For this week’s article I wanted to focus on a slightly different angle to the whole real estate investing game, and think about the reasons why someone should consider NOT passively investing as a Limited Partner in a real estate syndication…
While I think almost everyone could benefit from this sort of portfolio diversification, it has to be the right investment, at the right time, for each individual. And just because it may not be the right move for someone now doesn’t mean it won’t be the right move in a few months or next year.
So here are what I believe are the Top 5 Reasons to NOT be a Passive Investor / Limited Partner (LP) in a Real Estate Syndication deal:
Reason #1 – Your time horizon is short, and you need your funds to be liquid. By design, investing in a syndication is a longer-term investment, and it’s very difficult to get your dollars back prior to the business plan being worked to its completion. So while with an online Robin Hood brokerage account you can push a few buttons on your phone to sell some stocks and have the proceeds back in your bank account in a day or two, that’s simply not going to happen for an LP. Your funds are going to be tied up for years, based on the projected business plan, and while not necessarily impossible to get them back early, it’s not something that should be counted on. This is perhaps the biggest reason why this type of investment is not for everyone, and should be considered carefully prior to investing.
Reason #2 -- Passive investors by definition have no influence or control over the business plan. In order to remain passive, and therefore avoid any of the legal liability that can come from direct real estate ownership, investors have no “say” in how the assets are managed or how to best execute the business plan. You must be willing to give up control of your investment and allow the General Partners to make all the decisions related to the investment. Someone who desires to be very hands-on with their investments may inherently not be comfortable with this type of arrangement, and therefore may decide this type of investment isn’t the best option for him/her.
Reason #3 – You have discomfort or distrust for the Operator or General Partners involved. This could go without saying, but I believe it’s one of the most important aspects of this type of investment. Trust and integrity are of the utmost importance in any endeavor, but when your hard-earned dollars are at stake then you need to have a high level of trust for those charged with managing your dollars wisely. This is not to say that any particular real estate deal can’t go south even with the best laid plans and people involved, but you need to be able to trust your team to always act with integrity and honesty. If not, then the best deal is sometimes the one that you pass on…
Reason #4 – There is a fairly high financial barrier to entry. This type of investment isn’t ideal or even possible for everyone, given the higher minimum-dollar investments generally required for syndication investors ($50,000 is pretty typical). One reason for these higher investment amounts is because of the Securities and Exchange Commission (SEC), which governs these types of transactions. There are strict rules of who can invest in syndications, and also how many non-accredited investors are allowed into any given deal. The limit is 35, and if the minimum investment is set at $5,000 (for example) and $3M is needed for the capital raise, it will take 600 investors at the minimum level to raise the full amount. This is obviously well above the limit of 35 as set by the SEC. Additionally, just to be frank, if someone has $5,000 to invest, it’s fantastic that they are looking to invest those dollars instead of spending them frivolously, but this probably isn’t the best investment vehicle for them. Reference #1 above, and think that someone with $5,000 of disposable income is perhaps more likely to need those funds to be liquid in case of emergency versus someone with substantially more available.
Reason #5 – If you won’t be able to sleep well at night, maybe it’s best to pass… I believe that real estate is one of the best, if not the best, investment vehicles available, but to some people investing in commercial real estate can sound “risky” or “dangerous”. I believe that this is primarily due to lack of full understanding of all the benefits that real estate provides, especially when compared to the stock market and its wild, unpredictable swings. But if handing your dollars over to someone else to purchase some real estate, and then trusting them to make all the right decisions to increase its value, gives you anxiety and keeps you up at night worrying, then it’s perhaps just not worth the added stress in your life. There are a lot of things we can worry about in today’s world, but ideally your investments shouldn’t be one of them!
Thanks for taking the time to read these Top 5 Reasons to NOT be a Passive Investor. I believe that there are many more reasons why someone SHOULD consider being a Passive Investor, but we’ll save those reasons for another day!