There are two sides to every story, including the ones told in private equity real estate investments. First, there is the story of how a project’s business plan will unfold, as written in the offering materials. Reality often tells us something different.
Why? This probably comes as no shock, but no one can actually predict the future.
Due to this lack of magical power, the operator must have enough agility to pivot amongst changing circumstances, whether those circumstances are micro, macro, economic, demographic, acts of God, or countless other issues that may arise.
The key is understanding the operator’s track record and how they have dealt with various situations in the past. As the investor, you want to make sure the operator knows when, where, and how to change course through the challenges they will inevitably face during the project’s hold period.
We want to tell you our side of one such story. The intent here is to give a glimpse into what happened when one of our real estate syndications started strong but took an unprecedented (hint, hint) turn.
Our Syndication Story
We (Mark and Ada) were general partners on a Class B/C property for approximately four years. Originally purchased in 2017, the property was substantially refurbished during our ownership. Tenant quality improved, rents increased, and safety in the community was enhanced. All we saw were strong positives, and it was trending toward a high sales price with better-than-expected financials.
Then, COVID hit.
Many working-class residents lost their jobs and could not pay rent. Similar situations were occurring in neighboring apartments and the surrounding area. Crime increased, collections decreased, and tenant quality decreased. The market was moving in the wrong direction.
In addition, a large storm damaged several units. Yes, the property was insured, but this event created additional vacancies as repairs were completed. Our NOI dropped further as a result. The projected five-year end date was quickly approaching, and our team had to decide the best move. We weighed the options and determined it would be best to exit the property and allow another operator to implement improvements.
The property still marketed well and sold at a decent profit in 2021. However, the returns were not as high as we expected at the outset. (Though they were still better than the stock market.)
We contributed some of our equity back to the limited partners to achieve the returns and profits we had initially laid out. We were forced to play the hand we were dealt, under circumstances that were obviously not in the business plan. By selling early, we were able to achieve decent returns, avoid capital calls, and return 1.6x of the capital.
The Lessons Learned
As mentioned, no one has a crystal ball. We certainly could not have predicted a global pandemic would hit a year before we geared up to sell.
Just like the weather, financial forecasts are often wrong. It is important to note business models are just that: models of what MAY happen in the future based on educated guesses.
They say that the only thing constant is change, and every investor should know that the results are essentially guaranteed to be different than the projections.
Expect the best, prepare for the worst.
What you should strive to understand is what happens when assumptions change. A general partner/operator/sponsor will present their offering through the lens of best-case scenarios. As a potential investor, you need to discern the difference between these predictions and the range of outcomes and risks. Yes, you will have to read between the lines and ask this question: can an operator make this project work if circumstances change?
Character is everything.
Maybe more so than anything else, you need to understand an operator/sponsor’s character because that will define how they react to changing circumstances. More importantly, it will have a large impact on the returns you as a passive investor receive. This not only affects your financial returns, but the overall experience you have during the entire hold period.