Passive vs Passive

How Passive are your Investments?

After a long break of writing almost daily in LinkedIn, and due to the multiple calls and emails we received from Investors last week, I decided to write and make some comments about “Passive” Investments

Some investors looking for “passive” real estate income choose to invest into REITs and/or private funds. Fund Managers get funds from many individual (or institutional) investors to purchase one project and/or an entire portfolio of properties, then Fund Managers execute well-planned business plans, run the day-to-day operations, make monthly reports and quaterly distributions to their Fund investors.

Investors looking to deploy capital into Real Estate markets have multiple options. However, during the last 2 weeks many questions have arisen, and those who are looking for a true Passive income have questioned themselves about “how passive is passive”?

Let’s explain it:

Passive investors can leverage the knowledge and expertise of professional real estate fund managers.  Passive investors relay on the Manager’s experience and their capabilities to create a deal-flow, manage the assets, and perform great exit-strategies for its business model.

Some fund managers call their own multifamily (apartment) funds a “passive” income because of the rents those apartments buildings bring in. However, investors understand that the monthly “passive” income highly depends on many factors such: Vacancy, Secondary Income (storage, parking, concessions, and many other potential income besides the monthly rent). Then the “passive” income should come after paying property taxes, insurance, salaries, utilities, maintenance, repairs, reserves, management and the mortgage payment – The cashflow (or “passive” income) could be positive/negative as a result of those factors.

Although we acknowledge that apartments have a great potential for investment, we consider them to be “active” investments rather than “passive”. We make the same considerations when it comes to self-storage, retail, office, business centers, commercial plazas, strip centers, etc.

When do we consider a RE investment to be passive?

We consider “passive” investments those who deliver a consistent, conservative and risk-adjusted returns. Those related with Debt rather than equity. In order words, rather than participate in the equity side of theose asset-owned funds (as partners/shareholders), we participate in the market by investing in the same asset-class but in the Debt side of it (as a loan).

Our capital gets deployed as a Loan to the builder/developer/sponsor to either purchase, build, rehab, refinance or cash-out. By investing on the debt side of the project, we have the first position of all the payments. Once the rents are collected, the landlord makes the mortgage payment to us before any other payment/expense goes out. This first position allows us to make predictable current income returns to our fund investors

Are all Private Debt Funds Created Equally?

The answer is no.  It can be tempting to get tunnel vision and focus only on funds that brought stellar returns in recent years, but managers play a huge role while analyzing performance and risks. Altough it’s important to look at the fund and how it performed over the last years, it is more important to evaluate the real estate experience of the fund manager.

Make sure you select a fund manager (and not a fund) who has the character and capabilities to overcome situations during this current market shift. Managers must have a strong strategy for these days, a well-seasoned asset management team, risk-management policies and procedures, a deep understanding of the market their serve as well as clear competitive advantages.

Investing in private debt funds is worth considering, however due to the different levels on how certain private debt funds are structured to generate returns for its investors, it is extremely important to go into the space with abundant caution. Many investors run their own process to select the best private lending funds and most of them focus on the character and resources of the manager, and not on fund’ s past performance.

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