Passive Investing in Multifamily Real Estate: 5 Biggest Beginner Mistakes

If you're considering investing in a real estate syndication or a fund, it can feel like a pretty steep learning curve. How do you set yourself up for success? How do you avoid beginner mistakes?

In this article, I'm going to walk you through the five biggest beginner mistakes I see investors make when they're passively investing in multi-family real estate.

Let's get right into it.

1. They Don't Build a Support Team

Who’s on a support team? Well, many different people. But at the minimum, you need a good accountant and a good lawyer. You can also have a wealth manager and some other people. But again, this is the bare minimum — a solid accountant and a solid lawyer. Both should understand sophisticated real estate investments.

As you may know, real estate syndications or funds are not basic beginner-level investments. They are sophisticated investments. You need an accountant who understands the syndication and the fund structure, especially how cost segregation and tax credits come into play, because this is going to affect how you minimize your tax situation.

You also need a solid lawyer who understands syndications and funds, so they can actually review the OMs, PPMs, and all the paperwork. They can also counsel you about the pros and cons — the risks and rewards — of that specific investment opportunity. If you're a beginner investor who is just getting started in syndications or funds, you need to rely on your support team and their expertise to guide you.

Since this might be your first time going through it, you need trusted advisors. Your accountant will be a huge help in saving tax and structuring yourself. Then, your lawyer has to explain to you the PPMs, what you're investing in, and how everything works. Because chances are, you're a beginner; you're going to have a lot of questions. While the syndicator or fund manager will be able to answer them, you should also have somebody on your payroll advising you well.

2. They Don’t Think About Structure

A big mistake people make when researching real estate investment opportunities is not thinking about structure and how it relates not only to tax efficiency but also to asset protection — two huge components.

So first, you want to make sure that your future real estate investments — syndication or fund — plays well with your other assets, and that you're taking advantage of structuring opportunities to reduce your tax liability, making your taxes more efficient so you're not paying too much tax.

Secondly, you also have to think about asset protection. Maybe you have a large stock portfolio. Maybe you own a bunch of single-family homes and residential property. How are you protecting all your various assets in case of a catastrophic event? You always have to be forward-thinking, making sure you're structuring yourself in the safest and most efficient way possible. This is where your lawyer and accountant come in. As experts in sophisticated real estate investments, they can advise you on the best course of action tailored for your situation.

I get asked all the time about tax advice and structuring advice. The truth is, I don't know your specific situation. Everybody’s different and there are many ways that you can structure yourself for both tax efficiency and asset protection. You should be talking with your support team because they have all the details about your situation and they can give you the best advice.

3. They Fail to Understand Underwriting

Underwriting is the modeling that goes into the investment opportunity. So this is doing the forecast, figuring out your capex (capital expenditure), and your business plan for the property. This is what I mean by underwriting. Now as a beginner investor, you don't have to become a real estate expert or a spreadsheet wizard. That’s not what you have to do. But you have to understand the basics. You have to understand the mechanics of a real estate investment:

●    How do these multi-family properties make money?

●    How do you improve the value?

●    What sort of things should be expected?

That’s the expectation for a beginner investor.

A lot of investors, when they first get started, will just look at a deal. They'll see the IRR number and if it looks really big, they will invest without understanding why the property is going to be valued this way five years into the future.

What's the business plan? Does the business plan make sense? Or maybe the syndicator is being too aggressive with their rent appreciation? Maybe they're being too aggressive with market appreciation. Maybe they are planning on exiting the deal at the same cap rate that they purchased it for, which is probably not the most conservative approach.

Like I said, you don't have to be an expert, but you do have to understand the basics of underwriting, just so you have a general idea of what to look for. This can help you ask better questions. It's not about having all the answers, but it's really having that understanding so you can see something and say, “Hmm I should ask this. Let me find out why they're doing it this way.” This will not only allow you to have better conversations with the syndicator or the fund manager but will also make you feel more confident in your investing choice.

4. They Don’t Consider Refinances

This is a personal favorite of mine. What is a refinance and why do we do refinances? Well, in the value-add strategy, we force the appreciation of the asset so the value of the asset goes up because we've increased the NOI (net operating income).

At this point, a lot of people plan to do a refinance and put more debt on the property because the NOI is higher. So the property can support that new debt and then return investor capital. So the investors would get some money back.

Here's the thing: refinances are never guaranteed. Maybe the debt market will be absolutely horrible in three years when you're planning on doing your refinance. So it's not guaranteed.

This is my pet peeve. Because some people will actually work in refinances in their underwriting. So they're basically promising the investor, “In order to hit this return I’ve promised you, we're going to do this.” Well, it's not guaranteed by any means. So if the refinance doesn't happen, your 17 percent IRR can quickly disappear and it just goes up in fairy dust.

So as a beginner investor, if you see a refinance being worked into the underwriting — and this goes back to understanding the basics of underwriting — you don't have to do a big X on the deal and not go forward, but it should prompt you to ask better questions and find out why. What is the strategy? What makes them so sure that this refi will occur? What are the contingency plans if this doesn't happen?

This is all about being a prudent investor and understanding the basics so you can ask better questions. So if you see the refi worked in, it doesn't mean it's the end of the world. But you should be asking questions and probing to find out why they're actually working this into the underwriting rather than leaving it as a bonus and a happy day if it does happen.

5. They Don’t Have “Decade Vision”

This is probably the most important thing that has nothing to do with real estate. I call it having a decade vision. We actually spend an entire week on this in a course I run called Discover Multifamily. This is probably the most important foundation you can have for your investing.

Because the question is, where do you want to be in 10 years? What do you want your life to look like? This will dictate everything — every single decision you make will go back to your decade vision. How you structure yourself for asset protection goes back to where you want to be in 10 years. How you structure yourself for tax efficiency will also change, depending on what your decade vision is. The people you bring onto your support team will definitely change depending on what your decade vision is — what your goal is for the next 10 years.

Take somebody who wants to travel the world versus somebody who wants to stay put. The people they bring onto their support team will be totally different. How they structure themselves will be totally different. The actual properties they invest in will be totally different.

So it's really important to have this decade vision — that vision for the future. This is something I didn’t have at all, and it was one of my biggest mistakes I ever made. So decade vision is huge.