Syndication deal structure - seeking opinions

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Syndication deal structure - seeking opinions

David Cas
New York, NY · Member since 2015 · 10 posts · 0 votes

Hi -

I'm an investor & new partner working on a $1M+ deal with a syndicator / sponsor. Here's how the deal is being put together:

- Property ownership: Syndicator ~80%, rest split among investors depending on amount invested. ($100k investment would get 10% ownership on a $1M deal)

- Cashflows: Investors receive up to 12% annual return on their investment paid monthly. Investors get paid if NOI is positive for the month. Syndicator has preferred return for first $500, any free cashflow beyond 12% goes to syndicator. Expenses split according to ownership stake (in this deal, syndicator has responsibility for paying 80% of expenses)

- Additional details: Mortgage under syndicator. Syndicator put the deal together end-to-end (finds deal, negotiates, closes, sets up LLC, works with lawyers/banks/accountants/management companies, etc)

I have a good relationship with the sponsor and am simply looking for an opinion as this doesn't seem to fit your traditional syndicated deal structure.

Thanks!!

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Brian BurkePro Member
Investor · Santa Rosa, CA · Member since 2012 · 2k+ posts · 7k+ votes
10y

Wow...this structure is heavily tilted in favor of the sponsor.  If the investor's return is essentially capped at 12%, the deal more closely resembles a debt deal than an equity deal.  A debt deal with added downside, that is.

I'm not sure I understand the concept of the sponsor retaining 80% ownership if the investors are contributing 100% of the capital.  Typically, the entity that is created for the deal will own 100% fee title to the property subject to any assumed or originated secured debt.  Within the entity, units or partnership interests are "owned" typically in the same proportion to the profit split or contributed capital.

If the syndicator has enough folks to fund the deal with that structure, more power to them, but it's not scalable.  Once they tap out their inner circle they won't attract capital for their next deal with those terms.  Then they will be promoting deals with much more favorable terms to the investor and you will be on the inside looking out while new investors are making better returns than you.

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  • Joel OwensBusiness Member
    Moderator
    Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
    10y

    To be the sponsor I look for 50% of equity upside and I look to give out 8% preferred return.

    Some passive investors focus in on that extra 1 or 2% preferred return but I would care more about the sponsor running the ship and the property.

    Extra return sounds good on paper but 12% of nothing is nothing. 

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  • Trevor Ewen
    Rental Property Investor · Weehawken, NJ · Member since 2014 · 1k+ posts · 704 votes
    10y

    @David Cas

    It's a bit different than what I am used to. Capping your returns at 12% seems a little odd to me at the outset. Wouldn't he want you to share in the spoils of a better than average outcome?

    All that being said, if he can deliver and you don't have another reasonable option, it's better than the stock market.

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  • Daniel Chang
    Professional · Riverside, CA · Member since 2009 · 254 posts · 273 votes
    10y

    I personally wouldn't do that deal.  I'm assuming this is a long term buy/hold since you don't mention disposition.  

    That setup overall benefits the syndicator.  Syndicator gets first $500, and then you get whatever is left up to 12%, then syndicator gets the rest.  So if the property only cash flows $500/mo...then you get nothing?  The syndicator's incentive is up to the 1st $500/mo.  If he happens to knock it out of the park, then he gets all the upside above 12%.  I also don't understand how the expenses are "split".  If there is positive cashflow, then all the expenses are taken care of.  Are you suggesting if there is negative cashflow, then you need to pay your portion?  So not only are you capped on the upside, you might have downside...as in contribute more capital?  In a sense, you are not a limited partner then.

    I look for win-win situations and incentive based compensation to the syndicator.  This deal is great for the syndicator.  Not for the investor.

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  • Brian BurkePro Member
    Investor · Santa Rosa, CA · Member since 2012 · 2k+ posts · 7k+ votes
    10y

    Wow...this structure is heavily tilted in favor of the sponsor.  If the investor's return is essentially capped at 12%, the deal more closely resembles a debt deal than an equity deal.  A debt deal with added downside, that is.

    I'm not sure I understand the concept of the sponsor retaining 80% ownership if the investors are contributing 100% of the capital.  Typically, the entity that is created for the deal will own 100% fee title to the property subject to any assumed or originated secured debt.  Within the entity, units or partnership interests are "owned" typically in the same proportion to the profit split or contributed capital.

    If the syndicator has enough folks to fund the deal with that structure, more power to them, but it's not scalable.  Once they tap out their inner circle they won't attract capital for their next deal with those terms.  Then they will be promoting deals with much more favorable terms to the investor and you will be on the inside looking out while new investors are making better returns than you.

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  • Derek Carroll
    Syndicator and Fund Manager · Victor, NY · Member since 2012 · 760 posts · 345 votes
    10y

    @Brian Burke

    what are you seeing for investors appetite in a deal where the sponsors ownership % exceeds their level of capital contribution?

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  • David Cas
    OP
    New York, NY · Member since 2015 · 10 posts · 0 votes
    10y

    Thanks for the feedback, really helpful.

    @Daniel Chang Regarding expenses, when there is positive cashflow to pay everyone it's a non issue. In case of net loss, the amount is deducted from the owners for that month in proportion to ownership %. Anything in between is distributed among investors in proportion to ownership %, up to that 12%. The sponsors return is the preferred amount minus their responsibility on expenses. So with big unexpected expenses, the sponsor takes on the bulk of the burden.

    @Brian Burke The LLC does own the property. The difference here is within the entity, ownership is split 80% towards the sponsor and the remaining 20% among investors. Reasoning being the sponsor is the one on the mortgage, investors are not.

    On future deals, the sponsor is willing to take a minor (10-15 %) ownership to oversee operations as long as we, partners, take responsibility for financing it through a bank. As of right now, we do not qualify for financing these large deals so it is a way for us to build assets/credit history. 

    Does this make sense?

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  • Brian BurkePro Member
    Investor · Santa Rosa, CA · Member since 2012 · 2k+ posts · 7k+ votes
    10y
    Originally posted by @David Cas:

    Thanks for the feedback, really helpful.@Daniel Chang

    @Brian Burke The LLC does own the property. The difference here is within the entity, ownership is split 80% towards the sponsor and the remaining 20% among investors. Reasoning being the sponsor is the one on the mortgage, investors are not.

    On future deals, the sponsor is willing to take a minor (10-15 %) ownership to oversee operations as long as we, partners, take responsibility for financing it through a bank. As of right now, we do not qualify for financing these large deals so it is a way for us to build assets/credit history. 

    Does this make sense?

    Well, it doesn't make much sense to me.  The entity, not the sponsor, should be on the loan if the entity is the owner of the real estate.  The sponsor may have to be a guarantor, but that comes with the territory of being a sponsor.  Is that guarantee worth something?  Yes, but not 80% of the deal.  It sounds like you are dealing with an inexperienced sponsor, evidenced by the proposal that the investors can obtain the financing in future deals (it doesn't work that way!).  If you don't have specific real estate experience either, this arrangement can result in the blind leading the blind...which sometimes spells disaster.  Just be really careful.

    As an example, when I raise money from investors for a real estate offering, the investors get most of the profits AND my firm (the sponsor) is on the hook for the loan guarantee.  It is my experience and track record that convinced the lender to make the loan in the first place, but that doesn't mean that I should get 80% of the deal.  30% to 50%, yes, but 80%, no way...unless I contributed enough capital to cause my pro-rata investor share plus my sponsor promote to calculate up to 80%. 

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  • Brian BurkePro Member
    Investor · Santa Rosa, CA · Member since 2012 · 2k+ posts · 7k+ votes
    10y
    Originally posted by @Derek Carroll:

    @Brian Burke

    what are you seeing for investors appetite in a deal where the sponsors ownership % exceeds their level of capital contribution?

    There's plenty of appetite and it's actually quite common.  The contribution of capital and the sponsor promote are two separate things. 

    A sponsor can contribute zero capital and still earn a promote.  The promote is the sponsor's compensation for the things (other than capital) that the sponsor contributes.  Such as, experience and track record that is needed to convince the lender to make the loan, the sourcing of the deal itself and the associated local market knowledge and resources, the loan guarantees, fund administration, and of course the management of the asset and the investment plan, among other things.

    Promote aside, if the sponsor contributes capital then there would be further participation in the cash flow via the sponsor's pro-rata share of the equity stack.

    Things start to get imbalanced when the sponsor gets more of the deal than the equity partners.  There are some circumstances where that might make sense, but in the case of the OP it doesn't sound like this particular example is one of those cases.

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  • David Cas
    OP
    New York, NY · Member since 2015 · 10 posts · 0 votes
    10y

    @Brian Burke Thanks for the feedback again. Regarding the financing that's how it's being set up, I just worded it poorly. On lack of experience, our sponsor has been doing deals like these for the past 7 years, closed dozens of deals (200+ units) across a few states. Although I am fairly new, this is not a case of the blind leading the blind. 

    On the ownership %, I agree and it's the main reason that prompted me to post here.

    I'd like to thank everyone for the feedback, it's time for me to negotiate better terms.

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  • Peter P.
    Denver, CO · Member since 2012 · 5 posts · 0 votes
    10y

    Second Brian's response. It Does not seem to be a very good deal for the investors/you. What I would expect/look for as an equity investor is a preferred return paid out before the syndicator receives anything then a more reasonable equity split based on the total equity in the deal not total investment value. Example: preferred return first, then syndicator fees, then remaining cash distributed based on % of total equity in the deal.

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  • Pat G.
    Rental Property Investor · Northville, MI · Member since 2015 · 179 posts · 92 votes
    10y

    I agree with Brian's response. What specifically is the Syndicator doing besides guaranteeing the loan to warrant the 80%? Make sure everything is spelled out in the LLC documents on who does what or else the syndicator might have you doing a lot more for your smaller %.

    If you have not closed yet, you still have time to make or suggest some changes, and if the syndicator balks or won't change things - well you will know then that he/she is not somebody to work with in future. Also you may want to consult with a lawyer to see if you can get out of this if the syndicator won't modify. 

    Good luck

    P.S. At least you took action, you will only learn something from all this. 

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  • David Cas
    OP
    New York, NY · Member since 2015 · 10 posts · 0 votes
    10y

    @Pat G. The syndicator is putting the whole deal together end to end. Finding deal, working with brokers, lawyers, banks, day to day operation, etc - all the items Brian mentioned. The operating agreement is fairly simple and our only responsibilities as investors are expenses. Say you have 10% equity then you are responsible for 10% of expenses. The syndicator, as 80% owner, has responsibility for 80% of the expenses. I think this is the main difference and mostly applies to expenses that go beyond gross income (say we have an unexpected $10k expense after income, the syndicator is responsible for coming up with the $8k) - Curious to know how this works in other syndicated deals.

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  • Rafael Gutierrez
    Investor · Linden, NJ · Member since 2009 · 5 posts · 1 vote
    10y

    David, I am not clear on how much investors have to contribute in this deal. I guess if two investor contribute $100k for a 10% ownership ,that means only $200K is need it on this deal?

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  • Joel OwensBusiness Member
    Moderator
    Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
    10y

    If more cash is needed then in the operating agreements it can spell out a "cash call" where an investor puts in additional amounts of money .

    Some projects have additional cash needed to be put in. If a sponsor had to dump more of their cash into a deal then the terms would likely change.

    Nobody is going to throw in extra money just for the sake of it no matter who they are.

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