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SHOW NOTES FOR EPISODE 541: FIVE BIGGEST FACTORS OF RISK YOU NEED TO KNOW
Passive real estate investing can be extremely lucrative. But where do you begin? Learning effective due diligence to reduce risk and boost success is key! In today’s episode, CEO of RealCrowd Adam Hooper shares the 5 main factors of risk you need to know to help determine the best deals.
What You Will Learn
- What the single most important risk factor is when considering investing in a syndication or partnership
- The future of remote job placement
- What real estate asset class faired best during and after the pandemic
- When assessing the manager of a deal, what must you absolutely not be afraid to do?
- As an investor, what are the key aspects of each risk area that are critical to know?
About Our Guest
Adam Hooper
Adam Hooper is the founder and CEO of RealCrowd, an online real estate equity marketplace that has brought its members access to $7.5 billion of investment opportunities. Founded in 2013, RealCrowd is a Y Combinator backed company that has grown to be a leader in the real estate crowdfunding space. RealCrowd operates as a direct investment marketplace, where investors participate directly in the underlying asset, rather than a platform sponsored entity. This benefits investors by increasing efficiency, transparency and most importantly, reducing fees and layers of middlemen.
He recently launched ReAllocate, a subsidiary platform that is a registered investment advisor where they’re helping other RIAs get their clients access to private real estate investments.
Prior to founding RealCrowd, Adam was a partner at a leading real estate capital markets firm where he was involved in over $1 billion of transactions sourcing and structuring joint venture equity investments. In the commercial real estate business since 2004, he has been involved in launching three prior national platforms for investment sales and brokerage, as well as institutional joint venture equity investments.
Activity Since Last Appearance
- Previous guest appearance on the Old Dawg’s REI Network Podcast: 243: Crowd Funding Strategies for Real Estate Investors
- From the marketplace perspective, Adam’s company has stuck to their model
- Still act as a direct marketplace
- Investors can have a direct relationship with a real estate manager through their portal
- Q2 of last year was brutal
- His business revolves around financial transactions
- The transactions market was at a halt
- Coming out of it, in summer, they started with some multifamily activities
- Multifamily has certainly held up better than other asset classes
- Pricing continues to be strong
- Industrial has also been strong, perhaps as hot as it has ever been
- Paused hospitality deals
- Possible shift from hospitality to multifamily
- Extended Stay hotels converting to apartments
- Office is still a question mark
- Trying to figure out what it is going to look like (This was recorded in May of 2021)
- Waiting and watching
- Retails is shifting from selling goods to selling services
- Strong in medical applications
- Shift of use repurposing
- Cautiously optimistic
- Mangers are anxious to get going
- Land and construction is very expensive right now
Going Remote
- In March, his company went full-remote
- Because they are already a technology company, it was not difficult to make the transition to a remote operation
- There were cultural challenges to try to maintain the culture while operating remotely
- Staying on the same page can be more of a challenge
- The key is good communication
- Zoom meetings helped keep consistent communication
- They used the downtime to take a step back and assess what they want to be like coming out of the crisis
- Where to they want to be as a company in 3 to 5 years?
- How can we use this time to refocus on the marketplace and establish new goals or projects
- They are still remote as of this recording (May 2021)
- He’s seeing the economy get more active
- Downtown areas are getting busier
- Mid to late summer they hope to see a return to the office
- Team meetings
- Remaining flexible
- Still remote work for focused periods
- People are having Zoom fatigue and work-from-home fatigue
ReAllocate Platform and Assessing Risk
- They created a new platform to respond to respond to
- Behavior they have seen in the marketplace – a “returns based” investing
- People who just look at the IRR of a deal and invest with the highest returns without concern for the risks they are taking with the higher returns
- They have tried to combat this sort of thing from the beginning with content on their podcast and educational content on their website to help them make better investment decisions
- People who just look at the IRR of a deal and invest with the highest returns without concern for the risks they are taking with the higher returns
- And a number of Investment Advisors were using their platform for their personal capital but they couldn’t invest for their client because of fiduciary requirements because they are not experts themselves to recommend RealCrowd.
- Behavior they have seen in the marketplace – a “returns based” investing
- Since he founded the company, Adam wanted to try to figure out which deals are better for certain people
- Some investments are better for some people because of their goals and risk tolerance
- And the same deals may be bad for another person
- He knew he had to have this objective, universal language of risk so they can understand the risks they are taking in a portfolio and then build an appropriate portfolio of risk for that individual person
- They knew that they had to take a step back and try to change the way you think about investment decisions
- Looking at it through a lens where I can ask, “Am I taking the right amount of risk for my portfolio?” rather than asking, “Am I chasing the right amount of risk for my goals?
- A shift in the fundamental analysis of how we look at real estate
- To do this, they formed a subsidiary, ReAllocate Advisors, LLC, and registered it through the SEC as an Investment Advisor so they can actually help people build those portfolios
- When they started researching this and looking at the landscape of risk, they tried to distill the universe of all the different types of risk down into an approachable subset of categories and they came up with five: The Market, The Manager, The Physical Asset, How the Investment is Capitalized and Partnership Structure
- This is for those who are investing in an asset, not purchasing an asset for yourself
- Like someone investing in a syndication, as a LP (limited partner) with another manager
- Across the 5 factors of risk, there’s a number of different metrics that they can quantify:
- They can look at historical data
- They can quantify those different measures of risk
- They can then figure out how much risk you are objectively taking in that investment
- That’s how they got into this conversation on risk – by asking the question, “How do we objectively quantify the risks that we know and how much risk you’re really taking?” And then build a portfolio around that
- Right now, they’re looking at multifamily, specifically, but they hope to do the same for industrial and office soon
- It’s the most robust asset class they’ve seen throughout the crisis
- And it’s the one that has some good tail winds behind it where that asset class is going to go as a long term investment
- If a person is interested in utilizing this service, they are only working with other RIAs (Registered Investment Advisors)
- You can go to: BuildMyRoadmap.com (Mariner Wealth Advisors) and get signed-up to work through them
- Or, if you already have an RIA, Adam’s company can work as a sub-advisor
Five Biggest Factors of Risk You Need to Know
Here are 5 key factors and the areas of risk associated with those factors that every investor should know when assessing a syndication or similar real estate investment.
1) Markets
- When looking at a market, risks are driven by
- Jobs
- Employment data
- What’s the nature of that employment?
- What’s the concentration of employment?
- How well diversified is that employment
- What is the foundation of that employment
- Population growth
- Is it coming or going?
- Costal, urban markets are seeing exodus to the suburbs
- Sunbelt states are seeing a lot of growth from California and New York
- Supply
- What is the demand for those assets in that market – from a person and employment perspective
- What is the existing construction supply look like
- When Covid hit, they looked to see if the model held up and it did pretty well
- A lot of the markets that they put through this analysis have an elevated risk score
- That’s to be expected because of Covid because we’ve seen
- Tremendous job loss
- Now we’re seeing accelerated job growth in some markets – more knowledge-based markets – more technology focused
- That’s to be expected because of Covid because we’ve seen
2) The Manager
- It always starts with the manager, even on the marketplace side
- As a passive investor, the manager is the most important factor
- The manager:
- Finds the investments
- Sources and structures the deal
- Finds the capitalization for he deal
- Does the actual work at the asset level
- A lot of the work Adam’s company does centers around the manager
- When they look at the manager from a risk perspective, it’s a full review of their entire track record
- How many properties did they buy?
- What did they buy them for?
- What kind of assets were they?
- What kind of a strategy did they employ?
- How does their historical work compare to the investment they are preparing to do now?
- For example, if a manager has all his experience with industrial projects but is now moving into multifamily, that has a higher risk factor
- Adam’s company generally gets involved after the manager has identified the property, has it under contract, and are doing their due diligence to figure out what their capital stack looks like
- The manager would have gone through RealCrowd’s approval process
- Adam will have their risk score pretty well determined at that point
- Then, they’ll look at the investment to assess other risk factors (market, capitalization, partnership structure, etc.) in addition to their qualifications, background and strengths as a manager
- In evaluating the manager, they look at third party data sources and information (i.e. Thomson Reuters CLEAR), data provided by the manager (pro forma, financial model and strategy) and Adam’s company will run their own numbers
3) The Physical Asset
- How old is the building?
- When was it last renovated?
- What’s the business plan for the asset?
- How much are you trying to grow net operating income before you get stabilized?
- That can be an indication of business strategy
- If it’s already stabilized, then they’ll probably grow rent set to 2-3% per year inflation in your underwriting
- That’s less risk than something that’s set at 7-10% per year in rent growth
- What capital improvements are going to be required?
- Deferred maintenance?
- Replacement costs or appraised value?
- Deferred value?
- That can be an indication of business strategy
- Acquisition to other benchmarks
- How much are you trying to grow net operating income before you get stabilized?
- Property condition reports within physical structure of the investment
PLEASE NOTE: There was a short discussion here on Opportunity Zone projects for those who want to listen to it (notes were not written)
4) Capitalization
- Traditional financial metrics:
- Loan to value
- Something bought with all cash or a 35% loan to value is inherently less risky from a capitalization perspective than something you’re going to put an 80-85% LTV against it
- Debt Service Coverage Ratios
- Debt yields looking at some of the more financial-performance metrics
- Basic fundamental financial analysis
- Loan to value
- Common sense plays
- How many capital positions are there?
- If you’re investing i a senior loan, that’s less risky than if you’re investing behind a senior, behind a preferred equity piece
- Then there’s your common equity
- There going to be more senior positions with your capital, therefore, more risk
- How many capital positions are there?
- Capitalization is pretty straight forward
5) Partnership Structure
- Not applicable if you’re investing in your own property, on your own account
- But, if you are investing with a manager, the partnership structure is pretty crucial
- What’s in the PPM, Operating agreement and governing documents pertinent to the partnership structure?
- Who gets paid what and when
- What the co-invest is
- What the net co-invest it
- What the fee structure is
- What kind of a promote structure there might be
- They try to figure out, from an investor in this investment, what is their protection and/or exposure from the partnership:
- How the cash flow and distributions will be treated, both from operating perspective and events (refinance, sale, etc.) at the end of the asset investment and the risk associated with it
- Who’s entitled to what percentage of cash flow and distribution of capital events and what is the risk associated with that
- Looking at what percentage of your returns are coming from cash flow vs. appreciation at the end of the investment period
- That’s another indicator of risk
- If you’re getting 80% of your returns from cash flow that’s lower risk than…
- 80-90% of your returns from the sale of the asset at the end
- If you’re getting 80% of your returns from cash flow that’s lower risk than…
How Risk Data is Presented
- In the initial meetings with the advisor, they will come up with target allocations plan for that client
- And that will set the framework for how they’re going to recommend investments to the client
- Once they do the work at the investment level, they know how that client’s capital is to be allocated and where they see deals tat fit within that allocation model
- They’ll make that recommendation to the advisor and provide them with the report and underlying material
- The financial advisor and the client will have the final decision as to whether they agree or invest more or less on that particular deal
- They have already done a few deals with this new tool
- They are looking to ramp it up this year
For Those Assessing Their Own Deals
- All five risk areas mentioned are important
- If you’re investing in a syndication or with another partner, “you pick the jockey, not the horse!”
- A lot of it comes back to THE MANAGER
- Also, ask the right questions and the hard questions (that some people may feel intimidated to ask)
- What is your track record?
- Have you lost money on deals?
- If you did, why and how did you work it out on behalf of the investors?
- How did they act when they faced a deal that was challenging?
- How well did they communicate that to investors?
- Also, you have to do the fundamental analysis
- Jobs
- Population growth
- Migration data
- The Market fundamentals
- Financial analysis key metrics
- Loan to value
- Debt Service Coverage Ratio
- Other key factors
- Relationships
- Do you know someone who invested with the manager?
- How did it go?
- How did it go with others
- Think critically on the underlying aspects of the investment
- Take a few steps back
- Dig a little deeper
- Put some of those key factors in place to look a layer beneath the story to figure out what some of those factors are and is there a comfort level
- If you don’t understand something, ASK THE QUESTIONS
- If tey are a good manager, they will answer your questions
- If they’re in it for the long haul, they will appreciate the relationships
- They want to make sure their investors understand
- They want to make sure they’re on the same page and doing what’s right for them as well
- That sets up a long term relationship with the manager and investor and really making sure that alignment is there by asking those questions and not being afraid to do so
Resource Tip
- For great free economic market data, go to St. Louis Fred: https://fred.stlouisfed.org/
How to Reach Adam
- Website: RealCrowd.com
- If you are a Financial Advisor or work with one: BuildMyRoadmap.com
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