Multifamily For LPs: Pitfalls To Avoid

While passive investing in multifamily can present tremendous return opportunities, there are many pitfalls LPs should avoid. Selecting the right sponsor, whether the deal is structured as a fund or a syndication, is key. On this episode, Andy Hagans of AltsDb: The Alternative Investment Database, joins Scott Hawksworth to discuss.

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Episode Highlights

  • What LPs should know about fee structures, and why “creative” structures are often worse deals.
  • Which hidden fees LPs should look out for.
  • Why track record is one of the most important factors to consider when evaluating a sponsor.
  • Which multifamily markets are particularly attractive right now, even in an economically uncertain environment.
  • How leverage tends to vary between Core, Core-Plus, Value-Add, and Opportunistic multifamily deals.
  • Factors to consider when determining the type of multifamily assets you’re investing in.
  • Key differences between multifamily syndications and funds.

Featured On This Episode

Today’s Guest: Andy Hagans, AltsDb

About The Multifamily Investor Podcast

The Multifamily Investor Podcast covers trends and opportunities in the multifamily real estate universe. Host Scott Hawksworth discusses passive investment offerings in the space, including direct investments, DSTs, opportunity zones, REITs, and more.

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Show Transcript

Scott: Hello, and welcome to “The Multifamily Investor Podcast.” I’m your host, Scott Hawksworth, today joined by Andy Hagans, co-founder of AltsDb. And this is going to be actually a new first episode for us. Over the time that we have been running “The Multifamily Investor Podcast,” our focus has shifted a bit, to really focus more on passive multifamily investing. And as part of that, we also had some challenges with our Apple Podcasts feeds. So Andy and I were discussing and we thought, you know what? Let’s just do a brand new episode one. And so that’s what we’re gonna be doing today. Andy, thanks for being here. How you doing?

Andy: I’m doing great. You know, sometimes technology can be such a pain, especially when you’re dealing with external providers. Actually, I’m kind of an Apple fanboy, so I don’t wanna, you know, gang up on Apple too much. But yeah, their podcast app, it can be a little bit buggy, shall we say.

Scott: We had a bit of a gremlin situation happening that we had to sort out, I think.

Andy: You know what? That’s okay, though. I think, as you said, you know, I’ve followed this show from the beginning. It was sort of a spinoff of AltsDb, you know, our larger parent site.

Scott: Mm-hmm.

Andy: And, as you said, you know, your focus has sort of shifted over time to, you know, covering exclusively that LP side, of investing into high-quality funds, high-quality multifamily funds. And, you know, over the time, we’ve also seen a lot of stress in the market, you know? And honestly, even over the past couple years, there’s forms of stress on the run up, and then obviously now, in this environment, there’s more uncertainty. And so, I think it’s honestly a great opportunity for you to record a new first episode, and, you know, talk about challenges that LPs have when they’re trying to evaluate funds, and they may not necessarily be that expert in all the nitty-gritty details of due diligence, for example.

Scott: Well, a hundred percent, Andy. And, you know, there are so many funds and syndications out there in multifamily, and we’ll talk a bit about, you know, differences between funds and syndications in a minute here. But there are so many of these opportunities. And so, separating the good opportunities, worth considering, worth investing in, versus the ones that are not so good, I mean, that is the challenge that LPs are faced with. And then when you look at multi-family, even over the last few years, you know, it’s been such a gangbuster run, even, you know, longer than that. And there are so many folks out there where maybe it was their first syndication that they started, and a lot of them, it was, they had success because the market just, you know, you couldn’t lose, depending on the market. But as that economic uncertainty creeps in, as you have challenges, really, you can kind of, you know, get faced with separating the good from the bad, because the markets don’t make everything so easy, if that makes any sense?

Andy: As the tide comes in, what’s the saying?

Scott: Yeah.

Andy: The tide comes in and you find out who’s been swimming naked. And, I mean, I do honestly think that that was a real challenge for multifamily, and for a lot of areas of real estate. When it performs so well, you know, it attracts a lot of newcomers. Which is fine. You know, people can enter the market. New sponsors can enter the market. But they’re not always professional. They’re not always offering a good value, a good deal for their LPs, if they’re raising money in a syndication or in a fund. You know, and frankly, as an LP myself, I noticed that there is just a wide variety of, let’s say, professionalism. There’s a wide degree of professionalism among sponsors and syndicators. And so, honestly, I think a little bit of a correction, obviously, this, we’re probably heading into a tougher environment here, and that could be a good thing, to weed out, you know, some of the players that maybe shouldn’t be in the space, in the sense that they’re not offering a great value proposition to their LPs.

Scott: Right. You know, and Andy, that’s a great segue to, I think, the first thing for LPs to consider when they’re looking at a fund or a syndication, is the sponsor themselves. And I think as part of that, and you were alluding to this track record, and have they done this before? What conditions have they faced before? You know, a sponsor that survived through, you know, the financial crisis in 2008, and economic downturn, and has continued to have success and have deals, that is a sponsor that’s very different than one who is a bit more green, and has just had, you know, maybe one or two deals under their belt, in great times. I think that track record is something that I’ve spoken to before, you know, on webinars and elsewhere. And it’s something that I think is really important for LPs to keep in mind. So, Andy, I’m curious to your perspective, if you’re looking at a sponsor, you know, what do you think track record-wise are you looking at? Are you looking for past deals? Are you looking for if you’ve heard of them before? What are some of the things you’re evaluating?

Andy: Yeah, I think it’s a good question. And, you know, it’s important to point out that everyone has to start somewhere, right?

Scott: Mm-Hmm.

Andy: So I don’t wanna demonize a sponsor who’s raising capital for their first fund, right? But it might be their first fund, but then the question is, you know, how much talent and experience and expertise do they have in managing that type of asset. Right?

Scott: The team. Mm-Hmm.

Andy: It shouldn’t be your first asset, even if it is your first fund. You know, one other thought is, I’m an LP in various alternative investment funds, right? I also operate AltsDb, you know, co-founder of AltsDb, host of “The Alternative Investment Podcast.” Through that, I have a lot of exposure to different types of alternative investments. And I’m sort of a generalist, right? I like to hear about strategies, I like to think high-level about portfolio construction and things of that nature. I’m not, like, with multifamily, I am an LP in multifamily funds, but I don’t focus solely on multifamily. I’m not an expert, like you are, or a lot of your guests on “The Multifamily Investor Podcast” are.

So, when I’m looking for a fund, you know, I wanna look for that fund, that sponsor, that has the track record, that has more professionalism, and that might mean slightly lower returns than someone who finds a smaller opportunity that maybe isn’t scalable, right? So, I do think, you know, it is possible to find smaller deals off the radar, smaller sponsors off the radar, syndicated deals that could potentially have higher returns. But the question, as an LP, and I think you have to be very honest with yourself, do you have the skillset to really diligence this opportunity? And with that smaller opportunity that may be off the radar, that’s gonna require that, you know, you have the expertise in the deal itself, that you underwrite the deal itself.

And so, like, for me personally, I don’t have that deep of an expertise in multifamily. I mean, especially depending on, you know, the type of multifamily, because obviously you have ground-up versus value-add and so on. Whereas what I’m more comfortable with, at this stage, investing in alternatives, is at a top level, kind of top-down, looking at a sponsor, looking at their track record, diligencing the sponsor, right? And so, it still is a type of due diligence, but as an LP, and I think this is also true for a lot of wealth managers, RIAs, even family offices, there’s gonna be, you know, you’re gonna have to do due diligence on the sponsor at a level that’s within your ability, if you don’t have the ability to due diligence the deal itself, the underlying project itself.

Scott: Right. You know, and Andy, I think, within that, there’s, you know, I had an episode where I talked with Rob Beardsley of Lone Star Capital, and he talked too about some of these deals where maybe a sponsor doesn’t have, you know, the same amount of experience, or they’re newer, and they’re really trying to attract investors, so they have these really attractive terms, that kind of stand out. And sure, that can be a good thing, but also, many passive investors, rightfully so, have a bit of skepticism, because they’re saying, “Wow, these terms look really, really great. Why is that?” And what you’re saying, too, is, you know, maybe the returns aren’t as, you know, attractive on paper for some of these sponsors that have been around and they’re bigger. But for you, you’re kind of looking, you’re looking for something like that, because you don’t necessarily have all the expertise to underwrite every aspect of a given multifamily deal, right?

Andy: Yeah, because, I mean, multifamily isn’t really my personal focus, right? So I’m not gonna have the deep expertise. Someone who lives and breathes multifamily, they might be a GP in a particular multifamily deal, and then an LP in other deals, right? And that type of person, who already owns and operates multifamily, they’re gonna have the skill set to go in, analyze the deal, and underwrite the whole thing top to bottom. Right?

Scott: Mm-Hmm.

Andy: But I think most LPs, as well as most RIAs, and even a lot of families, they’re going to have to do more due diligence on that sponsor side. And, you know, you’re right. A high-quality sponsor, they’re not gonna charge peanuts for active management, because the truth is, active management is a heck of a lot of work.

Scott: Right.

Andy: You know what’s interesting? Like, I came from this world of, you know, Bogle-head, you know, and I do love Vanguard, by the way. I seriously do have a love affair with Vanguard. But, you know, so, indexing, low costs. I mean, Vanguard will send me an email about my, one of my kids’ 529 funds, and it will say, you know, “We’ve dropped the expenses by five basis points again this quarter,” and I’m like, “Great.” You know, and it’s already rock-bottom pricing. That’s passive indexing. When you’re talking about owning and operating, or, you know, ground-up development, value-add, this is very labor-intensive type of work, that needs expertise and skill. It’s stressful, right? So, actively managing in this world, this world of alternatives, and especially real estate, it’s gonna cost. If it doesn’t cost anything, you’d have to ask yourself why. Right? Like, why would a good management team operate this asset for free? That wouldn’t make any sense.

Scott: Right. And then, you know, there’s the flip side, when we look at these sponsors, these deals, and there’s those fees, then there’s the question of, okay, if the fees are, you know, really, really low, why is that? You know, what are they doing there? Or, if there are hidden fees, or fees that are, you know, significant, you know, if they have a due diligence fee that’s, you know, maybe a normal due diligence fee, or maybe an average might be something like $15k. But then you might see some of these deals where it’s, “Yeah, here’s our due diligence fee. It’s $100k.” Like, well, what are you using that for? You know, and what other fees do you have there? So I think those are two things that are really important to evaluate, kind of, from both sides. Like, okay, are the fees nonexistent or too low? Why is that? Or are they really high? And I have questions for what exactly are you charging here?

Because, again, it really runs the gamut with sponsors and how they structure things. And that’s the next question I actually wanted to ask you, Andy, is your thoughts on fee structure, because there’s a lot of opinions out there on creative structures, you know, waterfall, prep, how that’s all, you know, laid out for LPs. And, in my experience, and from talking to folks, again, I’m gonna reference that Rob Beardsley episode, which I guess will be technically episode two here, now. You know, he talked about how he is so dubious of really creative fee structures that aren’t, you know, kind of straightforward, what you normally see, run-of-the-mill. Because as you dig into those numbers, it tends to shake out that it is worse for the LPs than if it was structured more typically. So I’m just curious to your take on fee structures from that perspective.

Andy: Yeah, you know, that’s a great question, and I think I would agree with Mr. Beardsley on that point. Think of it this way. I guess, here’s the way I look at it. With a sponsor executing on any kind of fund or any kind of dealer project, you have execution risk.

Scott: Mm-Hmm.

Andy: Right? Like, even independent of what kind of fund, what’s the fund structure, is it, you know, is this inside a REIT? Is it a normal 2 and 20, you know, private equity deal? Is it inside a [inaudible 00:14:32] You know, put all the wrapper and fee structure stuff aside. There’s just that execution, operational risk of owning and operating any asset, and all the things that come with that. You know, financing, marketing, construction, everything. That’s one category of risk. But another category of risk would be, if this is a new widget, and when I say widget, I mean wrapper, or fund structure, whatever you wanna call it. If it’s a DST, you know, DSTs are highly regulated.

Scott: Mm-Hmm.

Andy: So, in general, if I’m doing a 1031 exchange into a DST, I know what that widget is. I know what it looks like. It has the seven deadly sins that restrict, you know, how it can be managed. In private equity real estate, as you’ve mentioned, there are typical fee structures. So if there’s any new kind of fee structure that is not typical in that private equity real estate world, then now, I’m saying to myself, “Well, now there’s a second type of risk.” We already have the execution risk of what the underlying assets inside the widget, inside the wrapper, right? But now there’s new risk of the wrapper itself. How do I evaluate it? How do I understand it? I mean, sure, you know, I can take that and model it out and say, oh, is this fee structure, is this widget, you know…under what circumstances is this going to be a better deal for LPs or a worse deal for LPs?

But ultimately, and I think this is true for any LP, or RIA that’s representing clients, do you really wanna spend the time evaluating that new widget, that new fee structure, right? When there are plenty of high-quality funds that have traditional fee structures, that are frankly just going to be easier to evaluate, because you don’t have to spend any time evaluating, you know, the creative fee structure. And so I think, honestly, it’s almost a time thing. But I also, I think that, I suspect that what you stated is also correct, that ultimately, creative fee structures end up being a worse deal for the LPs, not a better deal for the LPs.

Scott: Right. And I think, you know, tied to that, we have the fee structure. Then, I always like to point out alignment. I’m a big fan of sponsor co-invest, and making sure that, you know, GPs and LPs, that they’re skin-in-the-game, and that they’re on the same side of the table. And I think that’s an important thing for passive investors to consider as well. Especially when you look at, you know, markets where maybe that, you know, that exit won’t be as big as you thought it might be at the start of the deal. And maybe you really want that sponsor incentivized to bring as much value into the project as possible. And so I think you get that with that structure as well. And I’m curious your take on alignment, because I think you have creative structures, and then you have, you know, how it’s all couched there. So, what’s your take there?

Andy: Well, you know, it is a good thing when a GP is investing some money alongside LPs, right? Has some money on that LP side of the table, and is investing alongside LPs. But, I mean, realistically, again, talented managers, they’re not gonna work for free, right? They’re not gonna manage the asset, manage the whole fund on the same terms as the LP investors, because then they’re working for free, right? So they have to get paid. But I do think the higher-level concept there is skin in the game. Right?

Scott: Mm-Hmm.

Andy: So, even if it’s on the GP side, even if they have no money on the LP side, I think it’s very important that the sponsor has hard cash invested into the deal, under any terms, whether it’s GP or LP. And ideally, you know, they are investing some on the LP side. But another thing with those incentives, because you mentioned aligned incentives, they’re never gonna be perfectly aligned, right? They never…period. You know [crosstalk 00:19:07]

Scott: There’s a reason people like being GPs. You know, the economics of being a GP are pretty darn good.

Andy: Exactly. And that’s why a lot of family offices, you know, they look for GP, LP terms, or co-GP terms. But if you’re working with sponsors who have a long-term, you know, philosophy, and a long-term track record, I do think that that helps align interests in the sense that, you know, the sponsor, they want their investors to come and invest in their next deal and subsequent deals down the line. And so, for me, that’s a way, you know, as an LP, to get a little more comfortable that this sponsor is gonna be a good steward, because, you know, they’re investing in their reputation. So, again, it’s not a perfect alignment of interests, but I think that that helps align them a little bit more closely.

Scott: Mm-Hmm. No, I think that’s spot-on, Andy. And, again, that alignment is a critical thing to consider, you know, whatever the deal is you’re looking at.

Andy: Mm-Hmm.

Scott: I wanna shift gears a little bit. And, you know, in multifamily, it really runs the gamut. So, if you just say “multifamily” to describe a piece of commercial real estate, you could be describing so many different things. And I’ve kind of given this speech to folks before who have asked me, you know, yeah, multifamily could be, you know, some 10-unit project that was built in the ’70s, or it could be, you know, some brand-new, ground-up high-rise in downtown Miami. You know, those are very different types of assets, but they all fall under that multifamily umbrella. So I think that kind of leads to the next thing I like to point out for LPs to consider, is know what you’re investing in. And especially if it’s a fund, you know, is it a blind pool fund, that’s gonna go out, acquire some assets? You know, how diversified is the fund? Does it have assets that are, you know, located in markets like, okay, it’s got Sun Belt, but it also has some more, you know, boring markets, like just Midwestern, you know, standard-type assets in the fund?

Understanding that aspect of what you’re investing in, I think is another critical part. We’ve spent a lot of time on this show, and I know you talk about this on your show on AltsDb, about markets, and where things are going. And especially when you interview sponsors, you ask them about their perspective on what’s your thesis, and where do you guys develop? What are you doing there? I think that’s really important to understand of, okay is this a deal that’s in Texas? You know, in Dallas-Fort Worth? Or is it a deal that’s in California? And as an LP, that’s really, really key to understand. So I’m curious to your perspective, Andy, on how you’ve gone about when you’re looking at investing in a fund, kind of evaluating the substance of the fund and the assets themselves.

Andy: Yeah, that’s an interesting question. I mean, I have invested in blind pool funds. You know, not totally blind in the sense that it’s a fund that doesn’t own any specific assets or without a strategy. So, I mean, it’s a case of knowing what you’re investing in. And in that case, I’m investing in a sponsor that has a very clearly-defined and well-articulated strategy and focus. So, again, it comes back to that trust and that track record of, if I know this sponsor has a history of finding opportunities and executing on them, and if they kind of communicate, if they communicate in their deck, in their PPM, you know, in their materials, this is what the fund is, you know, this is the sector, this is the geographic focus, I can be comfortable with that, you know, because I like the diversification. You know, so that’s fine. If you’re a more, you know, the type of investor’s more experienced in multifamily, who’s comfortable underwriting deals, absolutely, you’re gonna know what you’re investing in. So I think a lot of that type of investor, who has that deep familiarity, deep expertise in multifamily, they’re gonna invest deal-by-deal, and they’re gonna do their own underwriting. But, you know, back to that creative fee structure, kind of, point that you were making…

Scott: Yeah.

Andy: I would say, you know, I do like when sponsors have a creative part of their strategy, right? They have a secret sauce, something that they do more efficiently, but, at the same time, if you can’t… You know, if you’re trying to communicate, “Well, my fund is in an entirely new sector that we’ve created,” it’s like, “No, you have to be able to explain what…”

Scott: If you cannot articulate it so that your investors know, that’s a problem.

Andy: Yeah. And at the end of the day, you know, most real estate isn’t that unique. What’s going to be unique is the way that a sponsor puts all the pieces together, of the entire process. And, you know, each process will be different, based on ground-up development, or value-add, or core, there’s gonna be a different process. But to me, a lot of the secret sauce is gonna be the general philosophy of the sponsor, and then execution. And I do think that’s where team is very, very, very important. I guess that’s a way of saying, “I’m okay with boring,” right? In terms of sector, geographic focus, I think that’s totally fine. You just communicate it, and whatever your sector is, whether it’s value-add, whether it’s core, if it’s ground-up development… Obviously, the Smile States are very popular places to invest, but…

Scott: Sure.

Andy: …shoot, even if it’s in Chicago, or, you know, any of these, you know MSAs that have, are sort of not so popular, there’s investors out there who are looking for that specific thing. So just, you know, communicate it in a direct way would be my advice to sponsors.

Scott: Yeah. And I think, too, this ties in also to risk. You know, you mentioned how, with funds, you like the diversification aspect of that. And, you know, one thing I was, I alluded to this earlier, talking about the differences between funds and syndications. And one thing I’ve seen in multifamily is that, you know, many syndications, they are focused on a single asset. There might be some varying professionalism, that you’re more likely to find in the syndication area than you are in funds, because they’re just larger, versus syndications, where there are, of course, large syndications as well, but you have some of these smaller ones, and that kind of ties into the risk and understanding what you’re investing in.

Because if you are investing in a syndication for a single asset, that’s a multifamily, you know, it’s an apartment complex that’s located in, pick your poison, Oklahoma City, whatever. And you really need to understand, or have a confidence in, that market, the sponsor, their ability to, as you were saying, Andy, execute, and deliver on those returns. And if they can’t, or if, you know, rents in the market start tanking, or, you know, problems come up, as they often do, how is that gonna be navigated? And if you’re looking at a single-asset syndication, or even a single-asset fund, I think that’s something to really consider too, is that risk aspect. And so, a lot of what you’re talking about, Andy, is really evaluating that when you say, you know, the team, the track record, you’re mitigating risk there, right?

Andy: Yeah, exactly. And I think that a smaller opportunity, there may be an opportunity for higher returns, with some smaller syndications, smaller funds, smaller projects. But you have to know what you’re doing. You really have to know how to underwrite and diligence those. So, you know, I think, at the beginning of the process, you know, even before you get to really an investment selection, you know, as an LP, or as an RIA, or as a family office, you have to do some personal reflection on your own competence and your own skill set in diligencing. Because, I mean, the truth is about alternative investments, and I think this applies to multifamily funds, multifamily syndications, there’s a lot of complexity. And if you’re not really in that world, you know, 24/7, the people who are in that world 24/7 are gonna have an advantage in understanding over you. So it can be, obviously, it can be a little harder to get under the hood and analyze these types of offerings, compared to that Vanguard Index Fund, compared to that Vanguard ETF that’s buying the S&P, or that’s buying, you know, a corporate bond index. It’s gonna be a lot harder to sort of x-ray, and really see what’s going on. And so I think that’s where diligence becomes so important. You know, the three rules of family office investing, don’t lose money, don’t lose money, and don’t lose money.

My advice to LPs, or RIAs, you know, wealth managers who are allocating capital, is, you know, apply a lot of the due diligence at that sponsor level, to just identifying good sponsors, with those solid track records. And then, that’s really step one, before you even get to necessarily that product selection, you know, for that individual offering. I mean, you know, I know as an LP with various funds, that once you’re invested with a sponsor in a particular offering, if they treat you well, if they communicate well, and then, of course, if they deliver attractive returns, there’s a high likelihood you’re gonna come back and invest in a subsequent offering.

Scott: Mm-Hmm. And that’s one of those questions you can ask a sponsor. You know, if you’re considering a deal, you know, tell me about your other investors. Do you have folks that have invested with you for multiple deals, have been with you for years? You know, I think that’s one of those questions, and we’ve had a number of episodes where we talk about what are the good questions to ask a sponsor? That’s one to ask right there. And Andy, I wanna dive in a little bit more on the risk side of things, and really, maybe, the different types of multifamily opportunities, because you’ve mentioned a few times, you know, we’ve got core, core plus, value-add, and opportunistic. I think it’s important for LP investors to not only understand the risk differences there. Obviously a core, you know, deal carries less risk, but then less upside, and then you have these opportunistic deals, which you might be more likely to find value-add opportunistic deals in, like, smaller staycations and things like that. That obviously carries more risk.

And then, once you sort of sort that out and say, “Okay, where’s my risk comfortable? Where’s my level at?” then you kind of dive in and you can look at things like debt, and what is the overall strategy there. And if you’ll permit me, Andy, I actually wanted to throw some numbers at you, and kind of get your perspective on this. So, Origin Investments has a fantastic article, and we’ll be sure to link to it in our show notes, where they talk about typical leverage, looking at core, core plus, value-add, and opportunistic deals. And I’ve got it right here, because these numbers are just great. You know, core investors, they’ve got this direct quote here, expect to achieve between a 7% and 10% annualized return, and use 40% to 45% debt to capitalize a transaction. So, that’s core. And so, if you’re looking at a potential core investment and you’re not sort of in that pocket, if you’re seeing, you know, more debt being used… Go ahead.

Andy: Well, yeah, and, I mean, let’s be honest. You’re not in that target market unless you’re an institutional investor, right? Unless you’re a pension fund. So, and by the way, Origin, they have great content. I have to applaud them, and I’m an LP in one of their offerings. So I’m glad you have that Origin link up. You know, but your point is, a core asset with a different amount of leverage can become a core plus…

Scott: Exactly.

Andy: …asset. And you can’t… You know, bigger names, generally, they’re going to be, you know, categorizing themselves correctly. But I do think, you know, and maybe you’re alluding to this with, like, a smaller fund, a smaller deal, a smaller syndication, you kind of need to categorize what the deal is yourself, based not only on the type of asset, but also the amount of leverage being used.

Scott: Exactly, Exactly. And then you have to consider, you know, if the markets change, if the, you know, if interest rates change, if you have challenges with this, then having more debt, you know, being over-levered, that can be a huge, huge problem. And that’s one of those core questions that an LP needs to ask themselves and do as part of their due diligence before investing. And I’ve got some more numbers here, if you’ll permit me. So, for core plus, between 45% and 60% leverage, and then they typically expect 8% to 10% annually in terms of returns. Then value-add, between 60% and 75%. And this is something, you know, I’ve interviewed lots of folks and I ask about, you know, how do you approach leverage, and that’s right in line, you know, with the percentages that I’ve seen, and then they look at returns between 11% and 15%.

And then lastly, opportunistic, 70% or more, and then that, of course, that leverage can vary, and, you know, they can expect the highest annual returns, often over 20%. And that’s risk, though. You know, that’s being very creative with debt usage, and trying to get those returns. So, I think understanding that aspect is really a critical thing as an LP, and I’m curious, Andy, you know, how do you look at debt when you’re considering, you know, an investment or a deal?

Andy: Yeah, that’s a good question. I mean, you know, back to the three rules of family office investing. You know, you really do need to think about the worst-case scenario. So I would say I’m probably about typical for an LP, right? I’m not an institutional investor who is deploying money into core deals, right? So, you know, I’m probably not far out on that opportunistic end, normally. But, you know, I have invested in some ground-up development, you know, so… It’s one of those things. You know, those are called, you know, the core, the core plus, opportunistic, value-add, they’re risk-return profiles, right? So, higher risk, higher return. Wherever you are on that risk-return spectrum, and again, I’m probably somewhere kind of in the middle, for a private investor, wherever you are, you’re taking risk because of the leverage, you’re taking operational risk. So my philosophy is… Or, execution risk, I should say.

My philosophy is don’t add on other types of risk where you don’t need to. Right? So, back to, like, the fee structure, creative fee structures, that’s a new, additional type of risk. And it’s like, if you can invest in that asset class and that sector, using a traditional fee structure, well, you’re still owning the same underlying asset, but now you’re not accepting that increased risk of some sort of creative fee structure.

Scott: Right.

Andy: Right? Or if you want to, you know, invest in ground-up development, and you’re investing with a proven sponsor with a long track record, versus, you know, a brand-new sponsor without a track record, you know, either way, there’s plenty of risk in ground-up development.

Scott: You’re still giving up liquidity. You’re tying up your capital, you know, especially for a ground-up development project and things of that nature. So, yeah.

Andy: Right. But you don’t necessarily need to take additional risk with…

Scott: Right. Exactly.

Andy: …taking a chance on a sponsor with no track record, or accepting a weird fee structure, or what have you.

Scott: Right, right. And I think that really is the core thing to consider, and why track record and team, and the fee structure, why understanding the risk profile of the asset, and the strategy of the fund or the syndication, is so important, because these are all risk factors, and they can be amplified when things aren’t going as well, when there are unforeseen challenges, or, you know, you have higher interest rates, which might mess with the refi and all of this. Those kinds of things are really critical to consider.

You know, Andy, we’ve kind of gone through really all of the pieces that I think, when you’re looking at good versus bad funds, you know, what’s something that’s worth investing in versus something that maybe you should take a pass on. Do you have any other thoughts, maybe considerations for LPs as they’re looking at multifamily deals and they’re trying to decide, is this something I wanna hitch my wagon to?

Andy: Well, you know, I won’t get into portfolio construction, right? Because I think probably anyone listening to your show to “The Multifamily Investor Podcast,” probably already kind of buys into the thesis of the 50/30/20 portfolio, rather than the 60/40 portfolio.

Scott: Right.

Andy: Or, you know, they’re already sort of sold on the idea of alternatives, or on multifamily, most likely. One thing I would say is, you know, being tax-efficient, which a lot of times is a matter of selecting the right wrapper, that can net out to 200%, 300% higher return, you know, 200%… Excuse me, 200 or 300 basis points in higher returns per year, right? So, you know, DSTs. You know, DSTs have been so, so popular in the past couple years, and I think, you know, they’re gonna continue to be popular, because, regardless if the real estate market goes up or down a little bit, you know, higher mortgage rates, higher interest rates, etc., there’s still a lot of investors sitting on very significant capital gains. You know, even if the price of everything, every asset, drops by 10% tomorrow, you know, there’s still a lot of folks would still be sitting on very significant unrealized capital gains. So I think DSTs are a very, you know, they’re a great vehicle to allow an investor to go passive, you know, into that passive offering, but still enjoy those tax benefits.

I’m a big believer in qualified opportunity funds, you know, Opportunity Zones. Very, very tax-efficient program, that can accept, you know, any type of capital gain, not just from the sale of real estate, could be invested into a QOF. So I think those are a great opportunity. And, you know, also, even independent of the wrapper, for any given investor or family office, they need to know their own tax situation. You know, whether they have income that they wanna offset with depreciation or not. And some of those wrappers are going to map to certain risk-return profiles. So, like, for a DST, you know, you’re probably looking at, I don’t know, technically core plus, or… Those are stabilized assets.

Opportunity funds, those are typically ground-up development, so that’s, you know, more opportunistic risk-return profile. So, as an investor, you have to, you know, really understand those wrappers and the, you know, the types of opportunities that will be available that use those wrappers. But 200, 300 basis points of additional return, you know, on a triple-net basis, annualized, you know, every year, over seven years, that can make a huge difference in an investor’s return. So I think it’s worth taking a little bit of time to just get educated on all those different tax-efficient wrappers, because I think those are a very, very important part of the process. You don’t wanna let the tail wag the dog, right? So it’s not like, all right, I want a DST, so I’ll just [crosstalk 00:41:22]

Scott: “I’m only looking for the tax. I don’t care about anything else.” Exactly.

Andy: Yeah. “I don’t care about the underlying asset or the spot.” Like, no. It’s still, still, the underlying asset’s important, and the sponsor’s important. So, you don’t let the tail wag the dog, but, it’s just an additional opportunity to enhance returns, by being tax-efficient with your investing.

Scott: Andy, I think that’s such a great point to make there, and I’m glad you brought up a number of excellent wrappers there. Certainly the Opportunity Zones program, we’re both very familiar with, with our friends at OpportunityDb. And I actually have, there’s another episode that I recorded with Jimmy Atkinson, founder of OpportunityDb, where he talked about the OZ program, and dove into that. So, for folks who are less familiar with that, I’ll drop a link to that in the show notes as well.

And I know on your show, on “The Alternative Investment Podcast,” you talk about DSTs, you talk about, you know, a lot of these really powerful, you know, tax-efficient rappers. So I think that’s another important thing to note. So, for folks that maybe are less familiar and wanna do that research, there are some great resources there.

Andy: So, Scott, that’s the part where you say, “Andy, I’ll be sure to link to your podcast in our show notes.”

Scott: Right, exactly. And I will link to yours as well, of course. Well, Andy, I think we really covered everything I wanted to cover in terms of, you know, what investors should be considering when they’re looking at multifamily funds, or even syndications. You know, how to really discern between the good and the bad, and take your time. I always say this. I’ve said this a number of times on episodes, and this is advice that has been passed on as well. It’s okay to say no, and in fact it’s a great thing to say no. It’s a great thing to see a deal and say, “Ah, you know what? Not this one, because there’s gonna be another deal.” And if you take your time and look for the right opportunity, you know, that’s just called prudent investing, right?

Andy: Absolutely. Yeah. There’s no shortage of opportunities out there, in any market environment.

Scott: Absolutely. All right. Thanks again, Andy. And yes, we will be sure to have those links in our show notes, and we’ll see you again next time.