How to Determine the Credibility of a Syndicator

Question

As the title states; How can the credibility and reliability of a syndicator be judged?

What assurances does an investor have that the general partner won't "take the money and run"?

Trying to avoid a Madoff ponzi scheme disaster.

Thanks in advance

Brian Burke · Answer

I'm sure you've heard the old saying, "garbage in, garbage out"?  That saying really applies here.

The output is credibility and reliability.  The input is character.  If the sponsor doesn't have good character there can be no credibility and no reliability.

Madoff was a thief.  So what you are asking is, "how do I know if the syndicator is a thief?"  Unfortunately, you don't know and you can't know.  No one thought Madoff was a thief (well, maybe someone did, but enough didn't to give him billions of dollars).  Even people who asked around missed the signals.

But certainly that doesn't mean that blind faith is prudent, either.  There are steps you can and should take to mitigate the risk that your syndication sponsor is a thief, or is of bad character.

The first step is to learn about the background of the principles.  Where did they come from and what did they do before they became syndicators?  What relevant experience do they have?  What is their track record of prior deals?  The sponsor should have some collateral material they can share with you to answer some of those questions.  Even ask to see a comparison of projected performance versus actual results of some deals.  But that doesn't stop someone with bad character from lying and making it all up, or only showing you the good ones.  And in this business, verification is difficult, if not impossible.

The next step, ask them about their worst deal and what caused it to go bad.  And more importantly, what did they do about it?  And how did it turn out?  Everyone wants to talk about their successes but few want to discuss their failures.  If they are open about it, that's a good sign.  If they acted in the best interests of their investors, that's an even better sign.  If they change the subject or don't want to talk about it, that's a red flag.  If they say they haven't had anything like that happen to them, that just means they haven't been doing this long enough and you probably don't want to invest with them for that reason.  No need to have the learning experience be on your dime.

Next, ask to talk to other investors.  This step sounds more valuable than it is because the sponsor isn't going to refer you to unhappy investors.  Nevertheless the conversations could be telling in some respect and either give you additional confidence or leave you with no information beyond what you had before you made the call.  Nothing ventured, nothing gained though.

Finally, go visit their office.  This is a pain, takes time and costs you money to get on a plane and visit them.  But you are going to invest significant money with these folks and as old-fashioned as it may sound, looking them in the eye and shaking their hand has value.  Plus you get to see if they are running a real business here or if this is a side-gig run from a bedroom.  You are looking for a true business partner here, this isn't buying a stock that you can sell on five second's notice, so treat it like a courtship and save marriage until you are comfortable that you are compatible.  There's no need to rush it.

Ian Ippolito · Answer

@William Coet, you're asking a great question. Legally there is usually nothing to stop the GP from taking the money from running. So you have to find some way to trust them and be able to sleep at night, or there is no way or reason to pull the trigger.

There are some investors that believe they can tell from talking in person (or on the phone) to someone whether they are trustworthy or not. I have not found this to be personally true for me. Most succesful con-men are extremely likable, have excellent body language, exceptional communication skills and fool many people. So I feel I'm not alone on this and don't use any of those things to judge a sponsor and deal. Instead, I assault the sponsor with a maximum amount of due-diligence covering every aspect of the deal and them.

For vetting a syndication, different investors do it 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 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.

Account Closed · Answer

@Brian Burke said it well. Having one really bad syndication experience taught me that vetting the sponsor is more important than vetting the deal. I prefer to meet in person anyone I am giving a large sum of money to. I do call references and I do ask them what has gone wrong and what has the sponsor done. Past experience counts. The longer the better. If the sponsor has only seen an up cycle you dont know what they will do in the correction. Also, good syndicators with history almost always have a full book of investors. If they are too eager for your money its a warning sign of inexperience. Then look at the assumptions. In MF if they are assuming flat or lower cap rates on exit, they are overly optimistic. If they assume constantly increasing rents based only on market, they are being too optimistic. Look at their breakeven occupancy projections. Last thing you want is another capital call,. Speaking of which I have turned down otherwise good projects because the contract had open ended punitive future capital calls. And in the end diversify. Because after all that you may still get in bed with a bad sponsor and you dont want that to ruin your life. Make the initial investment the minimum and if you gain confidence then invest more. Good luck,

Alina Trigub · Answer

@William Coet

In addition to some incredibly detailed responses, especially from @Brian Burke and @Ian Ippolito, you can perform an indirect search here on BP. Look for passive investors, reach out and ask about their experiences. One can say anything they want about themselves, but until you have the proof in your hands from their investors, I would triple check everything you're hearing/getting from a sponsor.

Here's a post that will help you with a list of questions for a syndicator:

https://www.biggerpockets.com/blogs/10850/76728-qu...

David Thompson · Answer

Hi William,

As a syndicate that works with several operator partners across three niches I created 10 tips from an insider on vetting sponsor / operators.  I hope you find this useful.  Thanks Chris Collins for the plug as well.

https://www.biggerpockets.com/blogs/9145/53959-vet...

Theo Hicks · Answer

Here are two other questions you can ask to gauge the character and credibility of a syndicator:

• What percentage of your investors came via referrals?
• What percentage of your investors have invested in multiple deals?

Referrals and repeat business alone aren't enough. But in combination with @Brian Burke's advice will minimize the chances of you investing with a Madoff-type syndicator.

Ben Leybovich · Answer

Allow me to tell you about my day today:

At 8 am I had a telephone conversation that went like this - I was referred to by so-and-so because of your honesty and character. I am sorry I didn't make it into the last one. I've got some questions... Would $50,000 be OK?

At 9 am I had another very similar conference.

At 1pm I took a lunch meeting with a couple of gentlemen. They flew in from out of State to take a look at the project and to meet with me. One is a current investor. The other is considering...

This is a normal day for me. Are you starting to see the picture?

Chase Louderback · Answer

As others in this thread noted, it can be difficult to verify the credibility and reliability of a syndicator.  In addition to all the good suggestions @Brian Burke stated, you could ask for previous pro forma suggestions on deals, then see how the investment turned out and speak to investors that were in that specific deal to see what feedback they have on how it went.

A great indicator would be the time they have been in business.  If they have been doing this for years, been through the ups and downs, then you will have pretty good odds that they will continue to perform well and be reliable.  If this is their first deal, you may want to sit out or be sure that you have a VERY close relationship to them.

Luke Miller · Answer

@William Coet to be completely honest, it can't be easily. This is something that has been a tough hurdle for some investors I've talked to. Frankly, there is a possibility in any investing type that you'll lose your investment - that's something all investors need to think about. There is no way to account for all economic, market, political variables that could play into a large scale syndication. There are guarantees in investing.

However, there are easy and basic steps you can take to ensure you're lined up with the right person. @Brian Burke laid them out very well.

I would also add that background checks and SEC violation checks are common and, although awkward to ask for, any person of merit should have no problem with this.

Charles Kao · Answer

@Brian Burke @William Coet Love Brian's response.  In most cases you just won't know and unfortunately it's difficult to always evaluate the character of a syndicator because if you start asking questions they will just go to an investor that will invest blindly.  What I will say is if you are going to go into a deal not knowing anything personally how to underwrite it then you might as well invest in an REIT or some other type of real estate fund.  Another thing I like to do is I will type in all of the general partners names in Google so for example 'person's name, crime" and "person's name, fraud."  It is amazing how many times I see charges for embezzlement with developers and syndicators for things.  On the flip side I will say that it's pretty hard not to get sued in this business if you have been in it long enough, and the bigger you get.  Lastly remember, numbers on an offering memorandum are just numbers.  Ability to execute and everything else can be there but that's all they are.  I saw a syndication recently where the investor secured a 5 year balloon interest only for the whole 5 years.  Cash on Cash Return was 8%, great, IRR of return projected was 14%, great.  Problem is the only strategy is forced appreciation through raising rents and while the market is strong that puts alot of pressure on execution of one strategy and market timing.

How to Determine the Credibility of a Syndicator

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