“Rule Number One: Never Lose Money. Rule Number Two: Never Forget Rule Number One.”
—Warren Buffett
The reason to invest your money is to make more of it, right?
That’s one of the many reasons I got into multi-family syndication, the returns!
Because of this, you may think that being conservative with your investments is contrary to making money.
But that’s the thing… it isn’t!
Being conservative in your investing is actually better for you in the long run, and I am here to show you why this matters in your multi-family investing.
Let’s get started!
Why Being Conservative Matters
When you are investing there is always a risk.
You are taking your hard-earned money, you are finding a good place to put it, and you hope for a return.
But what I often see happen is people get blinded by the promise of a high return. They are almost treating investing like putting all their money on black at the casino!
They get blinded by the possibility of getting huge returns, and they don’t look under the hood, so to speak.
But, unfortunately, what follows this kind of investing isn’t the glamour of cash, but it is often the dread of losing it.
Nobody likes to lose money right?
Who wants to give up retirement, or a dream vacation, or even a home you were planning to buy?
No one!
But why does this happen then? And why does this happen with an otherwise safe and reliable asset class like multi-family syndication?
Well, let’s look at the numbers.
The Numbers – Non-Conservative Deals
When you look at the deals that tend to not do well, they lean toward being non-conservative in more than a few ways.
More bluntly, they project things more generously than they should, and they often promise returns projected to the moon.
So, what should you look out for to spot these less than stellar deals?
Firstly, look out for deals that only ever show positive projections.
If the numbers look too good to be true, they probably are.
This isn’t to say that there aren’t deals that go well. However, if the sponsor of the deal isn’t able to comment on things that may go wrong or have gone wrong for them in the past, that is a red flag.
Secondly, these non-conservative deals will often over-leverage their debt.
This means that these deals are set up to only profit if they are working at peak efficiency. They borrow so much that the only way to cover the debt and make a profit at the same time is by meeting their projections exactly.
I don’t know about you, but that doesn’t sound like a recipe for success right off the bat.
That model doesn’t account for anything not going as expected.
What if the market downturns? What if there is a catastrophe of some sort?
As we all learned in a year of the Covid-19 pandemic, it’s hard to plan for the unexpected.
The ultimate consequence of all of this is that these deals either don’t perform well or even lose your money. And that is not a deal that I would want to be a part of.
When a Deal is Conservative
But how about the flip side? How about a conservative investment?
One of the key ways to know if a deal is truly conservative, and not just telling you that it is, is to look at the numbers.
See a pattern?
One of the first things to look at is the projected rent growth.
If the rent growth in a specific area has historically been at 5% year to year, you may think that using that number is a good projection. But a more conservative approach would be using a lower number such as 2-3% rent growth.
Using this lower projection creates an extra wiggle room in the budget that helps better prepare you in case the deal doesn’t perform as well as expected or something unfortunate does happen.
Another aspect that helps create that wiggle room is projecting the cap rate at exit.
Non-conservative deals will project a gain of maybe 5% or more in total value when the property is ready to sell. A more conservative way to plan is to assume that you will sell the property in a downtime.
By planning the deal this way, you are not relying on selling the property to gain profit. The day-to-day brings in profit, and the selling of the property is additive.
You should also look out to see if there are extra reserves in the deal. Do the sponsors have a rainy day fund in case something happens? Will they be able to cover the expense, or will it dig into your profits?
As well, you should see if they have contingency plans? Are there other options to make more money in the property that could be additive income to the property if things go better than expected?
And finally, another conservative approach to look out for is if they do not project rent growth in the first year.
Many sponsors will assume that with getting into a property and doing a renovation that the rent will be able to increase right from the start, but this isn’t always the case, and a conservative approach takes that into account.
The whole point of a conservative investment strategy is to plan for any hiccups that come along the way.
The outcome of this strategy is that if nothing goes wrong, you get more money than expected, and if the worst does happen, you don’t end up losing any money.
I’d call that a win-win.
What to Avoid
Something I’ve noticed after doing this for a long time is that people are drawn to big numbers.
20% return per year is better than 15%, right?
Well, not always.
A lot of these deals that are advertising these higher numbers are playing it non-conservatively.
They project higher rent growth and cap rates, over-leverage debt, and they assume only the best possible outcomes.
After all is said and done, these deals often perform worse than those with lower projections and they even lose money.
Many of the more savvy investors that I work with really prefer a deal with lower return projections. That way they don’t lose money, and there is the chance for a potential upside.
An example of this is a recent deal we did in Oklahoma City.
We projected it at 14% IRR, but there were also two other possible sources of income not in the projection that could help increase the returns.
The first was an additional building that had room for 10 more units. This could be used for more income if the opportunity allowed
The second was a possible $250K in back-rent from the government to cover the missed payments of tenants who were unable to pay due to the Covid-19 Pandemic.
Again, these things weren’t part of the projection. These were both opportunities for additional income that got savvy investors very excited.
The key takeaway from this is to make sure your sponsor is conservative.
By taking the conservative approach, you are protecting yourself from potential loss, and setting yourself up for long-term success.
As the great Warren Buffett said:
“Rule Number One: Never Lose Money. Rule Number Two: Never Forget Rule Number One.”
Take the conservative approach to your investing. Do what you can to not lose money, and you will be just fine.
If you are curious to know more about multi-family investing and other ways to not lose your money, then I have even more resources just for you.
Check out our special report about investing. It compares the stock market to real estate, and it also includes how the pandemic affects your investment future.
If you are interested in investing with us, we are happy to answer any questions that you may have. Join our investment club today and we will be in touch.
