How Passive Investments Net You a Greater Return

Passive Investment is the Way to Go

We often hear from others that they want to do a flip or buy a small multi-family unit independently. However, many of these people are busy with their successful day jobs and businesses. They don’t put enough weight into what those words mean. They often don’t understand the time and expertise it takes to get even smaller deals done.

Not everyone understands what kind of distraction property ownership will be from their primary source of income. If you want to be a real investor, you need to dedicate your time so that you have access to the best deals.

As a result, passive investing is the way to go for folks that want a truly on-the-side type of gig.

In this article, we’ll focus on what it means to be a passive investor and why it doesn’t mean that you’ll see lesser returns. In fact, in most cases, returns for passive investors can be quite impressive.

Active-Investors Don’t Understand the Time it Takes to Make a Great Deal.

This is the number one issue. Active investors don’t comprehend the time and frustration it can take to get a good deal done. In our case, it requires out of state travel. No one talks about the hundreds of deals that we look at before we finally get to the one that starts to make sense. It can take one hundred hours alone, just looking at underwriting potentials. And, alongside that, we’re fostering relationships that we have created with brokers and owners.

Once we have targeted that potential acquisition, negotiating the high-level terms for the LOI (letter of intent) requires many back and forth discussions before it will be acceptable to both parties. Subsequently, we need to work with our attorney and the seller’s attorney to come together on the PSA (purchase and sale agreement). Frequently, this can take weeks to hammer out. It often feels like brain damage! And all of this takes place long before we officially enter escrow. 

Don’t Underestimate the Due Diligence Phase

All of the work mentioned above takes place before we get to the due diligence phase. This phase requires a visit from a physical inspector to inspect a substantial sample size of units. We will get specific trades to the site, depending on the outcome of that report. If we plan on rehabbing units, we will get bids during the escrow period, including the more immediate repairs pointed out in the physical inspection. 

We also keep substantial reserves for any future unanticipated work that we may need to address. We pull all city records for the property to better understand the history behind the property. If there is any water body nearby, no matter how small, we make sure the property is not in a flood zone. If the property is determined to be in a flood zone, it could force us to incur additional substantial insurance costs.

All the while, we are obtaining the latest financial statements, rent roll, leases, contracts, and any other pertinent documentation for review. For example, we closely scrutinize every lease and conduct a lease audit to match up with the rent roll. Additionally, make sure to review all title documents with your attorney, especially any contracts that become encumbered against the property, such as contracts with cable providers, laundry services, etc.

We use a due diligence checklist to make sure we don't miss anything important during this process. Ultimately, this is how we protect our investors and ourselves and mitigate risk.

Moving on to Lending Options

After we complete the due diligence process, we will proceed with our lending options. Getting all the background and financial documents over to the bank, initiating the appraisal process, and any 3rd party reports that the lender may require, etc., takes time and perseverance (if not some persistence). Seeking lending options is an ongoing and iterative process where the bank continually asks for documentation during the underwriting process. This is a complex and tedious process. 

The lending process can take 45-75 days, depending on the lender and complexity of the deal. Assuming all goes well with the appraisal and documentation review, the file will move forward to final underwriting. From there, the file goes to senior management for final approval and then the last compliance review.

A draft of the loan documents is usually issued a few days later. Usually, there is some back and forth between the lender's attorney and our own over some particulars of the loan documents themselves.  Hopefully, finally, the loan documents are ready to sign, and the closing process is initiated.

Then Comes the Closing Process

Now we can start the various processes of closing. First, we must get the final rent roll, up to date collections, security deposit records, and any prepaid rents that the seller has collected. Depending on when the closing occurs, these rents need to prorated accordingly. A final closing statement needs to be issued, specifying all costs allocated to the buyer and seller appropriately based on the contract.

For example, we had a stipulation in our contract that required the seller to pay us $1,000 per unit that vacated during the escrow, up until five days before closing. We established this fee to compensate us for the unforeseen turn cost.

While this is all happening, the lender and subsequently us buyers need to wire the funds required. Depending on the county, documents are recorded electronically or physically at the assessor offices, and the title is officially transferred.

Active Investment Takes Time and Dedication

Active investment is a long, drawn-out process, especially considering that you spend hundreds of hours looking at potential deals before you can even start the lengthy acquisition process. Then the real work begins with asset management. This includes obtaining appropriate reporting, daily emails, weekly calls, resolving what could be costly issues, and making sure all projects are moving along.  We will go further into asset management in our next article.

Ultimately, all the effort and time is not worth an extra 2-3% in additional return. If you assign a cost per hour for all these activities, your return will end up being much less than it would be if you were in the passenger seat. Let's not even mention that since we are active in the market, we can usually source better deals and get better pricing from contractors to make up for any lost return you would see if you do it yourself.  Thus, even if you can achieve higher returns elsewhere, it usually behooves you to take the passive route. Your pocketbook and peace of mind will likely benefit as a result.