While I have done very well with Real Estate Limited Partnerships overall, I have also made mistakes along the way. Real estate has provided me with the majority of my income, capital gains, and net worth. I am conservative by nature, but I have also made mistakes with real estate investing. The following are the five biggest mistakes that I have made with Real Estate Limited Partnerships during my investing career.
Mistake #1 was investing in a Fund with a Sponsor I didn’t know
The first mistake that I made with Real Estate Limited Partnerships was investing with a new Fund Sponsor despite the partner’s limited experience that I found through a real estate crowdfunding platform. My biggest concern when conducting my analysis was the Fund Sponsor’s lack of experience. However, I liked the Fund Sponsor’s business plan and the idea of what they were doing.
The Fund Sponsor’s plan was supposed to be to redevelop houses that they bought in the Portland, Oregon market. My investment was at a time when the fix and flip residential model was common and profitable. Portland, Oregon had been a hot market at the time, and I understood the market because of my multifamily investments in the market.
The issues started when the Fund Sponsor decided to switch the business plan unilaterally without any discussion with the investors and without any concern for the Fund documents. The Sponsor decided to start doing residential land acquisition and development, which was not contemplated initially and was not allowed per the Fund.
Residential land acquisition, entitlement, and development is a much longer process. The crowdfunding manager overseeing this transaction started having discussions with the Sponsors about getting back on track with the original Fund purpose. But then the real troubles started. One of the managers of the entity disappeared and one of the Fund managers got arrested.
This was a case where I made the mistake of investing with an inexperienced Sponsor solely because I liked their initial business plan.
I am conservative and normally only invest in Funds with Sponsors who I know, like, and trust. Additionally, I rarely invest in development deals unless I know the Sponsor and their track record, so if I had any inclination that the Sponsor was going to get involved in development, I would have never invested with them.
At this point, I have only got a portion of my capital back on that deal. I’m still hoping to see the rest of it at some point, but we will see how everything transpires with the legal cases with the Sponsors.
Mistake #2 was trusting third party information rather trusting my own analysis
A second mistake I made with Real Estate Limited Partnerships was buying a property after relying too heavily on the information, data, and “gut feels” of third party vendors rather than trusting my own analysis.
I was the Sponsor of a 24-unit apartment complex in the Tacoma market in Washington State. The County where the property is located had the fastest growing rents in the country in 2017. The property had below market rents and occupancy issues. My partners and I bought the property at a good price per unit ($98,333 per unit) although the capitalization rate was lower than market at the time at 4.55%. Even with the low cap rate, we saw significant upside potential. There was a clear pathway to achieving the upside.
But you don’t know what you don’t know.
Initially, we were able to increase rents onsite and we were able to implement a utility reimbursement program. From the outset of the purchase, the brokers continued telling us how strong the market was, and the data also showed how strong the market was. But the problem we had with this particular property is that it was situated in close proximity to a military base where there were a high number of deployments. A lot of the tenants were military and when they got orders, they would leave immediately and not have to see out the term of their rental contract. As such, we would have to continually re-touch up or renovate every unit as the tenants left.
The second issue we had at this property was that our Property Manager initially was a third party vendor. They overcharged our property $10’s of thousands by arbitrarily attaching their employees to our property. We did not have a Resident Manager, but the Property Manager attached a Regional Manager, Property Manager, and Maintenance personnel to our property. We complained about these business practices for a year prior to firing the Property Manager because we were locked into a contract. They also had a clause that allowed them to attach all these personnel to the property despite our feeling that it was unethical to do so.
To make matters worse on that deal, we ended up getting an offer on the Property just prior to the COVID-19 pandemic. And just prior to the end of due diligence, the buyer asked for a significant discount. Unfortunately, we did not see a pathway back to profitability for us on that deal, so we accepted the lower offer.
We arguably paid too much for the property on the front end based on expectations of future rent increases and future upside potential. I have always been a believer in paying for current income and then getting any upside on your own. This was clearly a case where we did not follow our own guidelines and we arguably overpaid despite the price per unit being so good.
Mistake #3 was buying on emotion rather than rational decision-making
A third mistake I made related to Real Estate Limited Partnerships is that I made the mistake of buying on emotion.
I bought an investment property in Honolulu, Hawaii. I bought the property because I love Hawaii. I love the quality of life, I love the weather, I love the location, and I love all the things that there are to do there as well as all the things that I do not have to do in Hawaii.
The investment was fine. It was always rented and most of the costs were covered by the rental income each year. The property generated a return albeit a low cash-on-cash return. And the property had modest appreciation over my 7-year hold period.
But at the end of the day, I bought on emotion. I bought based on feelings rather than doing the best thing I could with my investment capital. I believe that if you’re buying with investment dollars to make money, your job as an investor is to try and get the best in-place cash flow possible and the best overall return possible.
I had quite a bit of money locked up in that property and ultimately decided to sell the property. When I sold the property, I got all my equity back plus I made my made some profit. From a tax standpoint, I did not owe much money, so everything worked out well. I think my lesson learned is that you should not buy investment properties on emotion. You should only buy investment properties based on rational decisions. The one exception is if you are buying a residential property that you are also buying for personal such as a second home. In my opinion, that becomes a lifestyle investment, which is different than a pure investment property play.
Mistake #4 was trusting a property manager too much
A fourth mistake I made with a Real Estate Limited Partnership was trusting a property manager 100%.
Finding a good property manager, especially a third party property manager, is very difficult. Oftentimes, the third party manager’s business is in conflict with the owners of the property. In my opinion, this conflict exists because the property management company takes responsibility for the operations of the property. The property management company has staff that it employs and needs to bill out, it has contracts in place with service providers, and the property manager oversees the accounting for the property.
A big issue with third party property managers is that you end up paying for the property management company’s employee’s time even when you might not need to be doing the work. I assumed a property management contract with a third party property manager on a multifamily property I bought. The property management company had good reporting, but what I learned is that was the best part of the firm. What I did not initially catch is that the property management company had a line item buried below the line that was effectively a repairs and maintenance line for their staff. For a small apartment complex, these extra costs were unnecessary. The property management company charged their staff to our account despite the lack of need for those staff onsite.
And when I asked about that line item numerous times over the course of half a year, they said they had a roving team and every property that they managed had an allocation to pay for these folks. And per our one year contract, we were required to basically pay the salaries of their roving staff regardless of whether we were using them or not. That was a clause in the contract that we missed and did not realize was there until we discovered it buried in our financial statements. Since we signed the contract, there was little that we could do.
The mistake was trusting the property manager that they would work with our interests in mind. When we use third party managers now, that is one thing that we look for in the contract, and that we pay attention to. Additionally, when we manage our own staff, we now try to determine how much time they’re actually allocating to a project and monitor why they are spending the money that they are spending, especially when it’s out of budget.
Mistake #5 was not doing more deals earlier
The fifth mistake that I would say has been my biggest mistake in Real Estate Limited Partnerships. This mistake may be counter to what you would expect, but it is that I did not do more deals earlier. As you have heard me say in the past, I am conservative. My conservatism made me move too slow on deals and second guess what I thought would make a good investment.
I had the benefit of having access to deals since I have been in the real estate finance industry for nearly all of my career. However, when I first started in the industry, I was nervous about investing in deals because I wanted to make sure every deal was right. In the finance industry, I was taught to see issues and risks. I was also taught to see opportunities. However, while I felt that the deal was conservative from a debt perspective, I missed out on a lot of deals from an equity perspective because I was being conservative.
In the end, that’s fine. I still feel that conservatism is good. I feel blessed that I have done as well as I have done especially since I did not start out with money. Over the last 20+ years in the industry, I have done well as a real estate finance intermediary, as a direct investor, and through Real Estate Limited Partnerships.
Real estate is the only vehicle that I have invested in where I get current cash flow on a monthly, quarterly, or annual basis. Once you have enough invested, the cash flow begins to snowball and I use the cash flow to reinvest in new, cash flowing deals, which has enabled me to continually increase my net worth.
And when I have a deal that sells that makes profit, I have a reinvestment strategy where I invest in additional cash flowing assets with my profit and original investment dollars.
While I have made mistakes in Real Estate Limited Partnership, I have made fewer mistakes in Real Estate Limited Partnerships than I have in other asset classes like stocks and bonds. Part of the reason is that you are investing in a physical asset or in a financial instrument secured by a physical asset.
I have made the majority of my income, capital gains, and net worth from real estate. I highly recommend investing in Real Estate Limited Partnerships, but there are things that you have to watch out for on deals. However, I truly believe that Real Estate Limited Partnerships are the smart way to make money and grow your net worth over the long-term.
Until next time, let’s continue increasing our cash flow and net worth together!