Vetting Syndicate Offerings and Sponsors

16 Replies

Hi. I'm new to the RE investing world and am working on educating myself on real estate syndicates. In particular, how to best evaluate potential deals and the sponsors running those deals. This is from the perspective of coming in as a passive limited partner to a 506(c) fund. I do have a fair amount of experience evaluating stock market investments, but translating what I know there to evaluating syndicate deals and sponsors is what I'm hoping the community can help me with. Any links, books, searches, and particularly, personal experience and advice is welcome. 

Thanks in advance,

-Jamie.

If this isn't the right section for this post, please let me know. I did look around to see where I thought it would best fit. Ultimately there were other syndication related posts here from a while ago, so I dropped mine here as well.

Hi @Jamie Turbyne , in order to improve your changes of being successful at investing in a syndicate you need to be able to evaluate the following:

1) The Sponsor - this is the team of people that source, the deal, get it under contract, define and execute the business plan and who manage the property managers. The most important factors in my opinion are their track record, whether or not they specialize in the asset type/business plan that they are offering

2) The Deal - you should be able to underwrite a deal and if you cannot there are many educational resources that will allow you to learn how to. You should look for conservative assumptions in the underwriting model, especially because of the long trend of declining cap rates / rising prices.

3) The Financing - is there financing in place for the duration of the business plan, are there penalties for refinancing (this is one exit strategy), are the projected rates realistic?

4) The Management Company - look at their track record, do they specialize in the area that the deal is located, do they have experience executing the type of business plan proposed

5) The Market - you need occupancy and ideally higher rental rates to make your investment work. We can be more confident in this if we see employment, population and wage growth, diversity of employment and a balance between supply of apartments and demand

I could go into so much more detail on any of those bullet points but I wanted to give you an idea of what to look for. I would suggest registering with a number of syndicator once you select an area and an asset class so that you can familiarize yourself with the kind of deals that they offer. Good luck!

Thanks @Ronan Donnelly , that's exactly what I was looking for. My primary focus is looking for syndicates that are investing in segments of the market that should be more recession resistant. Things like mobile home parks, self storage and retirement / assisted care communities. Ideally I'm looking to diversify a bit away from the stock market and into parts of the real estate market that are, hopefully, not overheated. As I have a full time job, and I'm fortunate to meet the Accredited Investor criteria, this seemed like a reasonable way to approach it.

-Jamie.

@Jamie Turbyne , what we saw during the last recession was that prices compressed, rather than dropped uniformly. What this meant was that lower cost rentals were less impacted than higher prices rentals. You are on the right track to look into mobile home parks (prices were not really impacted and there are real restrictions on any new supply, self storage is more of a discretionary item so may be more impacted in a downturn, retirement / assisted living certainly has growing demand but you should also check on supply. Class B/C multi family also did very well during the last recession as people downgraded from class A apartments and also needed somewhere to live when they lost their SFH's.

Also bear in mind that recessions don’t impact all areas equally so you might want to consider economic factors into your decision process like population growth, wage growth etc. Good luck!

@Jamie Turbyne this is a pretty loaded question and the answer isn't so simple.  In fact, the answer could be an entire book.

The good news is BP is putting out a book on this exact topic, authored by yours truly.  The bad news is it won't be released until the spring.  If you are interested in it, it's called "The Hands-Off Investor."  

Meanwhile, I posted a response in another thread a while back that contained a bunch of links to forum threads discussing various aspects of syndication.  Check it out:  
https://www.biggerpockets.com/forums/432/topics/736523-what-red-flags-to-look-for-as-a-limited-partner-in-syndication

Originally posted by @Jamie Turbyne :

 A lot of the books and resources I found were more on how to setup and run a syndicate. Finding info on how to evaluate one as a potential investment has been harder to come by.


That's exactly why I saw the need to write it!  Everybody wants to teach people how to be syndicators, not how to invest in syndications.  Probably because many sponsors don't want their investors to know all of the secrets.  :)

 

Originally posted by @Brian Burke :
Originally posted by @Jamie Turbyne:

 A lot of the books and resources I found were more on how to setup and run a syndicate. Finding info on how to evaluate one as a potential investment has been harder to come by.

That's exactly why I saw the need to write it!  Everybody wants to teach people how to be syndicators, not how to invest in syndications.  Probably because many sponsors don't want their investors to know all of the secrets.  :)

 

 

Well then, I look forward to reading it. If I've already invested in one by the time it comes out, hopefully it don't have an, "Oh crap, I missed that red flag." moment!


-Jamie.



Excellent advice here already. @Brian Burke I didn't know you have a book coming out! I'd love to help promote it.

If you can track down previous investors in a particular fund, that's a bonus. I try to do that when evaluating partners, to learn how they handle themselves when things go wrong.

@Jamie Turbyne , For vetting a syndication, different investors do it differently because every investor comes from a different financial situation and has different goals and risk tolerance. For me, I'm a very conservative investor and may look through a hundred deals a month, and at the end of the year only invest in 4-5. So things that are a red flag for me may be fine for someone more aggressive. Here's how I do my due diligence:

1) Portfolio matching: (takes 30 seconds per deal)

a) Have an educated opinion on where you think we are in the real estate cycles (financial and physical market cycles)

b) Then only then pick the strategies, capital stack, and specialized asset subclasses that make sense for that opinion. For example, I think we are late cycle, so I lean toward the safest part of capital stack which is debt (or debt free equity). I won't go with the riskiest opportunistic strategies, and will stick to core and core plus mostly with some value-added. I won't be investing in the riskiest/most supportable asset subclasses such as hotels, and tilt my portfolio the ones that have historically been more stable such as multifamily and single-family housing. I also don't want refinancing risk, so any deals with only 3 to 5 year debt are out for me. For someone that's not as conservative, or a different view on the next recession, they might have a different opinion than me on all of this

2) Sponsor quality check: (takes about 45 minutes per deal)

I believe that a great sponsor can take an average looking deal and make it great, and that in mediocre sponsor can take a fantastic looking deal and make it bad (especially if there is a severe recession). So I start with the sponsor first. Again, others might disagree.

a) Track Record: Get the entire track record for the strategy. As easy as this sounds, it's not simple and usually like pulling teeth. Many times they will claim it's wonderful and then try to hide their worst deals by only showing completed deals. Make sure to get unexited deals. Or if they are doing value-added multifamily, they will show you their hotel experience. That doesn't cut it for me. I want a specialist that's an expert, and not a jack of all trades and master of none. Also, in a mainstream asset class like value-added multifamily, I see no reason to take a risk on a sponsor that doesn't have full real estate cycle experience and didn't lose money. Again, other might feel differently here.

b) Skin in the game: as a conservative investor, I understand that the dirty secret of industries that the waterfall compensation is in the line with me and incentivizes sponsors to take more risk. So I require skin in the game (average is 5% to 15%) to offset this. Contrary to popular belief, this is not set because I believe it will give me a higher return. I believe it tends to give me a slightly lower return, because the sponsor is going to be more careful, and if there is a severe downturn will prevent me from taking catastrophic losses. Someone that is more aggressive, may want lesser even though skin in the game. Also, if the sponsor is new, I am fine with less skin in the game as long as it is significant to their net worth. On the other hand if they are a sponsor that is experienced in stopping a skin in the game, that's a huge red flag for me.

c) how open to scrutiny are they? I always discuss investments with others in an investor club because other people might think of things that I might miss. And even though virtually every sponsor agreement allows me to share investment information with others who might be advising me on it (especially when club members are bound by an NDA), I still ask the sponsor if I can share it, because it's a test. Most are fine with that, but a few will have problems with it and claim there are legal issues, etc.. That's a red flag for me.

d) death by Google: I Google everything I can about the sponsor. I check the SEC, FINRA, ratings websites for inside information on the principals in the company. I also look for lawsuits and see what happened in them. Many times it's an easy red flag. Sometimes it's ambiguous, but even then, why should I bother with the company that has numerous unresolved lawsuits, versus another company that is virtually the same but has none. Again, others might feel differently here.

3) property level due diligence: (takes seconds to weeks per deal): here is where I drill in with the low-level details.

a) pro forma popping: I examine all the assumptions, and see if they are overoptimistic or not. I look at every single item in the pro forma and imagine that it is complete BS, and see if I can challenge it. If there's a hole, it may be a red flag.

b) sensitivity analysis: I examine all the assumptions, and make sure I can live with the worst case scenarios.

c) "Stall and see": if they are getting money over multiple years, and there is no penalty for investing later, I would usually wait so I get some real performance data, versus having to look at theoretical pro forma information.

d) Recession stress test: I will not invest in anything, until I subject it to recession level stress and see if I can live with the result. And I take the worst recession I can find in the recent past. Sometimes there is only great recession data, and that recession was pretty mild on some asset classes, versus previous recessions. So I will usually 1.5x or 2.0x the stress. If the deal collapses and I would lose everything, I'm out. Others might be fine with taking risk, but least by doing this a person can get an idea of what might go wrong.

e) Legal document analysis: it will usually take a few days to go through the legal document properly, as almost inevitably there are tons of gotchas that either have to be explained, or mitigated with a side letter.

That is the very short summary of what I do. If you want more information, p.m. me and I can give you a lot more details.

@Jamie Turbyne

Not many posts here can beat what @Brian Burke already stated. :) Anyway that's not the point. I'm sure you can agree that just like with anything including the stock market, it takes awhile to understand the fundamentals, learn and become an expert (or somewhat of an expert) in any field. The same rule applies to real estate syndications business. So the way to go is to break it down into smaller pieces. What's involved: the syndication which as @Ronan Donnelly mentioned consists of 

1) the sponsor; 2) the market; 3) the deal

Let's look at it one by one:

1) So you evaluate the sponsor, talk to them. Here's a guide with questions to ask them: 

https://www.biggerpockets.com/member-blogs/10850/76728-questions-to-ask-a-syndicator

2) the market:

look at the metro demographics; job and population growth; supply versus demand; keep in mind that it will differ from one asset class to another. 

another guide is: 

https://www.biggerpockets.com/member-blogs/10850/81214-what-goes-up-must-come-down-or-market-cycles-fluctuation

https://www.biggerpockets.com/member-blogs/10850/86626-the-pros-and-cons-of-investing-via-real-estate-syndication

3) last but not least is the deal itself:

here is where you can leverage your stock market research and understanding background to see the full picture of the investment and look at such things as IRR, CoC, Eq Mpl, and etc... as a whole!

A few more resources:

https://www.biggerpockets.com/member-blogs/10850/87614-interpreting-the-private-placement-memorandum-ppm

https://www.biggerpockets.com/member-blogs/10850/84504-step-by-step-process-on-how-to-invest-in-a-real-estate-syndication

https://www.biggerpockets.com/member-blogs/10850/79257-deciphering-syndication-investment-terminology

Bottom line: take your time to understand the fundamentals, compare multiple offerings (but ensure you're doing "apples to apples" comparison and not "apples to oranges"!)

My best!


Thanks @Taylor L. and @Ian Ippolito .

Ian, what I'm looking to do seems to align pretty closely to what you outlined. As I mentioned above, my investing history is completely in stocks and other things that are publicly traded on the market. My portfolio there is divided between more aggressive growth and some fairly conservative (for as conservative as single stock investing can be) positions geared more towards slower growth, but paying out decent dividends. What's happened is that these more conservative positions are now valued well beyond what their fundamentals and growth rates would justify. So, from a capital appreciation standpoint there's risk there, and from a yield standpoint, it's no longer all that attractive because of the price appreciation. Many of these companies are "bond alternative" names, and with rates as low as they are, a lot of the price appreciation is coming from investors and funds seeking yield... If the price has been bid up to make the yield less attractive, and the price can't really be justified by the fundamentals or the growth rate, my conservative stock no longer seems so conservative!

Knowing a few people that do real estate, and that are here on BiggerPockets, I started digging around. This led me to syndicates. Weighing what I think the next ten years might look like from a total return standpoint on my "conservative" stock positions, versus what the same ten years might look like if that money were in syndicates, I'm fairly convinced the better total return can be had in the syndicates. 

-Jamie.

Nothing says Happy Saturday more than a bit of number crunching. +10 for coffee! I've been looking at the Prospectuses (Prospecti?) of a few funds, and one thing that caught my eye in a couple of them were the projected cash-on-cash returns. To try and make my life a bit easier, I've been converting things into metrics I understand from the stock investing world. Namely CAGR (Compound Annual Growth Rate). Where I'm at now is I have three different CAGR metrics I need to track:

(1) The CAGR of the cash-on-cash return

(2) The CAGR of the underlying properties

(3) The total CAGR of the investment over its lifetime.

In the example table, it's a 10 year hold. Column A is the year, column B is the projected cash-on-cash growth rate from the fund's prospectus, column C is my calculation on what % that return changes year to year, and column D is the projected dividend based on 150k invested. Year 10 assumes no dividend and that the property is sold with a CAGR of 7%. 

To go back to my three CAGR calculations, referencing the table, we get:

(1) The cash-on-cash return CAGR comes out to 16.24%.

(2) The CAGR on the underlying property comes out to 7%

(3) The CAGR on the investment over the 10 year holding period comes out to 12.8%

Some probably loaded questions and comments since I understand these numbers are in a bit of a vacuum...

 Do these numbers seem realistic? Increasing cash-on-cash return at a 16.24% clip over 10 years would seem to require underlying assets that were horribly under-managed. Getting a CAGR of 7% on the underlying property itself would seem to require an asset that was bought well below market and / or something that was fixed up and enhanced with ancillary services. An overall CAGR of 12.8% seems fantastic, but it doesn't take much to derail that if the cash-on-cash and / or property CAGRs don't meet their targets.

Am I on the right track here?

-Jamie.