Right before the great recession, I invested some money with a local real estate developer (we’ll call him “Ben,” but that’s of course not his real name!) along with a dozen other investors.
He had a fabulous reputation, and the project looked solid. For several months he made distributions and communicated regularly.
Then it all suddenly stopped.
Not only did the email updates stop, but phone calls weren’t returned, either. After a few months of this, the investors started to organize conference calls to collectively find out what was going on. Once that proved fruitless, one of them started calling the state’s securities office and his attorney.
You know where this story is going. That’s right: to court. And the SEC started an investigation. And of course the investors lost ALL of their invested capital.
When I started raising money to flip houses and later invest in apartment buildings (and restaurants!), I vowed that I would do things differently. You’re of course counting on smooth sailing, but what if things don’t go as planned?
3 Rules to Follow When Something Goes Wrong With Your Investment
1. Don’t Lose Principal
Of the 34 or so houses I flipped in my career, 30 involved other people’s money, and two of them didn’t do well. In fact, they lost money. One, I’m embarrassed to say, lost a lot of money — despite all of the experience I’ve built up to this point.
But my investors NEVER lost money. They ALWAYS got their principal and interest.
That means that I took the loss, even though legally I had the right to protect my downside and default on my promissory note and let the investors foreclose on me.
But that’s no way to treat your investors — and certainly not a way to build your career as a syndicator.
Sometimes there are situations where you simply can’t take a loss if things really go south. However, I’ve seen other syndicators take investors’ money and run for the hills when things went sideways without at least trying to make it right. And that is unacceptable to me.
2. Don’t Stop Communicating
When I purchased my first 12-unit apartment building with a handful of investors, the first 12 months did NOT go well. In fact, the prospect of running out of money and defaulting on the whole thing appeared inevitable (read the entire saga here).
When I wrote my first annual report to the investors and compared my projections to actuals, it wasn’t a pretty picture. And my investors of course weren’t happy. But they weren’t calling their attorneys, either.
One thing I did throughout the year was not only to communicate regularly as I had promised, but I actually INCREASED the level of communication. Therefore, investors knew what was going on and weren’t caught by surprise at the end of the year.
It’s always crucial to communicate with your investors on some kind of regular schedule, but it’s even MORE important when things aren’t going to plan. Communicating isn’t just common courtesy and more professional, it also staves off p**sed-off investors who might call the local securities authorities and their lawyers.
Related: Warning: How to Handle a Real Estate Investment Gone Bad!
One other consideration: if you communicate with your investors, they can act as your advisors and may actually be able to help.
3. Don’t Cut (Legal) Corners
I really didn’t like lawyers. I felt like they always looked for ways to run the meter on you. While that may still be true, I also learned (sometimes the hard way) that cutting legal corners can bite you.
For example, in the case of our friend Ben — he ended up with an SEC investigation. Why? Because he didn’t follow the rules. He didn’t give the investors the private placement memorandum and file Form D with the federal SEC and the proper local states.
When things go great, no one asks about what’s in the contracts. But when things go south, people start digging through the documents. And if you don’t have your i’s dotted and your t’s crossed, things can get ugly. Make sure you have your attorney involved with EVERYTHING you do. I know it’ll cost you money, but it’s cheaper than the alternative!
Related: Top 10 Ways to Make a Bad Real Estate Investment
Always do things by the book, disclose everything, communicate regularly and do your very best to return all of the investor’s principals. If you do all of these things, then even if a project isn’t going the way you projected, you will continue to be able to attract capital and do more deals.
Have you had an experience with a project that didn’t go so well (either one of yours or someone else’s)? What happened?
Leave a comment below and tell your tale!
The post 3 Unwritten Rules for When Things Go Bad With Your Investors is property of The BiggerPockets Blog. and is Copyright © 2014 BiggerPockets, Inc. All Rights Reserved.