You have probably seen the news about turbulence in the marketplace. If you haven’t read about it, you’ve heard about it around the office, in line at the grocery store, talking to neighbors, and everywhere else. Investors often feel exposed when you aren’t at the table when the deal is done. Limited partners might not be sure if your general partner is making the best decisions to protect your investment. We’re not one to beat someone when they are down. There are a lot of articles and blogs about the failures of property owners navigating the ugly world of foreclosure. Lots of finger-pointing happens and we aren’t here to do that.
We are, however, here to talk to you about why we take conservative underwriting so seriously. We would never bring you a deal unless the numbers work, with mutually beneficial protections in place. No one can promise certainty, but we can promise transparency and a proven system of conservative underwriting to best support your investment.
So, what constitutes conservative underwriting?
Conservative underwriting is the process of estimating the value of a property or investment conservatively, or on the low side. Making the numbers work with lower estimates minimize the risk of loss. When acting as the general partner (GP) of a real estate syndication, we practice conservative underwriting to protect the interests of you, our limited partners (LPs).
There are several factors we consider when conducting conservative underwriting, including:
- The current market conditions.
- The potential for future changes in the market.
- The specific risks associated with property or investment.
By considering these factors, we develop a more realistic estimate of the value of the property or investment and can make better decisions about how to structure the syndication.
When we were underwriting The Ivy at The Galleria deal in Houston, Texas we included the purchase of a rate cap to protect the interests of our investors. A rate cap is a financial instrument that limits the amount of interest that can be charged on a loan. In the event of rising interest rates, a rate cap can help to protect the LPs from paying more interest than they were originally expecting. This is the single most valuable piece of protection available in the face of rising interest rates.
How do Rate Caps Help Conservative Underwriting?
There are several distinct types of rate caps available, and the best type for a particular syndication will depend on several factors, including the length of the loan, the interest rate, and the risk tolerance of the LPs.
Purchasing a rate cap can help ensure that the LPs are not exposed to excessive interest rate risk. This can help to protect the value of the investment and can make the syndication more attractive to potential investors.
A few additional benefits of conservative underwriting and purchasing a rate cap:
- Increased investor confidence: When investors see that we, as GP, are taking steps to protect their interests, they are more likely to invest in the syndication.
- Reduced risk of default: By conducting conservative underwriting and purchasing a rate cap, the GP can reduce the risk of default on the loan. This can help to protect the value of the investment and can make the syndication more attractive to lenders.
- Improved cash flow: By locking in a lower interest rate, we can improve the cash flow of the investment. This can benefit both the GP and the LPs.
Mitigating Risk for Passive Investors
Overall, conservative underwriting and purchasing a rate cap are two important steps that can be taken to protect the interests of limited partner passive investors and to improve the success of the syndication.
If you would like to learn more about how to evaluate risk and benefits in a syndication offering, as well as all of the other details including how we work to protect our investors, check out our new course Passive Investor Coaching. We created this course with the goal of helping educate our limited partners to help them make the best decisions possible for themselves. We want all of our investors to have an easy pathway to meeting their goals for themselves and their families.