The world of Passive Investing in Real Estate can be a lucrative strategy for sophisticated and accredited investors alike, providing diversification, hands-off operations, lucrative returns, and tax benefits. However, its success depends on two things: the structure and the operator.
I was speaking to a friend of mine, let’s call him Kenneth, who has, at a mildly young age, amassed a healthy retirement for him and his wife. He has done so through hard work, savings, and timing of sales of his personal residences. His investments are limited to stocks, mutual funds, a previous rental property, and savings accounts. Although he has had good luck with selling his personal residences, he works full-time and does not want to be a real estate operator. This brings us to the situation we were discussing. Kenneth wanted exposure to real estate without the work. He wants to see larger returns for his family’s retirement portfolio and have some type of income when that day comes where neither he nor his wife are working.
Kenneth knew I was in real estate for the past 14 years and I was an obvious choice for the call. I explained to him about mobile home parks and RV parks, how these asset classes can provide both a healthy appreciation and a passive income of cash flow for retirement. The best way I knew for him to invest in them was through a syndication. That’s when the questions started coming in. I tried my best to answer them all; the conversation took well over an hour as I paced my backyard trying to pull as much information from my brain as possible to help him.. We were not able to cover it all on one call and took a series of phone calls to get him all the information he needed to determine if this was a viable strategy for him.
Kenneth: I don’t get it, what is a syndication?
Me: Really, it’s just a method for investors interested in mobile home and RV parks to pool their capital together to buy larger assets as a group and manage them.
Kenneth: But I don’t want to manage them.
Me: That’s okay, haha, no one does! That’s where the roles come in. There are two types of roles in a syndication: a GP and an LP. You would be the latter.
General Partner (GP): I like to call them operators. Most people call them the sponsor of the deal. The GP is the party that will find the deal, secure financing, operate the management of the property, and execute the business plan of the investment. The GP will maybe invest a small portion of their own capital; however, their value to the deal is in the operation, experience, and the active role they take on for the syndication.
Limited Partner (LP): This would be you, a passive investor, the investor with the money who will contribute the majority of the capital to the deal. There may be one, three, ten, or more LPs invested in a deal, all getting their proportional share of the available equity. What is common among all LPs is they have limited liability and no active involvement in the day-to-day management. You will get your return from the income generated from the property and from the appreciation of the property.
Kenneth: So I just pool my money together with a bunch of other people and we buy a mobile home park from someone?
Me: Well, yes and no. You don’t just pool your money together on your own. The GP will have a legal structure set up with the help of an attorney who specializes in these structures. Typically, they will be set up as a Limited Liability Company (LLC). This way, it provides limited liability for you and clearly defines the roles and responsibilities of the GP and the LPs. Your investment will be in the LLC which owns the mobile home park. You will give funds to a bank account in the name of the LLC. You will not give money to any individual or to a seller of the mobile home park. Everything will run through the LLC.
Kenneth: I do that and they just give me money every month after we buy it?
Me: Not really. You earn money a few ways:
1. Cash Flow: Generated from the rental income of the property. You will probably receive this each quarter as a distribution on investment. It is typically called a preferred rate of return, or pref. rate. Meaning you will get a 7-8% return on your capital invested as an example. Plus, many are set up where you get much more than that the better the investment returns.
2. Appreciation: This is usually not going to do much for you until the end of the life of the deal. When the GP sells the property or at least does a refinance with the bank to give you a return of capital. Here, you will get your money back that you invested and then typically your share of the sale profits or loan refinance proceeds left over.
3. Tax Benefits: Now, this may not be a check you get every quarter, but it does help you keep money in your pocket. Each year, you should be getting your share of the depreciation of the investment property. This will help with reducing taxable income. Investing in syndications can also help with potential tax deferral strategies. All of these may not be income per se, but they help multiply your money faster by helping you keep more of your money.
Kenneth: This is a lot different than just buying a single-family house and selling it.
Me: Yeah, it is. It really is a more advanced strategy for someone who is ready to step up their retirement and wealth planning. I love houses, but they definitely don’t do it for me when it comes to cash flow and wealth accumulation. But that’s just my opinion; I am probably biased as a mobile home park guy.
Kenneth: Yeah, you’re right, but single-family is so much safer. This sounds way too risky. Even stocks seem safer than this.
Me: Well, I am sure before you were taught stocks, you thought investing in some company over an app on your phone, that you had no control in, and had to read SEC documents to understand its performance was a bit risky or complicated too?
Kenneth: Yeah, you’re right. It’s not like they teach these things back in our high school!
Me: No, they don’t, but there are some risks, Ken:
1. Market Fluctuations: Just like the stock market, the market can change, values can go up and down.
2. Property Management: This one I see all the time, especially in mobile home parks. Poor management abilities really come down to knowing how to deal with people and property. Failing here means you lose tenants; lost tenants mean lost income, which results in lost value of your investment. The same goes for poor management of the property’s condition. Too many people think they can avoid doing repairs for the sake of saving money. That results in a lot of deferred maintenance which can result in lost value as your property deteriorates. Things can really go downhill fast in a mobile home park. You need an operator that knows what they are doing.
3. Business Plan Failure: Different from poor property management, this can simply be the result of the GP or operator failing to do what they said they could do. You are relying a lot on the GP to have the ability to perform to meet those promises he made to you. If they fail to do that, your investment may not grow as expected, it may stay the same value or even less.
Kenneth: Why wouldn’t they do it? They said they would, I mean it sounds like they are the ones who came up with the business plan? I don’t understand how it wouldn’t get completed?
Me: Yeah, you would think it would be a simple thing, to do the job you said you were going to! To be honest, there are a lot of bad actors in this space. Many people get into it because they heard how great it is, but didn’t realize the hard work. It’s not easy running a real estate operation, just like it’s not easy doing any job. You have to have a passion and purpose behind it. Some people lose motivation, others just never had the ability to begin with.
Kenneth: Sounds like the GP has not just a lot of control, but is the hinge pin to the whole thing! What if, like you said, the sponsor is bad at operating the investment? Or I guess what I mean is, how do I know he won’t lose my money?
Me: Yeah Ken, operators are one of the biggest factors in the world of syndications. You gotta really vet them.
Experience: Make sure you are investing with someone who knows what they are doing. I get everyone has a ‘first deal’ but ideally, you want someone with experience. For me, as an example, when I was new to the mobile home park and RV space, I had done hundreds of residential flips, rehabs, and placed thousands of tenants in homes. I may have been new to mobile home parks, but I came with a wealth of knowledge. I used those problems and issues I solved there to help me when I do rehabs on mobile homes, work with local governments, and market for tenants. I had already hit roadblocks doing those things and learned from them, overcame them, and moved forward. So, my experience doing the tasks was there, just not in mobile home parks. My learning curve was flatter, I guess you could say. The more problems they have had, the better they will be at solving them for you and your investment. That only comes with experience.
Kenneth: That’s a lot to consider. Is there anything that is the biggest character trait I should look for in a GP?
Me: They gotta be resilient. If nothing else, resilient.
Me: There are some other things outside of experience to consider as well.
Capital Involvement: I am not a huge believer in a GP needing to invest in the deal. I am hiring them as my Operator for their net work not their net worth. Its their ability to work I am after, Some people want to see a GP invest 5-10% of the capital raise. I sympathize with the intent behind it, but also think it’s a faulty requirment. I have seen alot of men lose their own money and not care. I would rather put more weight on their dedication, experience, and willingness to do whatever it takes to succeed. Honestly, if they only have those three things if their money is at risk, they are not my operator. I need inherent character, not contingent character.
Management Style: I will have to send you an article I wrote on the different types of operators or GPs in this business. However, just know who you are dealing with. Are they hands-on managers of the deal? Do they expect to hire a third party to manage the property? More importantly, judge how they are as a leader if possible. Talk to members of the team and get a feel for how the operator treats their team. Even better if you can find out how the team treats their communities and residents. If they are bad managers of their team and of their residents, I don’t see how you can expect the investment to perform well.
Transparency: This is it for me. Put everything else aside and really judge them on their openness and honesty. I have seen operators not communicate with LPs, not provide financial reports, hide details in fine print, and generally just skirt and avoid questions from LPs. If your gut says no, just walk away. A GP who is not open and communicative about their background, performance, the deal, and past investors is hiding something. Not worth the risk to me.
Kenneth: Can I pull my money out when I want if I get bored with it, like I do with my stocks?
Me: I am sure you know that is called liquidity, and sadly syndication investments are not as liquid as stocks. Quick answer, no you cannot just pull your money out when you want. However, I am sure whatever GP you invest with will have some section in their documents that explains how a sale of an LP’s share will work. Usually, you can sell it back to the GP or to other LPs in the same syndication. Otherwise, you may be allowed to sell to an outside qualified party. I have heard of some tech startups that are trying to be an outlet for LP share sales, but I don’t know much about them, pretty new from what I see.
Kenneth: Oh, so I gotta be in this thing for a while, huh?
Me: Yeah, typically you gotta assume at least 5 years, maybe more. Each one is different. BUT! There is a cool thing about them. A lot of times, the GP will refinance the property after they implement the business plan. The property will appraise out higher than you invested into it. The proceeds from the loan will typically go to pay back all the LPs their principal capital and then go to pay both the LP and the GP the extra proceeds at their agreed rate. Here is the cool thing: after you get all your money back, you still are invested in the deal. You still own your shares, the LLC still owns the property. You still generate cash flow and get paid your distributions. Now, it will probably be at a lower amount since you have more debt to pay off first. However, it’s pretty cool to own an investment, get paid on it, and have ZERO money at risk. So, technically, you could be owning shares in this for a while, but it’s really going to be case by case, so you need to know what your timelines and preferences are. Most people I know, when they get a good performing investment, don’t want their money back; they want it to keep working for them. But I know things happen in life, so be sure your syndication docs outline an exit strategy should you decide to sell before the closing of the syndication.
Kenneth: Do I need to hire a lawyer to do this? It sounds extremely complicated.
Me: Well, having a lawyer on your team is always a plus, as well as having a good CPA. The GP will have an attorney who specializes in syndications draw up some documents you will need to review. If you cannot understand them or have questions, you will either need to discuss with the GP or with your attorney. I always have a lot of LPs call me to go over the documents. It says a lot about a GP if they are willing and able to explain the documents and terms in detail. If you find a GP not being open about them or trying to skip over sections, it’s probably a sign; go have an attorney review with you. Honestly, if that’s the case, you probably should just walk away.
Kenneth: Hey, can I call you back real quick the wife needs me to help her with something. She is waiving me down. I will call you right back.
Me: Anytime bud, just call me when you are free.
Kenneth, No I mean I will call you back tonight. You cant leave me hanging like this!
Me: Haha, I wouldn’t do that, Okay, I will be here for your call.
Although My call with Ken ended for now, yours does not have to you can schedule a call with me right now using this link if you want to talk about this or anything related to Mobile Home & RV Parks or Passive Investing.
-The MHP Operator
