Investing in commercial real estate can help you build tremendous long-term wealth. But, most investors don’t have the capital, experience, or time to develop their own projects. Fortunately, an alternative exists – passive investing. More precisely, you invest funds and collect returns, and a developer handles the actual day-to-day management of the deal. As such, we’ll use this article to explain how to passively invest in a real estate development project.
Specifically, we’ll discuss the following topics:
- Why Passive Investing in Real Estate Development Makes Sense
- Options to Passively Invest in a Real Estate Development Project
- Final Thoughts
Why Passive Investing in Real Estate Development Makes Sense
Real Estate Development Risks and Rewards
Numerous real estate investing strategies exist. Among these, real estate development typically commands the highest returns. That is, the real estate professionals who can successfully convert an idea for a site into a stabilized property make a significant amount of money. For novices, this reality makes the idea of investing in development projects extremely attractive.
However, these high returns correlate directly to the risk a developer takes. During the entire development process – from site selection to funding to construction to stabilized operations – a deal can go off the rails in a variety of ways. When this occurs, developers run the risk of taking major losses.
Accordingly, new investors generally do not dive directly into real estate development. Instead, most gain exposure to these projects as passive investors. In particular, the following three factors make passively investing in a real estate development project a sound decision.
As outlined above, real estate development entails significant risk. Mitigating this risk to successfully complete a deal requires a ton of experience. Most real estate developers spend a number of years working for an established developer, which provides the experience and mentoring necessary to branch out as a solo developer.
As a passive investor, you avoid this experience requirement. While you do need to understand the numbers behind a deal to assess the investment, you do not need to run the deal from start to finish.
In addition to experience, real estate developments require a large amount of capital. Cash contributions can range from the hundreds of thousands to hundreds of millions, depending on the size, scope, and location of a deal.
As a passive investor, you are not required to contribute (or raise) all of this capital. Rather, you invest a certain amount of funds towards the total cash requirements, and the developer assumes responsibility for securing the remainder.
Development projects also require a massive amount of time to research, plan, and supervise. As a passive investor, you do not contribute your time – just your capital. This allows you to continue to focus on other pursuits (e.g. your business, a job, other investments, etc.) while still generating passive returns from a deal.
Options to Passively Invest in a Real Estate Development Project
Option 1: Crowdfunded Projects
Due to Securities and Exchange Commission updates, real estate developers can now raise funds via online crowdfunding. Through online platforms like Fundrise and Crowdstreet, developers list deals open to individual investors.
The online platform typically provides an initial screening of the deal’s underwriting, and then investors can review the particulars. If a given deal meets your investment criteria, you can then contribute cash for an ownership stake in that development project. Then, the deal sponsor (i.e. the developer in charge of the project), handles the day-to-day operations and provides distributions to you as a passive investor.
Option 2: Partner with a Real Estate Developer
Alternatively, investors can establish relationships directly with real estate developers. You can either do this through personal relationships or, frequently, CPAs have relationships with developers on the lookout for passive investors.
With this approach, you gain a level of trust working with an individual you know (or whom a trusted individual referred). However, this path also does not include the initial level of screening offered by crowdfunding platforms. As a result, passive investors working directly with developers should have a deeper understanding of how to analyze a potential deal.
Option 3: Buy Shares in a REIT
This option may not qualify as passively investing in a single real estate development project, per se, but it offers similar benefits. Real estate investment trusts, or REITs, are investment vehicles that allow people to pool capital for different sorts of real estate projects. You buy shares in the REIT, and the management team handles deal screening, execution, and day-to-day management. Tax law requires that these REITs then pay out at least 90% of their taxable income to shareholders as dividends.
Equity REITs (as opposed to debt REITs) invest in ownership stakes in real estate projects. Accordingly, you can choose to invest in an equity REIT focused on commercial real estate development projects that interest you. In this way, you passively invest in a development via a publicly-traded entity, so you don’t need pre-existing relationships with developers.
Option 4: Connect with a Commercial Real Estate Broker
You can also work with a commercial real estate broker to passively invest in a real estate development. Professionals like those on our team focus on building relationships with both developers and investors. This means that, at any given time, brokers likely know of a developer looking for additional capital to make a deal happen. By linking up with brokers, you can outline A) the cash you want to invest and B) the type of deals you’re seeking, and we’ll connect you with the right developer for your situation.
Successful real estate development remains one of the surest strategies to build long-term wealth. But, major obstacles prevent most new investors from diving directly into their own development projects. As an alternative, many investors choose to passively invest in projects – providing capital and receiving solid returns from a deal.
If you’d like to discuss different real estate investing options for your unique situation, we’d love to chat! Drop us a note, and we’ll set up a meeting to talk about available passive real estate development opportunities.