Asking Questions To Syndicators

16 Replies

Hi guys, I need your advise/suggestions.

When and if you'd invest in syndicators deal what questions would you ask to learn more about the process and vet the syndication. Let's say I am clueless about the whole thing (e.g. I am a doctor and I want to invest in a deal but I have no idea about the process).

Thank you for suggestions.

@Davit Gharibyan
Ask for the private placement memorandum and operating agreement. These documents will highlight the investment as well as provide more info on the sponsors and how monies are appropriated.

@Davit Gharibyan , any good syndicator will answer your questions and educate you to an extent on their field of focus but don't think after your conversation with them it would qualify you for SEC sophisticated status. You should be ready to research and educate yourself, if anything to make sure you protect yourself.

Depends on your level of investment.

Someone looking to place 500k to 1 million is different than someone wanting to place 10,000 and asking a million questions.

An investor just investing in a project with cash is one thing. An investor wanting to learn all about syndication and be educated on the subject is a lot more intensive and time consuming for a sponsor. This is generally why sponsors like accredited investors as they might have already made multiple investments and know the process.

It's kind of like a sign I remember seeing on a wall at a car audio place. It said radio and 2 speakers installed for 100 bucks ( this was 20 years ago). If you want to help or learn then it is 175 dollars.

Investing in a real estate syndication carries all of the same risks as investing in a property directly.  But there is also an additional risk factor, and it is a significant one:  the sponsor.  You need to do your due diligence on the sponsor to be sure that you are investing with the right group.

Here are a few questions/considerations that come to mind:

  • Ask to see the performance of their full-cycle deals. Compare the actual performance to the projected performance so you can see if they achieve the results that they forecast. If they haven’t had any full cycle deals, they might not have enough experience to justify investing with them—they are untested if they’ve never sold a property. Unless you are a test pilot, you wouldn’t fly in a plane that has proven to successfully take off, but has never proven it can land, would you?
  • Ask to see comparisons between actual and projected performance of properties in the portfolio.  This gives insight into how well they are managing currently. How many properties they are buying or the returns they are projecting are not the yardsticks for their success. The Measurement should be if they achieving the NOI and distributions that they had forecasted on the stuff they've already bought.
  • Ask about the worst deal they’ve had or one that didn’t perform according to plan. What you are listening for is how they handled it. Their real character is revealed when things go wrong, not when things are going right. If they say they haven’t had one, they just haven’t been doing it long enough. So, will the one you invest in be “the one”?
  • Ask if they are obtaining financing based on their own cash reserves and net worth, or are they relying on “loan sponsors” to bring the financial strength needed to qualify for debt. Lenders require the borrower’s key principal(s) to have a specific net worth, such as 1:1 on the loan amount, and cash reserves, such as 10% of the loan amount. If the sponsor has to bring someone in to meet those requirements, you might have an undercapitalized sponsor.
  • Visit their office. You might find that some don’t even have one. Are they working out of their bedroom? Have no staff? You’ll find out, plus you’ll get to look them in the eye and shake their hand (even in today’s world of email and text messages, this is still relevant). Not to mention, you’ll find out if they are even willing to carve out that slice of time for you. If they aren’t willing now, they won’t be later when you have questions after you’ve made your investment.
  • Ask about their team. Is this a one-person shop? Key man issues could be a problem if the only guy that knows what’s going on dies. So ask about the depth of their team and staff, and succession plan in the event that something unfortunate happens to one of them.

A good sponsor that has survived market cycles can get the best outcome in the face of adverse circumstances, but a bad sponsor can screw up a perfectly good real estate deal.  This is why sponsor selection is the most important decision you will make in your journey of investing in syndications.  

@Davit Gharibyan , That's a good question and smart to come up with a process before just diving in.

Every investor has their own method, and here's the process that I use. Background: 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 red flag for me may be fine for someone more aggressive.

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

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

b) Then only then pick the strategies, capital stack, and specialized asset subclasses that make sense for that opinion. For example, I think we are late cycle, so I lean toward the safest part of capital stack which is debt (or debt free 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 next recession, 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 and didn't lose money. 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.

People like Ian are much more educated than me, but since you are brand new (like me a year or so ago) here is what I did to educate myself

-  There are some great resources online to learn the very basics.    I think RealCrowd and CrowdStreet both have learning centers that start with the basics, like what is a "Cap Rate" and go more advanced from there.   There are other sites that provide deals and education, in my opinion these are the best 2, but looking at everyone can be informative and lets you make your own choice.

- Origin Investments, which is a well respected sponser, has been putting out blog posts on a lot of things.   Both tactical and strategic.   Very informative.

-  There are various podcasts on the subject.   I like RealCrowd's.   There are not too many so you can start at 1 and work up.   

-  One of the things I found most useful was looking at deals and listening to the questions others asked.   Both RealCrowd and CrowdStreet have a variety of deals.   They have archived presentations for each of them where you can watch the presentation from the sponsor and the questions.    I learned a lot by comparing between them.   

-  There is a book most everyone considers the sort of keystone guide.   Called "Investing in Real Estate Private Equity" by Sean Cook.   

That is how I educated myself.   I had a ton of fun learning something new, it had been a long time since I had learned something completely different.   I hope you have a similar journey.   

One last piece of advice.   There is always be a "next deal".   So dont feel pressured to jump in.   One constant you can count on is that the deal flow will be strong, especially with the change to the JOBS act and sites like RealCrowd and CrowdStreet being able to advertise the deals now.  

Good Luck

@Davit Gharibyan Three things you will want just to begin:

1. An Investment Summary of the property in question

2. A business plan for the property in question

3. Copy of the Operating Agreement for the syndicate

First largest concern is can you trust the syndicator? Second largest concern is how risky is the investment. Third largest concerns is can you be pushed out of the syndicate during cash calls. This should be apparent in the operating agreement language. You may want a lawyer to review it. 

@Brian Burke  I really appreciate the frank answer above. It is tremendous insight for new syndicators, we should be able to address the points you listed with great confidence. However, we all start somewhere and it would be encouraging to read how you were able to get the ball rolling as a novice syndicator many years ago. Specifically, how were you able to sidestep what you pose as the single most significant risk factor, "the sponsor" (you).  If you've answered this question before, please feel free to direct me to any podcasts, articles, or forums where you provided the answer. Or, feel free to drop a few lines here. 

Thank you for your depth of knowledge and eagerness to service "newbies" and seasoned investors, alike. 

Read this article by @davidthompson . It answers a lot of questions about syndication's.

Originally posted by @Larry Caper :

@Brian Burke I really appreciate the frank answer above. It is tremendous insight for new syndicators, we should be able to address the points you listed with great confidence. However, we all start somewhere and it would be encouraging to read how you were able to get the ball rolling as a novice syndicator many years ago. Specifically, how were you able to sidestep what you pose as the single most significant risk factor, "the sponsor" (you).  If you've answered this question before, please feel free to direct me to any podcasts, articles, or forums where you provided the answer. Or, feel free to drop a few lines here. 

Thank you for your depth of knowledge and eagerness to service "newbies" and seasoned investors, alike. 

Great question, Larry.  I told this story on numerous podcasts including the BiggerPockets Podcast #3, #76 & #152 plus many others listed on the media page of my website.  But I can save you hours and hours of listening by just summarizing here.

I started flipping houses, at first using seller financing, credit cards, credit lines, you name it.  After doing a few dozen flips with whatever money my 20-something-year-old self could scrape together, I leveraged that somewhat limited track record to raise a small fund from friends and colleagues.

Then I used the money from that small fund to grow my flipping business, and after having done a couple hundred flips I leveraged that track record to raise money from people that weren't friends and colleagues to grow the flipping business even more.  Then I started investing in small multifamily projects (my first one was a combination of a 1031 exchange and a seller-carryback) and leveraged that track record to start raising money to buy even larger multifamily properties.

My first fund was $500,000.  Fast forward to today and I've raised over $80 million.  But that "fast forward" is almost 30 years of organic growth.

You are right--you have to start somewhere.  But the mistake most make is they want to fast forward to the end game at the very beginning.  It doesn't work that way.  You could be a world hero and find the cure to cancer but when you were first born you couldn't even feed yourself--every one of us was just like that too.  You have to go through the steps and grow one step at a time. 

@Davit Gharibyan The feedback you received from @Brian Burke and others is invaluable. I will just add that you should also speak with other equity investors and ask about their experiences and lessons learned as to what they would do differently if they were starting out now.

Happy to share my experiences. If interested, feel free to PM.

Best of luck!