Investing in real estate can be a lucrative avenue, especially through passive investments that often promise returns between 12% and 20%. However, not all investments are created equal, and varying levels of risk are associated with different opportunities. The key challenge for investors lies in discerning which investments carry higher risks compared to those that are relatively safer.
Beyond risk, several other factors impact the returns from passive real estate investments.
These include the minimum investment threshold, duration of commitment, potential tax advantages, personal ethical considerations, and the accessibility for non-accredited investors. Recognizing these dimensions allows investors to seek opportunities that present asymmetric returns while minimizing risks.
Table of Contents:
Identifying high-risk investments
When evaluating potential real estate investments, it is vital to identify common pitfalls. Generally, investments can falter for two primary reasons: the operator either exhausts their financial resources or runs out of time. The market conditions from 2022 to 2025 have presented challenges in selling or refinancing properties, largely due to increased interest rates leading to elevated capitalization rates. Consequently, property values have plummeted.
Operators who relied on short-term bridge loans may find themselves in precarious positions as these loans mature. Selling under current market conditions could result in significant losses, while refinancing can also be costly due to the decreased property valuations—often by 25% to 30%—forcing operators to consider capital calls or additional funding.
Evaluating loan structures
While floating-rate loans are not inherently problematic, operators must have safeguards against rising interest rates. This could involve rate caps, swaps, or other risk-limiting strategies. It is essential to ensure that monthly payments remain manageable in the event of rate increases and that the operator’s forecasts account for the highest possible rate scenarios.
Choosing the right operators
In our investment group, we prioritize diversification across a range of asset classes, extending beyond just multifamily properties. These include sectors like industrial, retail, mobile home parks, and raw land. However, when selecting operators, we prefer those who demonstrate deep expertise within their specific niche. This means that for each investment, we seek out operators with substantial experience in their field.
For instance, if considering industrial investments, we would rather back an operator who has executed numerous industrial sale-leaseback deals than one venturing into this sector for the first time. The same principle applies to geographic markets; we want operators with intimate knowledge of local conditions and a reliable team on the ground.
The importance of local expertise
A critical question to ask when reviewing an investment opportunity is: “How many properties does the operator own in this submarket, and who manages them?” While many operators tout their vertical integration—having in-house property management and construction teams—our focus lies on the operator’s experience with the same local management team across multiple properties.
Hearing an operator express excitement about a new market or management team does not inspire confidence. Instead, we prefer operators who can demonstrate a track record of managing multiple properties in close proximity with the same team, ensuring consistent management practices.
Signs of lower-risk investments
What then constitutes a robust, lower-risk passive investment? We place great value on operators who possess comprehensive knowledge of their local market and asset class. For example, our investment group has previously partnered with a sponsor specializing in Class B value-add multifamily properties in Cleveland, targeting buildings that serve essential community workers such as police, teachers, and firefighters. This operator has completed numerous similar deals in the same city where they have resided for years.
The success of their investments is bolstered by the fact that all their projects are managed by the same in-house property management and construction teams, creating efficiencies and consistency.
Long-term strategies
While it’s impossible to predict market conditions three years down the line, successful investments typically yield positive outcomes when the time is right. Operators should utilize long-term debt structures, allowing flexibility in market timing rather than being pressured by short-term obligations. Furthermore, it is advisable to look for some form of rate protection when floating-rate loans are involved.
Ultimately, the market’s improvement shouldn’t be the sole condition for achieving projected returns. Aim for deals where the projected exit capitalization rate is on par with or exceeds current local rates. Additionally, steady rent increases—post-renovation, if applicable—are preferable to aggressive forecasts.
Investing in real estate is inherently risky, but with careful screening and the right strategies, investors can significantly improve their odds of success. Although no investment is without risk, understanding the landscape and learning from past market cycles can help mitigate potential pitfalls.
