Is syndicated co-investing (passive) right for me?

Question

I'm currently looking to take some money out of traditional investments and begin investing directly into real estate as a passive investor on syndicated deals.

The internet is pretty much copy-paste with advice on how to access real estate and defaults to saying "Just invest in a REIT - its the same" except you pay for the entire pool of existing properties (even if they have low yields in less opportunistic areas), the entire management team's multi-million dollar salary and their private jet, etc... No thanks.

So I really have been interested in passively investing in good deals with experienced sponsors, but want to set my expectations to be realistic and right for this. Any advice would be great as well.

My rationale is below:

- I have a career and don't want to focus on real estate full time right now. I want to be "hands off" for the development/management phase.
- I would like to get a minimum of 12-15% irr on average, with potential for higher returns.
- I have some past experience working with sponsors from PE funds on non-real estate deals.
- I get an experienced sponsor/developer that can run the show so I don't run the risk of making any (very expensive) mistakes from my lack of experience.
- I can get exposure to large multi-family with many tenants. If the occupancy is high, then I have less risk/hassle with one or a few tenants.
- I can invest across different types of deals unusual or difficult for a smaller investor (multi-family, opportunistic/distressed offices, hotels, etc.).
- I don't need to put up as much upfront equity as I would need to for doing it myself and I can use that capital across multiple deals.
- Pricing 'should' be better from the perspective of fees, contractors, rates, etc. that the sponsor gets vs. me as a solo investor.
- I don't care if the investment is less liquid vs. an ETF or REIT and I would aim to hold it for 5+ years at the bare minimum.

Some other questions I had and would appreciate any advice:

- Is an average minimum of 12-15% irr reasonable for syndicated deals ($10mm - $100mm) with an experienced sponsor? Assuming the deals are value-add or new developments with moderate leverage/risk targets. It seems to be a more than reasonable average with potential for 20%+ on some deals from what I read, but I would love to hear from experience. So far I've read that it may be difficult to get some of the irrs that are marketed since there has been a bull run across real estate with a low-rate environment the last decade and I would love to hear thoughts.

- What are the "usual" investment minimums for a deal? I've seen anywhere from $25k - 50k, but can even be $250k with the bigger companies, but want to get thoughts. It seems to always be flexible and at discretion of their investors they are looking to take on.

- Do sponsors/developers generally just look for GPs or preferred investors? Or do they charge massive fees that private equity sponsors charge for their LP investors for buying businesses (2% management / 20% profit)? It seems like GP/preferred is the answer so I would avoid these massive fees on the profits since developers seem to market a deal-by-deal in real estate and I would actually be a direct GP investor.

- How would you exit an investment say after 10 years after a commercial property is developed for whatever reason? I assume you can be taken out by an existing investor or using a broker to find a buyer for your stake if the asset is a good cash-flowing one?

Really appreciate any advice, feedback, or respectful criticisms! Thanks in advance.

Ian Ippolito · Answer

@Andy Port ,

This is the book I wish I'd read when I started...and I think it should be required reading for every beginner and pro.

It's called "Investing in Real Estate Private Equity: An Insider’s Guide to Real Estate Partnerships, Funds, Joint Ventures & Crowdfunding". And it's written under the pseudonym of Sean Cook by Paul Kaseburg.

Paul’s sat on both sides of the table on over $2 billion of real estate deals. And in my opinion, his book covers everything a newbie needs to understand: from asset selection, to evaluating sponsors, to capital structures. For pros, he challenges conventional wisdom and explodes sacred cows by exposing hidden conflicts of interests and mis-alignments that many in the industry won’t admit to.

And I feel this book took my personal due diligence (and how I look at deals) to the next level.

-----------
On your other question:

When vetting a syndication, every investor will do it differently because every investor has a different risk tolerance, comes from a different financial situation and has different financial goals. So a deal that look great to one investor will look horrible to another and vice versa.

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. Here's how I do my due diligence:

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

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

b) Then and only then do I pick the strategies, capital stack, and specialized asset subclasses that make sense for that opinion. For example, I am a little concerned about some aspects of the business cycle recovery and a potential for a double-dip so I lean toward the safest part of capital stack which is debt (or low-debt 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 cycle, 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 or that lost anything more than a small amount of money (and prefer no money lost). 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.

Greg Scott · Answer

I'll share my thoughts. I've done a lot of residential real estate deals including dozens of passive investments and have syndicated four apartment complexes.

REITS - These are more akin to stocks than real estate investing and do not come with the tax benefits. I do not invest in REITS

Passive Investing - I do lots of this. To date my annualized return has been north of 30%, so you can do quite well. However, you have to be very, very selective. You need to learn to read the PPMs and dissect what is in them. Without a hours-long conversation, here are things I consider.

1) I have never invested with anyone that charges an acquisition fee, and most syndicators charge an acquisition fee. If they get paid up-front, how hard will they work to make the deal profitable? I've seen as high as 4% acquisition fee, and anything 2% or over is too much.

2) I have never invested in a waterfall return. (Example 8% pref return, then 80/20 split until achieve 15% IRR, then 50/50) The main reason most syndicators offer a preferred return is because people that invest in mutual funds feel like they are guaranteed as high a return as they would get in the mutual fund. Typically waterfall returns will also come with a lot of fees to the syndicator because they are not going to work for free. (So, do you really have a PREFERRED return?) Also, this creates misalignment of interests as the deal unfolds.

3) Check the details of the operating agreement. Can the syndicator be removed if they are not performing? Are they required to publish financials or do they simple "intend" to publish financials? (There are passive investors in deals that haven't seen financials in years) Do the passive investors get to vote on anything or are they simply along for the ride.

4) Understand the business plan. How will they achieve the promised returns? Is that realistic? (I've seen deals where they say they are going to achieve $X in rent, but NOBODY in the submarket gets those kinds of rents.) How long is the hold time? What is the financing? Who is the property manager? Who is the asset manager?

I could go on, but that is a decent short list.

Henry Clark · Answer

OP your post topic. 1. what is your background? Is it technical?

2. Can you afford to either lose or tie up $50,000 to $100,000 for 5 years?

3. You’re the banker. Have you or can you analyze 50 or 100 business deals? Not passive up front.

4. Risk reward consideration. Do you know how to evaluate. Two syndications with 12% return, great management track records, everything the same except the deal itself.

Everyone above has given you a good breadth of concepts, so these fit your concept of passive?

BP put together a Passive Investor series as noted to you. Your concerned if it is worth it or to expensive. Forget the exact wording. My recommendation is you spend a year and $10,000 learning about syndications. Or find several of the brokers on BP and invest thru them.

Most of the BP posts are negative on Syndications for very minor LP investor and GP knowledge. These are people who are or have been in Syndications not identifying critical simple issues. I would spend a year getting smarter than them or learning from their mistakes.

Andy Port · Answer

Thank you for the recommendation and advice! I just ordered that and its relatively inexpensive off Amazon. Personally I love reading that isn't a school-style textbook and when its about putting things into practice, I'm all for it!

Gino Barbaro · Answer

@Andy Port

I would go to https://syndicationattorneys.com/, and start reading all of Kim's blogs. You can even get a copy of her book.

If you DM me, I can send you some additional resources that answer your questions.

Gino

Chris Seveney · Answer

Never afraid to give my 2 cents:

1. Is an average minimum of 12-15% irr reasonable for syndicated deals -

12-15% is reasonable, tougher today with higher rates and softening pricing. Do not expect that to be the pref. but total IRR after receiving the promote.

2. What are the "usual" investment minimums for a deal

This really depends, usually a 506c starts at $50k and bigger tickets could = better returns

3. Do sponsors/developers generally just look for GPs or preferred investors? Or do they charge massive fees that private equity sponsors charge for their LP investors for buying businesses (2% management / 20% profit)

Typically they look for preferred investors vs. co-go. Splits on MF are typical of min 2% management (throw in acquisition as well) - also what is that on ? Is that on Pref raised or total (including loan amount)... 20% back to the sponsor on back end also not unusual. Pay attention to fees and how calculated and when paid.

4. How would you exit an investment say after 10 years after a commercial property is developed for whatever reason? I assume you can be taken out by an existing investor or using a broker to find a buyer for your stake if the asset is a good cash-flowing one

These deals are typically very illiquid, only way out is to be cashed out from sponsor in most instances.

Hope this helps

Jay Hinrichs · Answer

BP now has Passive Pockets I would take a look at that.. @Scott Trench is Keen on giving BP members the best shot possible for a safe syndicated investment.

Andy Port · Answer

Thanks - I saw that and its definitely something I would be pretty open to subscribing to once I wanted to start and it isn't overly pricey.

I saw it has some intro information as well, but not sure if anyone has recommendations on books/reading for this area for some of the more detailed risks/points to evaluate? Most recommendations I saw on the forum look like they are on the non-syndicated topic and I've read a few of them.

Always appreciate and love to learn more from recommendations.

Andy Port · Answer

Great to hear I really appreciate it! I would definitely need to dive more into risks with the structures and sponsors, but it definitely keeps me in the direction I've been moving and seems to be consistent with what I am looking for. Like you mentioned and what I've read is the deal structure and sponsor carries the biggest risk so thank you!

Is syndicated co-investing (passive) right for me?

Is syndicated co-investing (passive) right for me?

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