As passive real estate investors, it’s easy to get caught up in the allure of high returns and flashy deals. However, as Aleksey Chernobelskiy, a leading advisor for limited partners (LPs), warns, “Investments are complex, and dumbing them down to a single variable is a big mistake.”
Chernobelskiy, who has managed a $10 billion commercial real estate portfolio and now advises over 3,000 investors, offers invaluable insights into the world of syndication deals. In this episode of the Passive Investing from Left Field podcast, he shares his expertise on avoiding common pitfalls and becoming an active participant, even in passive investments.
Chernobelskiy’s Journey and Expertise
Chernobelskiy’s journey, from growing up in Russia to becoming a leading advisor in the real estate sector, is a testament to his depth of knowledge and commitment to empowering passive investors. By sharing his insights and experiences, he aims to help LPs make informed decisions and navigate the complex world of syndication deals.
“I didn’t see anyone operating in the space,” says Chernobelskiy, explaining his motivation for launching his advisory business. “After a few Google searches, I was like, well, you know, I think I can help. And so I launched, and here we are.”
Chernobelskiy’s background includes a quadruple major in Finance, Mathematics, Economics, and Accounting from the University of Arizona, as well as experience managing STORE Capital‘s $10 billion commercial real estate portfolio and overseeing the firm’s underwriting team.
This diverse experience has given Chernobelskiy a unique perspective on the real estate investment landscape, which he now shares with the LPs he advises. By providing weekly articles to over 3,500 investors on his Substack, Chernobelskiy aims to empower LPs to make more informed decisions and navigate the complexities of syndication deals.
The Importance of Proper Vetting
One of Chernobelskiy’s key pieces of advice is to thoroughly vet syndication deals before committing your capital. Contrary to the prevalent notion that passive investing is straightforward, Chernobelskiy cautions that many people have jumped into syndications without understanding the risks involved, ultimately “gambling” with their money.
“I think a lot of people who got into syndications over the past few years shouldn’t have,” says Chernobelskiy. “And that is not a comment on deals going bad or the state of the market. I just don’t think it was a wise idea.” He explains that while many people are drawn to the potential for high returns, the reality is that syndications can be complex, with a multitude of variables that need to be carefully considered.
Chernobelskiy stresses the importance of not simply looking at a single metric, such as the internal rate of return (IRR), when evaluating a deal. “It’s a massive mistake to filter deals based on IRR,” he says, “for the same exact reason” as focusing on a single variable. Instead, he encourages investors to take a more holistic approach, considering factors like the general partner’s (GP) track record, the proposed capital structure, and the alignment of interests between the GP and the LP.
“Investments are complex,” Chernobelskiy reiterates, “and dumbing them down to meeting or not meeting a single variable is a big mistake.” He believes that this oversimplification can lead to investors making decisions that are more akin to gambling than sound investing.
Being an Active Participant
While passive investing may seem hands-off, Chernobelskiy stresses the importance of remaining an active participant in your investments. He argues that the best passive investments “always start in a very active manner.” This means understanding the complexities of the deal, the alignment of interests between GPs and LPs, and being prepared to hold the general partners accountable if needed.
“Anyone who sort of discounts that, I think to be candid, I think they’re just gambling,” says Chernobelskiy. “And when you gamble, sometimes everything works out and you might 2x or 3x, and sometimes you lose all your money.”
Chernobelskiy emphasizes that as an LP, you are setting yourself up for risk by committing capital to a deal, and you have little to no say in what happens after the fact. “You need to be compensated for taking on the risk and funding the majority of the equity stack,” he says. This means actively ensuring that the deal structure is aligned with your interests as an investor.
One example Chernobelskiy provides is the scenario of a GP who is struggling to sell a property at a loss. In this situation, the LP may be “desperate to get their money out” and willing to accept a significant loss. However, the GP may be reluctant to sell at a loss due to the potential impact on their business and reputation. Chernobelskiy believes that in these cases, it is crucial for the LP to engage with the GP and hold them accountable, ensuring that decisions are made in the best interest of the investors.
Return On vs. Return Of Capital
Chernobelskiy delves into the critical difference between return on capital and return of capital structures, which can significantly impact the performance of your investments. He firmly believes that LPs should prioritize getting their capital back before the general partner is able to collect their promote, as this ensures a more balanced alignment of interests.
“There should almost never be the case when a GP is sitting inside of their promote before you’ve made your money back,” says Chernobelskiy. “And the reason why that’s important is if the deal goes sideways, the GP could be collecting part of their promote, and you haven’t made your money back. That is a very off-balance alignment of interests that an LP should not sign up for.”
Chernobelskiy explains that in a standard waterfall, the first step is the preferred return (pref), followed by the return of capital, and then the promote. He believes that skipping the return of capital step is a major red flag that LPs should be vigilant about.
Navigating Changing Market Conditions
In the current economic climate, Chernobelskiy emphasizes the need for LPs to set realistic expectations and understand the potential risks. He advises against blindly chasing high returns, urging investors to focus on sound investment principles that can withstand shifting market conditions.
“My advice wouldn’t change, regardless of what macroeconomics are in place,” says Chernobelskiy. “What changes is investor sentiment and emotions. Those are very separate, in my opinion, from what is sort of like a healthy investment principle.”
Chernobelskiy cautions that some LPs may take the approach of “well, I’m already in here, so it is what it is, whatever happens happens.” However, he believes that for LPs who have a significant amount of capital invested or a deep understanding of syndications and real estate, it’s important to remain engaged and hold the GPs accountable.
“A healthy GP should keep themselves accountable,” he says. “What tends to happen when GP interests and LP interests start to diverge in distress situations is they need someone else to keep them accountable.”
Chernobelskiy provides an example of a scenario where the GP is reluctant to sell a property at a loss, even if the LP is requesting it, due to the potential impact on the GP’s business and reputation. In such cases, he believes that the LP has a responsibility to step in and ensure that decisions are being made in the best interest of the investors.
Whether you’re a seasoned investor or just starting your passive investing journey, this episode is a must-listen. Chernobelskiy’s practical advice and unwavering focus on aligning interests between GPs and LPs can help you avoid costly mistakes and maximize your returns in the long run.
By taking a more holistic approach, understanding the nuances of deal structures, and being an active participant in your investments, you can position yourself for long-term success in the world of syndication deals.
So, don’t be afraid to ask the tough questions and dig deeper into the deals you’re considering. Your future self will thank you for the time and effort invested in properly vetting and understanding your passive real estate investments.
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This article is for educational purposes only and is not to be relied upon as the basis for entering into any transaction or advisory relationship or making any investment decision. All investments involve the risk of loss, including the loss of principal. Past performance, and any performance results reflected in this article, is not an indication of future results.
