This is a companion piece to "How to Invest In Private Real Estate Deals".

In total, I have invested in three private deals, all apartment buildings. They make up about 3% of my real estate investment value.

I expect these deals to return about 11% combined

This is:

  1. well below my direct real estate investments
  2. above what I would expect from a REIT
  3. marginally above crowdfunding, and
  4. overall a little low given the liquidity and other constraints that are natural characteristics of private deals.

I also got lucky because I made my biggest investment in the best performing deal.

The three investments (I'll call them "Small, Medium, and Large" because of the investment size) are with three different individual sponsors. I knew all of them personally prior to investing with them.

Additionally, by the time I had invested in them, I had personal investing experience in similar projects. This includes owning two of my own apartment buildings and working closely with an apartment developer. I therefore felt that I was in a good position to analyze the offerings. Here's what they are, how they've done, and lessons learned.

SMALL – a large C class apartment building in a second tier market

The deal came because the sponsor was a personal friend, and a broker I knew well.  His plan was to improve the apartments and command higher rents.  He had a history of similar deals with great returns in other markets, and had never lost money.  I did not feel that I had the expertise to invest so far outside my neighborhood, and did not want to have to travel to this market to manage such a small investment.

The results from this investment have been poor. I received dividend checks for the first 3-4 quarters at which point the property started underperforming and the checks stopped.  It was a college town, and the seasonal vacancies made keeping occupancy up very challenging.  The plan to convert the renter base to non-students has been unsuccessful. Additionally it appears as though it has been hard to get good property management in place.

On a positive side, the sponsor did not give up on the deal in spite of the poor economics to him.  Reputation matters! The sponsor is laser focused on doing what he can do to fix this building. However, the nature of the town and property differed enough from his past experience that this maybe his first loss.

I expect to lose 50%+ of the money I invested in SMALL deal. Lessons:

Were I to do this again I would have spent more time vetting the specific assumptions, and then either made a much bigger commitment or none at all.  Instead I went on the general track record and did not look for the specifics of this case that would make it different than his prior deals.  Real estate is hyper local - his experience in, say, Dallas, did not translate to this new market - so when I talk about needing specific market experience, I really mean it. The sponsor needs to understand the asset class cold.

MEDIUM – a rent-controlled building in San Francisco in an area with growing tech worker demand

The sponsor is personally known to me, and owns similar (smaller buildings) on the same street.

The financial model is very resilient to a variety of turnover and rental assumptions, due to low leverage and provably below market rents.  I felt in this case that intensive management would make the difference between a good and bad result, and the sponsor could be extremely hands on (he lived right down the street).  This was not something I was willing to take on myself because of management intensity.

Overall rents have been higher than expected, and the property is performing well.

My initial concern about this deal was that the previous owner only held it for about 12-18 months so I wondered if something was inherently wrong with the building - why were they selling it so quickly.  Inspections turned out ok, and perhaps the answer was simple - they quickly flipped it for a profit.

My second biggest concern (and a growing concern) is that changes in rent control laws could negatively impact the value of this building.  New York recently underwent a rent control overhaul that has made building values plummet.  I worry San Francisco might end up in the same situation given the relatively high number of renters in the area and their resulting political leverage.

In fact, I just sold one of my own apartment buildings for this very reason.

Overall I am happy with this investment. I received my first distribution last month.  I’m not looking to sell my share but would at the right price. I believe this will have a 12%+ IRR.

I would not invest more money with this sponsor, but that is more reflective of my desire not to be overly invested in apartment buildings, especially in San Francisco vs. anything particular with this deal.  He had/has the required expertise and has proven to be a good performer who communicates with investors just the right amount.

LARGE – a ground-up multifamily development in Oakland.

The sponsor bought a piece of property, negotiated entitlements, is under construction, and will fill and sell off the property.

It should be complete this year.

This was and is a highly speculative deal; ground-up construction in a booming market inherently hopes that demand is still there when construction is finished. As a result my return expectations were greater than in the other two deals.

Happily in this case I applied all the hard earned lessons that I specified in my previous post.  Especially important here was deep expertise: the sponsor is more connected and has more experience in this area than perhaps anyone else in the country.  His family has been investing in Oakland for decades in exactly this kind of product.  He pretty much knows every street, every type of tenant, every law, and even most of the politicians.

I also satisfied myself that the reason he wanted money was that he was growing his investment base very rapidly. I vetted his track record and it was (and is) extremely good.

On this particular deal, construction has run slightly above budget, it took longer to build, but the initial rent forecasts have proven to be very low.  Oakland is booming, this is in a great area, and ultimately he will have built a brand new product for a very good price.

Another negative: I had to put in more money partway through the project. It was not meaningful, but a bit disappointing and usually not a great sign.

My main lesson from this investment: get comfortable with how busy the sponsor is.  He is one of the busiest people I have ever met, and is running several projects at once.  This may have caused delays. Ultimately he offset this issue by handing the project management off to a very competent lieutenant – without that, I think we would have had even further delays.

As construction nears completion, I am very happy with this investment and believe it will perform well (15%+ IRR)

With these three deals over the last several years, I have taken the time to step back and ask: has this all been worth it?

I've been able to commit smaller amounts of capital and "try out" how certain deal types work for me (I won't buy apartments in a second tier town, for example). It's grown my relationship with these individuals, at least one of whom I would probably invest with again. But financially, I'm not sure how much better off I am than I would have been through crowdfunding. And I'm certainly getting lower returns than I am in my direct portfolio.

In the future, I would consider investing in other private deals provided they meet my very strict criteria. The investments would need to diversify my away from my existing exposure, and provide me something I can't or don't want to do on my own.

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