Investor · Bremerton, WA · Member since 2018 · 7 posts · 7 votes
Hi Bigger Pockets community,
I have been investing in multi-family syndications for several years now and have experienced decent success in the space. When I started, I was living in Southern California and met the sponsors at local real estate investing meetup groups. Over the years, my life circumstances have changed and I've moved to the Puget Sound area (about 1-1.5 hours from Seattle).
I still invest with the sponsors I met that are successful and experienced. Additionally, for some of my recent investments, I've been utilizing a professional networker I met on bigger pockets (David Thompson) and later in person at one of the meet up groups in southern california. Im on his email newsletter so I just get offerings sent to me on a monthly basis which I look into and invest if I like the deal.
However, over the last few months, Ive started to question how I do my DD on these deal. I put ALOT of trust in the deal middleman and other sponsors Ive met and spend just an hour or two vetting out the offering. I usually look for clear value-add potential and conservative financing in a deal and Im happy. But with recession gloom on the horizon, I've realized that I need to step up my DD and get more involved.
So as someone who wants to step up my DD game and maybe at some point become a key partner on a deal or two, what some tips you have and how do YOU do DD on a syndication deal and partner?
Investor · Tampa, FL · Member since 2015 · 1k+ posts · 1k+ votes
4y
@Jonathan Gordon, different investors vet syndications 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 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.
Investor · Lubbock, TX · Member since 2017 · 8 posts · 5 votes
4y
You can always do your own underwriting based on more conservative forecasts and see if it makes sense (i.e. adjusting for what you think is a realistic occupancy rate, rental increases, etc.). Understanding the financing is important too. Most of these MF loans are done on bridge loans recently which will need to be refinanced in the next few years. Do you personally believe interest rates will be consistent or rise/fall in that time period and does the asset still have a good DSCR? Is their capital balance enough to actually withstand a bad year or two?
I personally do this on all the deals I'm working on or being asked to be a GP on. I also have my attorney review all KP/GPs that I work with even if I've done business with them before. You never know what could be outstanding against them, so it's worth it to CYA.
Rental Property Investor · St. Paul, MN · Member since 2016 · 3k+ posts · 3k+ votes
4y
Certainly can be challenging, but I would say transparency is huge. Is the sponsor willing to give you all that you need to make an informed decision? Are they providing the full rent roll, the current T-12, rental comps, etc. Are they giving you the full underwriting or just the sexy deal deck that makes everything look good?
How is their team and their personal experience?
Do they have a well thought out plan for when a recession happens or are they always counting on the market going up? I just saw a stat on Real Page showing Phoenix, AZ and other markets having -5%+ rent growth. I haven't fact checked it, but this should be something sponsors are talking about. What happens when rent goes down?
We like to be an open book, make sure the sponsor is willing to go into details with you.
Vetting a sponsor through a broker/capital raiser can certainly be a bit more challenging, but a lot of the same questions should be answered.
Investor · Tampa, FL · Member since 2015 · 1k+ posts · 1k+ votes
4y
@Jonathan Gordon, different investors vet syndications 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 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.
You should also check out Jim Pfeifer's left field investors. Jim is very active on bigger pockets and he has a community of people dedicated to performing due diligence on passive commercial real estate investments.
If you really want to dig deep, and I can see that you do, you should get @Brian Burke's amazing book on due diligence called The Hands Off Investor. Bigger pockets published this detailed manual in 2020. This will give you incredibly detailed information on performing due diligence on passive investment opportunities.
The best way to do DD is to join club of other AI/QP that's 100x smarter than you. You can learn from them. When I'm not the smartest in the room, suddenly I know there're a lot of things that I don't know that I don't know. Also, talk to an MF expert in that particular area, you could find it from the bp folks here. It really changed my perception.
I have been investing in multi-family syndications for several years now and have experienced decent success in the space. When I started, I was living in Southern California and met the sponsors at local real estate investing meetup groups. Over the years, my life circumstances have changed and I've moved to the Puget Sound area (about 1-1.5 hours from Seattle).
I still invest with the sponsors I met that are successful and experienced. Additionally, for some of my recent investments, I've been utilizing a professional networker I met on bigger pockets (David Thompson) and later in person at one of the meet up groups in southern california. Im on his email newsletter so I just get offerings sent to me on a monthly basis which I look into and invest if I like the deal.
However, over the last few months, Ive started to question how I do my DD on these deal. I put ALOT of trust in the deal middleman and other sponsors Ive met and spend just an hour or two vetting out the offering. I usually look for clear value-add potential and conservative financing in a deal and Im happy. But with recession gloom on the horizon, I've realized that I need to step up my DD and get more involved.
So as someone who wants to step up my DD game and maybe at some point become a key partner on a deal or two, what some tips you have and how do YOU do DD on a syndication deal and partner?
As someone who works in Investor Relations at a syndicator the questions I get these days are related to debt, hearing our companies history/track record, and asking questions about why the market we are buying in is the right one (questions about cap rates, population growth, job growth etc)
Wow! I really appreciate part c. about scrutiny. I've been really lax on performing much of the DD you describe. I will admit that I am a little more aggressive than you and I have small eggs in alot of baskets so that helps with diversification.
Yeah. Conceptually, I understand how important population and job growth are key factors in a deal. That is probably the largest detractor I have from investing in my local market.
These past few weeks, I have been scouring my local area for 2-4 plexes with interest rates where they are at, the smaller properties have stopped cashflowing. I am also considering whether to look at 5-16 unit properties local to me or to become a key partner in a larger 100+ property. For me, the largest barrier to investing locally is what I mentioned about the job growth whereas the largest barrier I have to going big with a partnership is the lack of control over my time and travel commitment.
