My business partner Adam tells a story that perfectly illustrates how easy it is to fool yourself about a deal.
He was on a call with a potential investor, walking through the underwriting on an apartment building we were looking to buy. The investor interrupts and says, “I only invest in deals with at least a 20% IRR.”
Adam pauses, then says, “Oh, I can make this a 20% IRR deal right now.”
He pulls up the spreadsheet, scrolls to the exit assumptions, and lowers the exit cap rate by a couple of points. Boom. Instantly the deal shows a 20%+ IRR.
Adam did this to prove a point: the investor was so focused on hitting an arbitrary IRR number that he didn’t care how that number was achieved. By tweaking just one assumption (an assumption completely outside anyone’s control) Adam manufactured the “20% IRR” the investor wanted.
The investor was chasing a number without understanding what was driving it. And when you don’t know what drives a deal’s returns, you can think you’re investing when you’re actually speculating.
The Difference That Matters
Most of us understand the basic difference between investing and speculating.
Proper investing usually means buying an asset that produces income and/or appreciates based on factors someone can actually influence. The returns come from how well the operators execute, whether that’s the property management team improving operations at an apartment building, or the leadership team at a publicly traded company.
You can calculate expected returns based on things the operators can influence. Sure, there’s uncertainty. But you’re not making bets on uncontrollable market forces.
Speculation is different. You’re playing a game of “number go up” and hoping someone pays more for the asset later. The returns depend almost entirely on market sentiment and/or timing. Most cryptos, meme stocks, flipping houses in a hot market without doing any work…those are all speculation.
The Gray Area
I see passive investors walk into this trap all too often.
You decide to invest in syndications. You see a deal for a value-add apartment building. It checks all the boxes: good sponsor, solid business plan, tenants in place, clear path to improve operations.
“This isn’t speculation,” you think. “This is exactly what I should be doing.”
Maybe. Maybe not.
The key question isn’t what you’re buying. It’s what’s driving the returns.
What Can Actually Be Influenced?
Think about what a deal sponsor can actually move the needle on:
Increasing occupancy
Debt paydown over time
Reducing expenses through better management
Raising rents through renovations and improvements
If most of the deal’s projected returns come from these factors, then yes, you’re investing.
But if most of the returns depend on things the sponsor has zero influence over? That’s speculation.
The two biggest factors outside anyone’s hands:
Interest rate assumptions – betting that rates will drop enough to refinance at a higher value and/or lower rate
Exit cap rate assumptions – an extension of interest rates, this is betting that market cap rates will drop significantly by the time you sell or refinance, significantly increasing the value of the property
These are massive levers that can make or break a deal’s returns. And they’re completely outside the sponsor’s power.
So if you can’t break down which portion of your returns comes from what the sponsor can influence versus what they can’t, you might be walking into a speculative bet disguised as an investment.
How to Figure This Out
So how do you know if a deal is investment-grade or just dressed-up speculation?
It requires diving into the weeds. You usually can’t tell from the high-level numbers in a pitch deck.
You need to look at the sponsor’s underwriting. Get on a call with them. Ask how they arrived at their projections, especially around exit cap rates and refinance assumptions.
And ask the uncomfortable question: “What happens to the returns if interest rates stay where they are, or go higher?”
If the deal falls apart with that one question, you have your answer.
Know Your Buckets
If you want to invest in ground-up development deals (mostly speculative) or YOLO some money into meme stocks, go for it. Nothing wrong with that.
But when you do that, you know what you’re doing. You know it’s speculative and higher risk (or at least you should). What you don’t want is to put something in your “conservative investment” bucket when it’s actually a speculative bet that belongs in your “high risk” bucket.
Know the difference. Understand where the returns come from. And once you have a good grasp of that, be honest with yourself about which bucket you’re putting an investment into.
Because the last thing you want is to wake up one day and realize the “safe” deal was actually nothing more than a gamble on interest rates.