Syndication refinance question--what happens at this event?

Multi-Family and Apartment Investing
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Syndication refinance question--what happens at this event?

Travis Doyle
Investor · New York City, NY · Member since 2015 · 19 posts · 1 vote

Hi guys!

I want to thank the very many kind, knowledgeable people here on BP for all the help. I have a quick question. If I raise money through syndication. Let's say 100k purchase with a holding period of 3-5 years. We cut ourselves 30% equity in the deal. At the end of that holding period, we refinance after the property is worth 200k and take 150k out. We dish out cash flow pro-rata during the holding period.

2 questions:

1) What does the cash return at the refi event look like? Who gets what? I assume we just split the 150k by equity ownership at that point? i.e. I take 50k for myself and the other 70% get 100k.

2) What about the remaining 25% equity left in the property? What does the sponsor do with it? What is the industry norm for this? Does the sponsor usually buy them out?

What essentially happens after the refi? I would think a sale closes the deal, but it seems that a refi keeps it open indefinitely?

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Anthony CharaPro Member
Investor · Centennial, CO · Member since 2012 · 329 posts · 232 votes
9y

Hi Travis, your Operating Agreement defines how the money is split. You could give a % of the refi money back to the investors and let them keep their ownership stake or you could have the OA written in such a way that you pay off the investors with the refi and remove them completely from the project, thus, leaving you with 100% of the deal. Or, anything in between the 2 scenarios mentioned above.

As @Jay Hinrichs wrote above, nothing is written in stone until you turn it into stone in the OA. 

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  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    9y

    if those are accurate numbers it would make no sense to syndicate its too expensive you should be able to find one investor to take that down .. as for how you split its simply a negotiation nothing is set in stone

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  • Anthony CharaPro Member
    Investor · Centennial, CO · Member since 2012 · 329 posts · 232 votes
    9y

    Hi Travis, your Operating Agreement defines how the money is split. You could give a % of the refi money back to the investors and let them keep their ownership stake or you could have the OA written in such a way that you pay off the investors with the refi and remove them completely from the project, thus, leaving you with 100% of the deal. Or, anything in between the 2 scenarios mentioned above.

    As @Jay Hinrichs wrote above, nothing is written in stone until you turn it into stone in the OA. 

    2Reply
  • Travis Doyle
    OP
    Investor · New York City, NY · Member since 2015 · 19 posts · 1 vote
    9y

    Thanks for the responses, we are looking to syndicate a 1mm portfolio and was curious how people get paid in this event. I assumed with no bells or whistles, everyone would just get paid pro-rata based on their slice of the equity pie.

    Is it normal to remove investors from these kind of things in the event of a refi?

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  • Nick B.
    Investor · North Richland Hills, TX · Member since 2013 · 1k+ posts · 1k+ votes
    9y

    Refinance does not remove investors from the project. They still own their share of the property or its holding company.

    Usually refinance proceeds are treated as return of capital  (sponsors get nothing until all capital is returned to investors) or as profit distribution in which case sponsors receive their share that is spelt out in the OM.

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  • Travis Doyle
    OP
    Investor · New York City, NY · Member since 2015 · 19 posts · 1 vote
    9y

    @Nick B.

    So as a 30% equity stake holder, am I not entitled to cash flow until the refi? Isn't the cash flow we get each year also considered a return of capital? 

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  • Michael Le
    Developer · Houston, TX · Member since 2015 · 1k+ posts · 1k+ votes
    9y

    @Travis Doyle, yes, the sponsor also participates in the cash flow. Sometimes the investors get a preferred return percentage that needs to be hit before the sponsors/KPs see any money but that's up to however you structure the deal.

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  • Jeff Greenberg
    Real Estate Consultant · Camarillo, CA · Member since 2010 · 2k+ posts · 1k+ votes
    9y

    As @Nick B. stated the refi and return of Capital does not take them out of the deal.  After they are made whole then they get the prorated split with the sponsor.  Cash flow could be part of the return of capital.  @Anthony Chara pointed that the operating agreement needs spell how the split and profit will be distributed. @Jay Hinrichs every thing is negotiable, but it must be in the OA. 

    There are many ways to structure the ownership and profit sharing.

    1Reply
  • Travis Doyle
    OP
    Investor · New York City, NY · Member since 2015 · 19 posts · 1 vote
    9y

    isn't a pref return just a fancy way of saying we will try to give you at least x% of your principal back each year? It is not an interest payment, right?

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  • Nick B.
    Investor · North Richland Hills, TX · Member since 2013 · 1k+ posts · 1k+ votes
    9y

    Depending on the OA, preferred return is either a dividend or an interest payment  (some sponsors treat it as if it was an interest payment). Either way, it is not return of principal. 

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  • Steven Hatcher
    Investor · Greensboro, NC · Member since 2016 · 10 posts · 7 votes
    9y
    Travis I could be reading into it but it seems like you really want to take care of yourself and not your investors. You will not be in syndication long if you do not make things win-win for them. Investors are putting the majority at stake and have equity. That's what most investors are looking for. I could be wrong but that's how I am interpreting your posts....I hope I'm wrong but that's how your post reads
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  • Travis Doyle
    OP
    Investor · New York City, NY · Member since 2015 · 19 posts · 1 vote
    9y
    Originally posted by @Steven Hatcher:

    Travis I could be reading into it but it seems like you really want to take care of yourself and not your investors. You will not be in syndication long if you do not make things win-win for them. Investors are putting the majority at stake and have equity. That's what most investors are looking for.

    I could be wrong but that's how I am interpreting your posts....I hope I'm wrong but that's how your post reads

    I genuinely don't know what the norm is for a liquidity event, whether or not that closes the investment, that's why I asked! I am not sure the investors want to be stuck in for more than 5 years in this scenario. I was just looking for an exit strategy for the investors. In your experience, do they want to stay?

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  • Steven Hatcher
    Investor · Greensboro, NC · Member since 2016 · 10 posts · 7 votes
    9y
    Ok cool. Exit strategy is when the property is sold for everyone hopefully at a profit At the refi folks like to get some or all of their initial capital back...but they still own the same percentage of the asset.
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  • Steven Hatcher
    Investor · Greensboro, NC · Member since 2016 · 10 posts · 7 votes
    9y
    Attorneys draft these documents so that they are legal....by the way
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  • Robert Shaw
    Investor · Madison, NJ · Member since 2016 · 57 posts · 30 votes
    9y

    Syndication is simple - there is a waterfall which outlines distribution. We typically will do a preferred return of 8%, then the return of investor money, then a split depending on the project. Sometimes there's a high water mark on the split as well. Something like LP 60% GP 40% until LP hits 15% IRR. Thereafter, LP 25% GP 75% for example.

    Obviously, the project level IRR has to be very good otherwise, you'll end up with very little as the sponsor.

    Your PPM has to spell out all the detailed expenses, related party transactions, fund and investor level costs.

    You may also need a broker-dealer registration if you're soliciting money publicly, and the money had to come from qualified investors.

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  • Travis Doyle
    OP
    Investor · New York City, NY · Member since 2015 · 19 posts · 1 vote
    9y

    @Robert Shaw

    Thanks Robert! So is this sort of what happens in your example?

    Let's say we start with a 100k investment that gives us 12K NOI for the year. You would:

    1) pay 8,000 in your pref

    2) pay 4,000 towards payback of principal

    The above would happen until a sale/refi? Outside of an asset management fee, acquisition/disposition fee, how does the sponsor get paid during the holding period of the deal? Do you only get paid through a sale or refi?

    *also, after a refi, what happens to the pref return, and how is it usually calculated? 

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  • Robert Shaw
    Investor · Madison, NJ · Member since 2016 · 57 posts · 30 votes
    9y

    Here's an exmaple:

    A project comes up and the sponsor wants to do a $1M project that will IRR 15% and exit in 2 years. The sponsor (general partner) says I'll pay 8% preferred return, then we'll split the profit 50/50.

    The investor (limited partner) invests $800K, GP invests $200K.

    Project level year 1 makes 150k. year 2 makes 150k, total is $300k profit

    That 300k goes through distribution waterfall and gets split in this order:

    1) $64,000 goes to you, the LP first. (8% of $800k invested)

    2) Return of capital - 800k you invested in the syndicate

    3) Remaining profit $236k gets split 50/50, so you get $118k more, GP gets $118k

    So as the LP, you got $64,000+$118,000=182,000

    $182,000/800,000 invested = 22.75 CashonCash return in 2 years.

    1Reply
  • Robert Shaw
    Investor · Madison, NJ · Member since 2016 · 57 posts · 30 votes
    9y

    Of course the above includes an exit. Exit means a sale. Even if you refi it's not a sale. All projects have to have an end point in the projections in order for you to calculate CoC returns, unless you tell your investor we're going to hold on for cashflow forever. In that case, profits will be split the same way, just the returns will be lower since it's over a longer time horizon.

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  • Robert Shaw
    Investor · Madison, NJ · Member since 2016 · 57 posts · 30 votes
    9y

    Sponsor don't get paid during the holding period of the deal other than a management fee. Investors want to get their money back first. Of course you can structure it however you want. You can say after preferred return, the GP gets a "catch-up" return of x%, and then return of capital invested, then a split. Then that split will favor the LP because you got some profit upfront as well. 

    When I raise a fund, I always look after investor money first, and have to wait a few years to get my share. I look for projects with high IRR to make this work, otherwise, you won't make any money after pref.

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  • Travis Doyle
    OP
    Investor · New York City, NY · Member since 2015 · 19 posts · 1 vote
    9y

    Thank you to all for the responses!

    Two questions:

    1) Is the sponsor usually getting nothing outside of asset management fee the norm?

    2) let's say the investors are paid off in full during the refi, what happens to the pref return after that if we choose to hold? is this usually removed after a 100% payback of principal? what is it now based from, the remaining equity in the deal?

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  • Robert Shaw
    Investor · Madison, NJ · Member since 2016 · 57 posts · 30 votes
    9y

    Yes. Sponsors typically charge a management fee 1-2% and if it's a large raise that requires broker dealer reg, 1-3% on new money invested.

    Investors are part of your LLC. They own a percentage of your company. There is no "paid off" after refi, only the operating agreement or what is stated in your PPM. Pref return first, then return of capital invested, then a split on all future profits derived from income and sale until the LLC dissolves.

    This is equity, not debt, so they own a part of everything the LLC owns.

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  • Travis Doyle
    OP
    Investor · New York City, NY · Member since 2015 · 19 posts · 1 vote
    9y
    Originally posted by @Robert Shaw:

    Yes. Sponsors typically charge a management fee 1-2% and if it's a large raise that requires broker dealer reg, 1-3% on new money invested.

    Investors are part of your LLC. They own a percentage of your company. There is no "paid off" after refi, only the operating agreement or what is stated in your PPM. Pref return first, then return of capital invested, then a split on all future profits derived from income and sale until the LLC dissolves.

    This is equity, not debt, so they own a part of everything the LLC owns.

     Ahhh, so in your example, let's assume instead of a sale, we refi and returned 100% of principal invested. In year 3, after debt service, we would just split profits 50/50 in perpetuity?

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  • Robert Shaw
    Investor · Madison, NJ · Member since 2016 · 57 posts · 30 votes
    9y

    Yes. Even though you returned the principle to investors, you didn't buy them out. They still own a percentage of your LLC. Everything has to be spelled out clearly in the operating agreement of the LLC and Private Placement Memorandum.

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