The Indispensable Triad: Operator Experience, Audited Record, and Co-Investment in Real Estate

Based on my 20 years of experience and my involvement in starting and managing two separate distressed institutionally-back real estate platforms during and after the Great Recession, I've learned that being a successful passive real estate limited partner (LP) largely depends on your network. In this blog post, I'll share with you the three most critical qualifying criteria to consider before investing in real estate as a passive investor.

1.??????Operator Experience

One of the most important factors to consider is the experience of the operator. It's crucial to work with developers who have a track record of success and possess the ability to navigate complex real estate projects. Experienced operators are skilled in creating value by bringing together various elements, such as financial, geographical, and political factors, all within the constraints of time and return on investment. When choosing an operator, think of them as surgeons - would you prefer someone who has performed the procedure numerous times or a recent medical school graduate?

Ensure that the operators you consider have weathered at least two down economic cycles. These professionals wake up every morning with a clear understanding of how to achieve value in real estate. They are not weekend warriors or inexperienced flippers but rather well-capitalized individuals who operate within established, fully integrated family offices with robust construction operations. Dealing with experienced operators reduces risk and provides greater control over your investment.

2.??????Audited Track Record

While it may seem like common sense, many investors overlook the importance of an audited track record. Countless individuals have lost money due to first-time multifamily owner-operators overpaying for properties or weak and inexperienced operators struggling to lease up projects efficiently. An audited track record demonstrates transparency and accountability, providing you with reassurance that the operator has a proven history of success. Make sure you review and verify their track record before making any investment decisions.

3.??????A Strong Equity Co-Investment

The third qualifying criterion to consider is the operator's capital co-investment. This refers to the operator or sponsor's personal contribution to the project. The amount of skin in the game that the operator has is crucial in assessing their commitment and confidence in the investment. While a wealthy family may provide the equity contribution while obtaining a loan from a bank, it's essential to know how much capital the operator is personally investing. A thoughtful co-investment is typically around 5%, but a meaningful commitment is often seen at 10% or more. By evaluating the operator's financial stake, you can differentiate between serious operators and those who may lack conviction.

Note that the level of capital co-investment may vary depending on the operator's experience. Be cautious of deals where the equity is syndicated from numerous smaller investors whom the operator doesn't personally know. To ensure the operator's commitment, inquire whether the capital contribution comes from their own checking account and whether it holds the same level of importance as your investment.

Under what circumstances is it acceptable to invest in a venture where the operator is not contributing any personal capital? One such scenario is when the operator possesses a legendary track record akin to the late Sam Zell, where their reputation holds more value than any monetary contribution they could make.

Conclusion

When evaluating real estate investments, it's crucial to ask yourself two important questions: Do I trust this operator with my wallet? And are these the types of assets I could pass on to my heirs without burdening them administratively? Passive investing allows you to inherit assets without the need to directly handle operational and tenant issues. By considering the operator's experience, audited track record, and equity co-investment, you can increase your chances of success as a passive real estate investor.

Investing in real estate is an opportunity to grow your wealth, but it's vital to make informed decisions. Building a strong network of experienced operators and continuously evaluating investment opportunities is key to achieving long-term success in passive real estate investing.

Excerpted from Chapter 8: Introduction to Commercial Real Estate, from my third book, "Investing Legacy: How the .001% Invest”, available on Amazon and as narrated by the author on Audible.

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