Mortgages & Creative Financing

Don’t Make This Mistake and Leave Money on the Table When Syndicating Deals

Expertise: Business Management, Commercial Real Estate, Landlording & Rental Properties, Real Estate Deal Analysis & Advice, Mortgages & Creative Financing, Personal Development, Real Estate Investing Basics
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I’ve recently had a chance to speak with several real estate investors who want to raise money to purchase multi-family properties, and they’re all making the same mistake.

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They’re giving their investors far too much of the deal and very little (or nothing at all) for themselves.

How is this a win-win?

This tells me that they’re either talking with very sophisticated investors or they’re copying the deal from a very experienced investor who is raising money from very sophisticated investors.

This is a Big Mistake

While sophisticated investors do give you access to big money, they do so by wanting terms that are very favorable to them and leave little on the bone for you.

I’ve been down this road several times myself and every time my gut told me not to do it. I’m glad I listened, and so should you.

I ask the investor how they’re structuring the deal, and they tell me, “I’m giving my investors an 8% preferred rate of return with 80% equity”, and I say “Wow, did it occur to you that you might never make any money on the deal – ever?” And then they give me a puzzled look like I’m crazy.

RelatedHow to Structure Syndicated Investor Deals: What Investors Are Looking For

Let’s assume that you take a $100,000 investment from a single sophisticated investor wants to bankroll you, and you’re eager to take his money because it means you can do your next deal.

You’ve got your happy ears on.

You project a healthy 10% cash on cash return and maybe a little higher in subsequent years. Your deal isn’t a real value play but there is some upside.

Giving the investor an 8% preferred return means that the first $8,000 of cash flow are paid out first to the investor, and then the investor gets 80% of what’s left over and you get 20%.

Let’s translate this to real dollars. Let’s assume you’re actually making a 10% cash on cash return in the first year (as projected), which is $10,000 per year. Of that, the investor gets $8,000 off the top (8% of his invested $100,000), which leaves $2,000 of cash to distribute. Of that, the investor gets 80%, or $1,600 and you get $400. So the investor is paid $9,600 and you are paid $400.

Really? You’ve done and are still doing all the work, you looked at 80 deals before you finally got this one under contract, you completed the due diligence, raised the money, got the financing, risked your deposit and against all odds succeeded to close the deal. Then you sifted through property management companies until you selected the best one. Now they are optimizing income and adding value. And you get paid $400 per year? Really?

That was the Best Case Scenario

What happens if you’re projections don’t go quite as you predicted, and you only achieve a 5% cash on cash return. That means that ALL of the cash flow is distributed, and you get paid NOTHING. That’s right, nothing. And what’s worse, the 3% (or $3,000) you failed to pay out are now carried over to next year, so that in the next year, you owe 11%.

Do you see where this could go? You might never get paid anything at all, ever! And you might even owe money when you sell!

Well, you say, you’ll get paid at the end, when you sell. That’s because you have none of your own money in the deal. So, fair enough, you might get paid something in 5 years when you sell. But you’ll only get 20% of any profit, and that’s after your investor is paid his preferred return and his 80%, and then you get paid what’s left. Unless you knock it out of the park, you’ll hardly see anything worthwhile.

Why bother with something like this? Just so you say you’ve syndicated a deal?

Don’t be that guy (or gal) that works only for the investor. This is such a sweet deal for the investor and not at all for you. So don’t do it.

What’s the lesson here?

Don’t take money from very sophisticated investors until you have a very established track record and are doing BIG deals.

Here’s the Alternative

Raise money from friends, family and high net worth individuals (I’ll call both collectively “friends & family”).

What’s the difference between friends & family and the sophisticated investors?

While it’s true that friends & family may not be able to give you a million dollars to invest, they are capable at investing  $50,000 and more. However, they’re not going to ask for a preferred return, so don’t offer one.

Also, keep it simple. Don’t talk about advanced concepts like “IRR” (internal rate of return) because no one will know what to do with this and it will only confuse them. Talk instead about annual cash flow (the “cash on cash” return) and the average annual return. These are concepts the friends and family investor will know and care about.

RelatedDissecting an IRR: A Quick Way to Assess Investment Risk

If you currently have a single sophisticated investor who wants to invest with you but only at terms that are very favorable to him, then it’s time to expand your horizons and start talking to other individuals.

Will this be a little more work? Probably. But is it really worth doing a deal you won’t get fairly compensated for? I would say decidedly not.

I don’t offer a preferred rate of return to my investors, and I give them 60% to 80% of the deal. How much depends on what I need to do to achieve the 11% – 15% average annual returns I want for my investors. If the deal is awesome I may be able to keep more equity, if it’s a little skinny I might have to give up more. But I want to end up with at least 20% of the deal for syndicating the whole thing. Anything less than that won’t be worth it for me.

At the end of the day, you want a win-win for you and the investors. Make sure you’re not giving up too much when you’re syndicating your next deal!

How are you structuring deals with your investors? What’s been working for you (and what hasn’t)?

Michael Blank is a leading authority on apartment building investing in the United States. He’s passionate about helping others become financially free in 3-5 years by investing in apartment buildi...
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    Sharon Tzib
    Replied almost 6 years ago
    Great info, Michael, as usual. Those examples were pretty eye opening!
    Michael Blank Rental Property Investor from Northern Virginia, VA
    Replied almost 6 years ago
    Thanks Sharon!
    Scott Isley
    Replied almost 6 years ago
    Kudos Michael, Good post! Why do I feel this was directed at me? 🙂 Changed up investment strategy from this advice. Thanks!
    Michael Blank Rental Property Investor from Northern Virginia, VA
    Replied almost 6 years ago
    Eric Drenckhahn
    Replied almost 6 years ago
    I actually just declined a preferred investor deal in TX. 8% guaranteed, carried over. It wasn’t a lot of money, and I may need it for a better deal here in MN that has come up. Nothing is actually guaranteed. Borrowing money from friends, and losing it, might be worse than having a deal with no profit. I know if I borrowed 50K from a friend, and the deal went sour and I could only pay them back $40K after 5 years, I would feel very bad. After all, most syndicators do not have anything but time and some legal expenses in the deal. And they are the ones who control the deal, and have done the due diligence. If they did it bad, they should be the ones who suffer most.
    Michael Blank Rental Property Investor from Northern Virginia, VA
    Replied almost 6 years ago
    Eric … losing other people’s money in general is TERRIBLE. I feel a much higher sense of responsibility when I invest other people’s money than when I use my own. It is truly a huge responsibility. Certainly, losing your father in law’s or friend’s money is worse, and some people don’t take friends and family money because of that. I think that’s a mistake. Nevertheless, if the deal goes sour it will make for some awkward Thanksgiving dinners! WRT the syndicator suffering the most. I think the syndicator and the investors must be aligned. If the deal goes well, everyone makes money, if it goes bad, everyone loses. It’s got to be a team effort, and that’s how I approach my deals.
    Hadar orkibi
    Replied almost 6 years ago
    it sound rather counter productive doing that for the 20%. im not sure if it is the norm in the states BUT i would suggest you split the balance over 8% 50%/50% if you have to. Here property fund offer set return and future capital growth no extra on the return. And, often the shareholders pay an annual rate of sat 2% of the PORTFOLIO VALUE to the management company who is the original investor who set the deal up.
    Brian Burke
    Replied almost 6 years ago
    There is also a middle ground–it’s called the catch-up provision. First, the investor gets 100% of the profit until they get their 8% pref, then the sponsor gets 100% of the profit until they receive as much as the investor received, then after that the profits are split according to the percentage, 70/30, 80/20, or whatever. This way, if the sponsor doesn’t do a great job or the deal didn’t perform all that well, the investor investor gets some return on their money. On the other hand, if the sponsor performs as forecasted, they end up getting the whole 30% or 20% split. So many different ways that deal structure can be designed to carve up the pie!
    Michael Blank Rental Property Investor from Northern Virginia, VA
    Replied almost 6 years ago
    Brian, I had not considered that as an option, but I like it …!
    Replied almost 6 years ago
    This is exactly why I have not completed any syndications. My commercial clients are very sophisticated with money and want a preferred return. I am fine with that but do not have the time to babysit a project for syndicating for a marginal return in todays dollars. I have also heard if you get a loan and have more than a 20% equity interest then you will have to be on the loan as well regardless of contribution money. I can make 5 to 6 figures in commercial real estate commission per deal with clients so the syndicate route makes me less money and take sup more time. I am looking at making a syndicate up for acquiring distressed commercial land banks are dumping for development. I can find the parcels and they can be purchased. I make commission going in and out plus 20% equity when it sells. Buy all cash and sit on the dirt for a few years and make a 3 to 5 times multiple or better over acquisition cost. It works for me because it gives me projects that do not require my constant attention so I can keep transacting. It works for investors with large wealth who do not care about cash flow but equity growth goals in a certain number of years. The other downside to syndicating is built in costs. You have to find an exceptional deal to make the number work versus a regular purchaser. Syndications have there place but are not the end all to be all. It seems on value add syndication there is more room for profit with forced appreciation. ( I am talking about 50% occupied type deals and not fully performing but rents can be increased etc.)
    Michael Blank Rental Property Investor from Northern Virginia, VA
    Replied almost 6 years ago
    That’s true. As the sponsor you will sign the mortgage docs. There’s no question that you will need to find higher-yield deals to achieve a reasonable return for your investors. On the other hand, syndicating deals allows you to do more and bigger deals and will accelerate your ability to build wealth because you are not limited by your personal funds. However, brokering deals during a time when it’s hard to find good deals is an excellent place to be! (like the gold rush: why look for gold when you can supply the shovels!)
    Hadar Orkibi
    Replied almost 6 years ago
    I Agree with Brian Burk, we must remember that EVERYTHING is negotiable. managing an investment fund or syndication doesn’t have to be ban idea to the investor. I suggest give the money investors set return and future % of capital growth if you sell. The organizer investor who does all the work: should be putting money in as share of the equity and return on that, give monthly property management fee if he manages the property, and have an asset management fee over all the portfolio of say 2%pa. AND usual some fee for relet % fee if it is commercial property.