Most investors shouldn't pick their own private real estate deals.
Why?
There is huge dispersion in outcomes, quality, leverage, fees, assumptions, and operator skill.
Manager selection matters a lot more in private markets. And this is just Funds. Imagine how wide the dispersion is for individual properties.
You can do it, but it requires work + skill.
“I know a guy with a deal” is not an investment process.
All pitch decks sound good. The hard part is pricing the RISK.
The number of investors I talk to that A) just pick whatever deal shows the highest IRR or B) think real estate is basically “risk free” would… well… shock you.
However, there are savvy investors on the other end of that spectrum.
The high net worth investors that can pull off deal-by-deal investing (individual properties vs. funds):
- Have time to conduct diligence
- Have real deal flow (takes 5+ years to build)
- Have built up deal "spidey sense" (BS detector)
- Are a former operator or allocator
- Understand that some properties will lose money
- Know their way around a financial model
Yet, far too many people invest their entire real estate allocation into only one property.
This is wild to me.
I’m not sure people understand that even elite operators lose money - almost all have a small percentage of their deals go sideways.
Done well, real estate is hard to beat: non-correlated, highly tax-efficient. But leverage cuts both ways. The margin for error is thinner than most realize.
Therefore, you should be thinking of your real estate investing at a portfolio level.
Where good and great deals can outweigh an unlucky loser.
Because sh*t happens.
Yet, for some reason people think it's fine to let it ride on one deal.
That's the equivalent of putting your entire retirement account in one stock.
Or to a lesser extent, being too reliant on just one sector (we’re seeing a lot of that today via overexposure to technology stocks).
Easy to forget, but concentration is for getting rich, diversification is for staying rich.
And unfortunately, proper diversification in real estate ain’t cheap.
If you must invest deal-by-deal, make sure you have enough capital to spread it around into high-quality sponsors / assets.
Brad Johnson
(1) Research: Blackstone
