Real Estate Syndications - Key Questions to ask before investing ANY money with a syndicator

You want to invest in real estate. You've heard the success stories from your uncle who bought a fourplex multifamily apartment and from the Bigger Pockets Grant Cardone guru who keeps emailing you to invest $10k into their deal with very limited space left. You might understand some of the tax (depreciation) benefits and you also want to diversify away from your 95-100% public equities stock portfolio. What could possibly go wrong investing in a private real estate offering that should generate you a 20% IRR and 1.60x multiple on invested capital?

Before laying out some of the most important questions to ask when thin-slicing the countless syndicators that are soliciting your hard-earned dollars, I'll briefly overview what Syndicators are and why they exist.

What are syndicators? They are often individuals or small firms who crowd-source the equity needed to acquire commercial or multifamily properties, and often times they raise the equity in check sizes ranging from $10k - $50k, and from anyone who will give it to them. Investors in syndications are usually doctors, lawyers, corporate professionals, retired working class people… anyone with some cash to spare and wants direct real estate exposure.

Syndicating the equity needed to acquire commercial real estate properties is not a new concept, in fact, it has been around for a very long time. However, enabled by "Masterclasses" taught by "Gurus", thousands of new syndicators have crawled out of the woodwork in the last decade to "Build Generational Wealth in Real Estate". The vast majority of these men and women have little or no prior experience in the CRE industry, much less know anything about operating commercial properties. Many or all of these groups made lots of money from 2015 - 2021 by acquiring properties with virtually-free debt (sub 3% coupons), spending the bare minimum renovating the property, and selling into a market where nearly every multifamily property appreciated in value, regardless of quality, location, financial picture, etc. At the time of this writing, there are many cases of syndicators that have since blown up and lost tens or hundreds of millions of their investors' money.

 

Syndicators prefer the crowd-sourced model for a few reasons:

1) they control the deal and key decisions

2) they can charge very high fees and contribute very few of their own dollars or none at all into the deal

3) the capital is much cheaper than alternative options (institutional) - they get much more favorable profit splits when dealing with individual investors who aren't as familiar with the profit-sharing waterfall concept

4) they don't have to provide the same level of due diligence items that institutional investors demand, and don't need to have demonstrated track records through up and down market cycles

5) because they report to many individual investors (sometimes thousands), if they lose investors' money on a single deal, they can simply just call new, unknowing investors to do future deals with.

 

BUT, not all syndicators are the same and we've occasionally come across groups that have long track records and actually have been thoughtful financial stewards of their investors' capital. The following questions should help you discern the good from bad.

 

Questions for the Syndicator/Sponsor

  1. What percentage of the equity stack will you be contributing as the sponsor and how much of this amount is personally yours?

    Color: (You typically want to see the sponsor contributing at least 10% and up to 20% of the required equity - the higher the better - you need true alignment / their "skin in the game")

  2. What are the key operating assumptions for….

    1. Market rent growth?

      Color: (3% is acceptable but on the high end, anything higher is unrealistic) 

    2. Vacancy, bad debt, credit loss?

      Color: (these should combine to at least 7%, higher is more conservative = good)

    3. Expected rents & Renovation premium? 

      Color: (do the new rents that they are expecting to achieve make sense and compare with similar vintage properties in the area? This is another easy way to easily & artificially juice deal returns)

    4. CapEx? 

      Color: (Are they doing the bare minimum renovations or putting meaningful dollars into the property? Are deferred maintenance & back of house items such as roof, asphalt, elevators, etc. all being addressed?)

  3. What fees are you charging?

    Color: (1.0% acquisition fee (of gross purchase price), 1.0% asset management fee (of gross revenue), 2-3.0% construction management/development fee (of capEx budget) is typical and market. Anything higher and any additional fees are not justifiable. Additional fees that syndicators like to sneak in to pay themselves additional dollars are: capital markets/financing fee, leasing fee, disposition/exit fee)

  4. What is the profit split waterfall between investors and the sponsor?

    Color: (this is another way unknowing investors get taken advantage of. Investors should usually only give up a maximum of 20-30% carried interest "promote" to the sponsor as a reward for outperformance. Many syndicators will take 50-70%+. Most retail investors don't understand this concept and why it harms them)

  5. What is the untrended Yield on Cost? What Exit cap rate are you using?

    Color: (for value-add multifamily, the untrended Yield on Cost needs to be at least 150-200 basis points higher than where market cap rates are today. So if market cap rates are 5.5%, then the untrended yield needs to be 7.0 - 7.5% minimum. Often times, a syndicator will get around this by simply using a lower exit cap rate than what is realistic. Lower exit cap rate = higher underwritten sale price)

  6. What financing will be used?

    1. Fixed or floating?

      Color: (fixed rate is broadly considered safer because you know exactly what your interest costs will be upfront. Floating carries more risk)

    2. What leverage ratio (LTV/LTC)?

      Color: (55-65% is considered safe and less risky. Anything higher is concerning)

    3. DSCR?

      Color: (Generally going-in DSCR should pencil to at least a 1.50x. Anything below a 1.0x means that the NOI is not high enough to cover debt service costs, and anything between 1.0 - 1.50x is considered risky)

Note: I did not ask about IRR, equity multiple, or cash on cash yield. This is because these are outputs of many of the above assumptions and can easily be manipulated and inflated by improper or aggressive assumptions. Therefore, we recommend that you ignore any IRR, equity multiple, or cash on cash number that the sponsor advertises, and instead do your own analysis to determine if their assumptions are valid and realistic.

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