, but maybe you're looking at self Storage, you're looking at office buildings, retail, whatever it might be. All of those things have their own characteristics and have their own drivers for growth in that area. So it's really important for you to understand that and look at each one and why certain thing might be good in a certain economy in a certain area. It's also been said that real estate is local, it might be hyperlocal, so a certain block might be better than another block. So you can't just assume that you've heard a certain area does well. Again, it's vital for you to understand the exact pin of the area that it's in. Go to Google Maps, pin it and figure out what's in that area. Also ask sponsors what is special about this area that will make it do better than maybe on the other side of town. Now I would just take it at face value. I'd make sure everything is laid out for you by the sponsors so that you can comfortably understand this, do the analytics and do the quick high level data analysis to understand whether it's a good market or not and you're moving in a good direction. Because here's the thing about making money from passive investments. You want to make sure that the performance of the property does well from an operational standpoint. You want management to be good. Maybe take a property that isn't performing as well and help it do better, meaning the renovations do better marketing, whatever it might be. And that's part of the equation. And then the other part of the equation is what the market in that area does. Now if all of that is moving in the right direction, that's when you get massive growth and massive potential. When it comes to return on investment. It's also absolutely important to understand what are the environmental risks dealing with that investment. This is something I've had to learn the hard way. If you ever listen to any of my previous podcasts, you might have heard me talking about a good deal gone bad. I dealt with man made environmental stuff like a dry cleaner dumping chemicals into the ground. But you might have to deal with, I'd say weather type stuff, hurricanes, tornadoes, fire zones, flood zones, whatever it might be. Every area deals with something as important for you to understand what those are. Maybe you're going to get unlucky, get hit by that once in a century storm, but it could happen and it actually changes the way this property might perform over time and the risks that are involved with that property. If you're a risk averse person, would you invest in a high probability flood zone, for example Maybe there's a property that you could shoot for that doesn't have to deal with that. Maybe that one offers high returns, but it comes with that high risk. You want to ask about these things. What are the worst case scenarios? What are the insurances that cover some of these environmental issues so that you and the other investors that are involved in this won't get stuck in a bad situation. It's just again, some unfortunate circumstances happen. So that is a question that I absolutely ask. What are the environmental risks that you are concerned about that we as investors should be concerned about with this investment? And how could it change the ultimate performance of that investment? And how does it affect the risk profile as well? And if you're not comfortable with all of that, then move on to another one that doesn't have to deal with a lot of those issues. And lastly, if you want to mitigate risk in a private real estate deal or passive real estate deal, like a syndication or real estate fund, you have to assess and understand what's called concentration risk. Are all of your eggs in one basket? I think conceptually all of us understand that that's not a good thing to do. Many of us do that when it comes to medicine. All of our income is that one basket. But if there's anything you learn to what we do, diversifying creates that power, creates that freedom for you, and really smooths out returns over time so you can live life however you want. So when it comes to these investments, it's also important to understand diversification is the key. Now. How can you diversify? I diversify across sponsors, meaning I invest my money with different operators. Some of them do better at certain times maybe than other times or in. I invest all across the United States in different areas, whether that's the West Coast, South, Midwest, East. Again, everything has different characteristic. I invest in different asset classes. So not only in apartment buildings, but in self storage, in office, some minimal retail, some development, whatever it might be. You're able to invest across different asset classes because they're known to perform differently over time, meaning in different parts of the economic cycle. And there are always cycles. Some perform better than others. I'm also investing in the different risk profiles of each of these investments. There are ones that are known to be a little bit less risky. Maybe they're higher performing properties, higher quality. Then there are ones that need a lot more lift, they maybe need a lot more work to get where they need to be. There's more risk there. Maybe they're investing in something like a development deal. Where you don't know how that's going to go, but there's more upside on that. But again, higher risk that comes with that. I diversify across that whole spectrum to make sure I get this blended risk and return rate that I'm comfortable with. It's just like you invest in stocks, you probably just wouldn't invest in one stock. Maybe some of you do, maybe some of you have done extremely well, like you just invested in maybe Tesla very, very, very early. But more likely many of you had invested across a diversified portfolio. It's allowed you to sleep at night, not ride the waves as much. And for me and my family, providing that ultimate security and financial freedom, it's important for us to have that diversification, that portfolio of investments which allow returns all throughout multiple cycles. And I think it's really important for you to know also when it comes to that kind of risk, I don't concentrate all in one year, meaning I don't just invest in one property in one year and that's it and let it ride. I like to invest across all parts of the cycle. Meaning that when real estate is hot, when real estate maybe is doing okay, and even times when real estate is not doing well, meaning that overall sentiment out there in the marketplace like there is today, that people are really worried because that's when the real opportunities are out there. Now by putting all of these tips together will help you minimize risk when it comes to looking at syndications and funds at all of these passive real estate investments, when you feel secure that the risk has been mitigated, it allows you and frees you up to be able to invest in these opportunities with confidence. Now maybe all of this is a little bit overwhelming to you. For some of you it might be. I learned over trial and error over many, many years investing in these people. Ask me, how many of these deals am I invested in currently right now, in active deals? Over 30 investments that I'm currently tracking. That might sound overwhelming to some people, but these are passive investments. So all I do every quarter is look at an update and that's about it. The key is to understanding the front end, how to do the due diligence, mitigate your risk. Once you make the investment, you're set to go. That should be passive for you. And that is the goal. Now we built up communities around this stuff for people who want to learn together to share opportunities, to create more resources for people looking into these investments. It's a team sport. We have something called Passive Real Estate Academy, a course where people in four weeks can learn how to confidently invest in these investments, understand how to do due diligence, really mitigate that risk. Because isn't that what it's all about? And we do this all together as a big community. We have thousands of people that are part of this. Again, you can go to passive realestate academy.com we launch this only two times a year. We have a waitlist for it. If you should go out and take a look at that, we'd love to have you as part of it. But either way, make sure to learn how to do the proper due diligence. You're going to cut your risk. It's going to make you sleep better at night. It's going to help you make better investment decisions to get you closer to your goals. Thanks so much everyone. Take care. Enjoy the show. Let me know by dropping a review in the podcast app you're listening to us in. And if you haven't already, make sure to hit subscribe. Are you part of our community yet? Join thousands of physicians who are also on this journey to creating their ideal lives through multiple streams of income. You can join us on our Facebook group PassiveIncome Docs, and you can always learn more at our website, passiveincomemd.com thanks again for allowing me to be a part of your journey. See you next time.