How to properly analyze a syndication offer

Question

Hi folks - I have an opportunity to participate in a syndicated investment, as presented to me by a friend (trustworthy) who works in commercial lending. The face value numbers are intriguing: 7% preferred return with excess split 70/30; 7-year expected hold period and after return of principle, profits then split 50/50. 2% acquisition fee of purchase price and ongoing 5% fee (EGI) for management. Projected Cash on cash is a little over 11% yearly. Aside from due diligence on the market, the sponsor, and his support team (legal, accountants, etc), what else do I need to consider in evaluating this opportunity? I should mention as well that I currently hold no investment property, so I'm not sure how this would impact my taxes as well. Any advice?

Benjamin Lapidus · Answer

@Bryan Watts The most important thing to evaluate is the operator/sponsor.  Is your friend the one syndicating the investment or is he going to be another passive investor?

I'll tell you on my first syndication that I raised, which was very similar setup: 8% pref, 50/50 split, 7 yr hold, 11% annual cash on cash I ended up being very wrong in my rent increase projections and I also ended up having to take a 20 yr loan to make the deal work instead of a 30 yr loan.  This killed cash flows and the cash on cash return I proposed.

Despite having some seriously negative months, I never did a capital call, I always maintained honest communication, and I never stopped looking for a creative exit.  Luckily the area appreciated and I was able to offload the portfolio and at least get my investors a 7% annual return all said and done.  I made incredibly little for several years of effort along the way (but learned a ton!)  Now I'm getting my investors over 20% these days! So that short tale has a happy ending :)

Having a solid impression of how your operator will act if and when things don't go according to plan is most important.  What happens if returns never surpass the 8% pref and there's no financial incentive for your operator anymore?  Does your operator have personal investment in the project?  Is he going to guarantee the note?

As a non-investor yourself, it will be very hard to get to know the market well enough to make a good investment decision on this project.  So focus your due diligence on the character, experience, and historical performance of the operator and especially get to understand their play by play in the worst case scenario.

Lastly, maybe look into the securities filing?  If it's not going to be filed as a regD506b or regA then it's not quite legal for unaccredited folks to be passive, silent investors.  That said, that's really a liability for your sponsor/operator, not so much for you.

Good luck!

Michael Le · Answer

Hi @Bryan Watts, you say 'Aside from due diligence on the market, the sponsor, and his support team' but I think that's the most important step by far. All the other numbers provided to you are their estimates of how things will go but those are just the proformas. How well they plan for that and how well they execute to meet those numbers will be paramount and the results will mainly depend on the sponsor.

As for other numbers to consider, what is the IRR on this deal? Since it is a 7-year hold then the time to get your principle back is longer so the IRR will be a little lower. Also, are you an accredited investor? Because the sponsors shouldn't be bringing this deal to you if you aren't. Of course this could be a 506(b) deal but that would still mean you need to be a sophisticated investor and I'm not sure if you would qualify if you're not sure how to evaluate the deal.

John Casmon · Answer

Absolutely @Benjamin Lapidus@Bryan Watts - there's a recent blog post on vetting a sponsor from @David Thompson that you may want to check out as well.

Benjamin Lapidus · Answer

Thanks @John Casmon! Pumped to meet in person in Denver end of this month at the Best Ever Conference!

John Casmon · Answer

@Bryan Watts You want to understand how the property is being underwritten and the business plan for the property. Are the projections aggressive or conservative? You will find this out by looking at the comparables - e.g. are projected rents at the top of the comps or middle of the road?

As others mentioned, the sponsor is going to be the most critical piece. Ensure the sponsor has thought about the risk factors that can jeopardize the project and has a plan to minimize these things. @Benjamin Lapidus gave a great first person account of how projections can be off. Ensure the figures and sponsor are grounded in reality.

Bryan Watts · Answer

this is really helpful - thanks guys!

Bryan Watts · Answer

thanks @Michael Le, I agree that the due diligence can't be overlooked. To answer your question re: IRR, investment vehicle IRR is projected at 19% and investor at a bit over 15%. I'm not an accredited investor, so that's a great point to highlight; thanks for making me aware of that.

How to properly analyze a syndication offer

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