How Do Syndicated Apartment Holds Fail?
Investor · Hendersonville, NC · Member since 2013 · 754 posts · 281 votes
How Do Syndicated Apartment Holds Fail?
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Investor · Phoenix, AZ · Member since 2017 · 583 posts · 919 votes
7y@Jay Hinrichs alluded to management, but here are some ways to fail strictly related to underwriting:
- Underestimating operating expenses
- Underestimating expense growth
- Overestimating repositioned rents
- Overestimating rent growth (post stabilization)
- Underestimating capital expenditures
- Not enough reserves
- Not enough contingencies
- Not inflating exit cap rate enough
- Not inflating interest rates enough (if not fixed)
As an investor, you need to be able to understand and "check" all of these out during your due diligence.
62 Replies
- 7yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
syndicators are not personally guaranteeing your returns.. and yes syndicated deals fail all the time with total loss of capital many of those deals are the deals the new syndicators are picking up.. the bones of bad ones.
sponsor is critical.
they fail form
1. inept management'
2. big employer left town to many vacancies and because these deals to get returns.
3. bad buy out of the gate.
4. malfeasance in management
- Investor · Phoenix, AZ · Member since 2017 · 583 posts · 919 votes7y
@Jay Hinrichs alluded to management, but here are some ways to fail strictly related to underwriting:
- Underestimating operating expenses
- Underestimating expense growth
- Overestimating repositioned rents
- Overestimating rent growth (post stabilization)
- Underestimating capital expenditures
- Not enough reserves
- Not enough contingencies
- Not inflating exit cap rate enough
- Not inflating interest rates enough (if not fixed)
As an investor, you need to be able to understand and "check" all of these out during your due diligence.
- 7yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
Originally posted by @Sam Grooms:
@Jay Hinrichs alluded to management, but here are some ways to fail strictly related to underwriting:
- Underestimating operating expenses
- Underestimating expense growth
- Overestimating repositioned rents
- Overestimating rent growth (post stabilization)
- Underestimating capital expenditures
- Not enough reserves
- Not enough contingencies
- Not inflating exit cap rate enough
- Not inflating interest rates enough (if not fixed)
As an investor, you need to be able to understand and "check" all of these out during your due diligence.
yes and this all falls to management doing their job.. right ?
- Investor · Phoenix, AZ · Member since 2017 · 583 posts · 919 votes7y
Originally posted by @Jay Hinrichs:
Originally posted by @Sam Grooms:
@Jay Hinrichs alluded to management, but here are some ways to fail strictly related to underwriting:
- Underestimating operating expenses
- Underestimating expense growth
- Overestimating repositioned rents
- Overestimating rent growth (post stabilization)
- Underestimating capital expenditures
- Not enough reserves
- Not enough contingencies
- Not inflating exit cap rate enough
- Not inflating interest rates enough (if not fixed)
As an investor, you need to be able to understand and "check" all of these out during your due diligence.
yes and this all falls to management doing their job.. right ?
Absolutely. I wasn't sure if you meant investment/asset management (sponsor) or property management, but both can ruin your investment.
- 7yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
Originally posted by @Sam Grooms:
Originally posted by @Jay Hinrichs:
Originally posted by @Sam Grooms:
@Jay Hinrichs alluded to management, but here are some ways to fail strictly related to underwriting:
- Underestimating operating expenses
- Underestimating expense growth
- Overestimating repositioned rents
- Overestimating rent growth (post stabilization)
- Underestimating capital expenditures
- Not enough reserves
- Not enough contingencies
- Not inflating exit cap rate enough
- Not inflating interest rates enough (if not fixed)
As an investor, you need to be able to understand and "check" all of these out during your due diligence.
yes and this all falls to management doing their job.. right ?
Absolutely. I wasn't sure if you meant investment/asset management (sponsor) or property management, but both can ruin your investment.
its all about the sponsor.. if they do their job correctly .. if they don't then you can take a loss I have seen it first hand..
but sometimes you can do everything you can up front but then 08 hits you and the values drop 50% and your sponsor had a loan due in 5 years that no one will refi.. and the bank that made it went out of business and Rialto bought the assets and wont negotiate and forecloses.. this is what led to the melt down of the GFC.. so one major issue I see with these deals is having long enough fixed debt so you never get caught with a note that is due and for whatever reason cant be refinanced.. or rates go up and your in trouble.
Investors can be worked even if you were to sunset in 5 years if timing is not right at least the investors are not going to cause the project to go under.. but senior lenders can..
- Developer · Charlottesville, VA · Member since 2018 · 4k+ posts · 4k+ votes7y
@Jason Merchey great points above.
The other thing to watch out for is the exit strategy. Most syndications are counting on a refinance or sale event to cash out equity investors. Very difficult to predict where the market is going to be with interest rates and values 3-5 years from now.
Investing is risky and you can lose your capital. Multifamily is generally a much safer bet but you need to take a close look at the asset, the market and do your homework and your own due diligence to make sure you feel comfortable that you will get your money back.
- Rental Property Investor · Glen Rock, NJ · Member since 2015 · 3k+ posts · 2k+ votes7y
As @Sam Grooms and @Jay Hinrichs pointed out, syndications is not a guaranteed investment. So you need to understand the risks going in and be comfortable with it. You should talk to a deal sponsor about their risk mitigation strategy. Also, ask them about their past experience to see if they'll share any lessons learned from the past. No one is perfect and everyone has gone through some learning curves. So see whether a deal sponsor is fully transparent and sharing their past lessons/failures with you as a potential investor.
Also, there is always a possibility of the risks from natural disasters, but those no one can foresee. You can be prepared for a flooding by getting an appropriate flood insurance coverage, but you never know when or whether you will have to use it or not.
- Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes7y
There are many private offerings that have performed well below expectations during the largest bull run in apartment history. Similar sponsors and properties will fail during the next downturn. Typical reasons:
- Under capitalized properties - no money to maintain the property, rents drop, death spiral
- Untimely balloon payments - can lead to foreclosure if values are down, credit is tight, and the resulting LTV is too high
- Poor management
- Bad locations
- Fraud
Kiss a lot of frogs to find your prince.
- Rental Property Investor · San Diego, CA · Member since 2014 · 1k+ posts · 2k+ votes7y
I am working on my third deal with investor's money. It gets real really fast. You need to go with someone that is honest, a teacher at heart, has integrity, and would protect your money like a pit bull. In the deals that I have taken my money and investors money in, I am guarding my money and their money with my life. It would kill me to lose anyone's money!! Don't get me wrong, sometimes it takes longer to achieve all the predicted goals, but that is a far cry from losing money.
Don't accept anything less!!!
Swanny
- London · Member since 2019 · 722 posts · 386 votes7y
Originally posted by @Jason Merchey:
I'm looking into investing a good amount of cash in my first syndicated apartment deal. Buy-fix-reposition-hold. I am imagining there are about 25-50 fairly sophisticated individuals involved on the equity side, maybe $5-10m in debt. My question is, what are the odds of a total meltdown in the process? In other words, do competent and experienced syndicators pretty much always do what they say they are going to or make it up to you in the coming year, or is some kind of significant permanent loss of my investment an actual concern? I am trying to conceptualize the risks of giving money over to a syndicator and property management outfit for 4-6 years.
Jason,
If there was little to no risk (the syndicators always deliver), the rate of return offered the equity investors would be a tiny bit above the US Government bond rates. Risk vs reward. If the rewards are higher, you should assume a higher risk.
I am not saying you can not find great deals. As others in the thread have shown, there are lots of ways a great deal can go bad even when the management has done everything correct.
- Investor · Hendersonville, NC · Member since 2013 · 754 posts · 281 votes7y
This is all fantastic feedback. I gulped while reading....
- Investor · Hendersonville, NC · Member since 2013 · 754 posts · 281 votes7y
@J Scott any feedback would be welcome
- Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes7y
On a cell phone, so apologies for any typos...
Just like any investment in any asset class, there are three categories of risk:
Deal Risk: This is simply the inherent risk of a deal not penciling out the way the operator presumed it would. For syndication, perhaps the rent increases weren't viable, perhaps the expense decreases work viable, perhaps there were hidden issues that couldn't be determined during due diligence, Etc.
Market Risk: Economic factors can impact any investment. Should the market change during the investment., that change can impact the profitability of the deal. I've only invested in a single apartment syndication on the passive side, and it was back in 2008. I lost money. Unfortunately, I don't think they could have been avoided by the operator, as he was pretty conservative and the numbers were solid until the market shifted.
Operator Risk: Some investors are better than others. Likewise, some apartments syndicators are better than others. The operational piece of apartment syndication is critical, and even if a deal is solid and the market is strong, poor operation can sink a deal.
Those are the three major types of risk. Within each, there are hundreds of details and things that can go wrong.
As an investor, it's your job to sit down with the operator, and:
- Ensure that you understand the numbers behind the deal and that everything makes sense. If something doesn't make sense, ask questions until it does or walk away. Don't let an operator convince you that something makes sense when your gut tells you it doesn't.
- Ensure that the underwriting accounts for potential market shifts. For example, an exit cap rate higher than the entry cap rate. And underwriting out to 10 or 12 years, in case a project needs to hold longer to recover from the downturn.
- Do your due diligence on the operator. Ask for references, look at other projects, and make sure that they have a reputation for both finding great deals, analyzing well and operating well.
- Syndication Expert and Investor · Indianapolis, IN · Member since 2016 · 591 posts · 808 votes7y
Here's a few the items on my list that I look for when evaluating a deal -
Debt - look for fixed rate debt with a term that is at least 7 years ideally 10+ years. Even with it's headaches, HUD debt with 35 year terms definitely make it easier to sleep at night (the REACS and surplus cashflow calcs don't help but that's for another topic). Does the deal rely on an extended interest only period? Does the deal rely on a refi at a specific time?
Operations - DD on sponsor, DD on their assumptions, DD on the asset itself, DD on the PM if it's a third party.
Market Analysis - Population growth, job growth, income growth, is area income less than 30% of target rent?, demographic makeup vs unit makeup.
Sensitivity Analysis -
What is the breakeven economic occupancy? I'm looking 25% or less in the skinniest year (usually when the IO period ends)
What does COC look like if rent growth growth is flat?
What does the exit IRR look like if the cap rate is 100 bps, 200 bps, 300 bps, 400 bps above current market.
Taxes - What if there is a significant tax reassessment? What does that look like in the skinniest year.
What if a combination of these issues happen all at once?
There's more but if you can go through this list and you are still comfortable with your return you should be able to feel confident in the deal.
At the end of the day as an LP you risk loosing 100% of your capital, having a capital call and choose to invest more or be diluted - and then you can loose that capital as well. It does happen, almost always with inexperienced sponsors.
- Real Estate Attorney & Investor · Greater NYC Area · Member since 2016 · 70 posts · 48 votes7y
@Jason Merchey a lot of great advice was already given, but when it comes to the controlling agreement for the equity partners (i.e., LLC Operating Agreement) the Sponsor who is managing the deal should be incentivized with staggered promotes in the amount of return they achieve so that your equity, as the silent equity, becomes preferred equity that gets paid back first. After you've received returns up to a certain threshold then the sponsor can begin collecting their returns and is incentivized to get better returns because they will achieve a greater percentage of the returns once they reach certain staggered thresholds.
- Rental Property Investor · Weehawken, NJ · Member since 2014 · 1k+ posts · 704 votes7y
A lot of good comments have been made here, so I probably do not need to add much.
One thing I would consider is gaming out the downturn situation. So say we have another 2008 style recession.
If residential: Are these the kind of units tenants can leave to cut costs and live somewhere else?
If commercial: Are the businesses the kind that last through an economic downturn?
Personal preference, but I am always concerned about assets that involve people making discretionary spending choices. Resorts, vacation homes, cuisine, entertainment, event space, class A buildings with a ton of amenities, condo developments in odd locations.
If there is a large group of people that can choose against the transaction for austerity reasons, I see warning signs there.
If your syndicators are good, they will have already considered these scenarios. These considerations should fit into an overall philosophy that the sponsor embodies. It will be reflected in the kinds of projects they choose.
- Syndication Expert and Investor · Indianapolis, IN · Member since 2016 · 591 posts · 808 votes7y
@Account Closed why would competitors invest in each other's deals?
Have you ever participated in a syndication? You've given a lot of blanket advice recently that doesn't seem to come from much experience. - Rental Property Investor · Chantilly, VA · Member since 2017 · 104 posts · 149 votes7y
@Jason Merchey Another thing to evaluate is the Syndicator and Property Management Company's ability to hire great onsite staff. This includes Contractors, Maintenance Techs, Leasing Agents and the onsite Property Manager. This is especially important when executing a value-add plan in a secondary or tertiary market.
Staff turnover, and the inability to find great and affordable individuals on the payroll will lead to inflated costs and longer timelines. This can result in slower unit turns, slower lease ups and will have a drag on returns, increasing your refinance risk, among other things.
While conservative underwriting is critical, execution is everything. The Syndicator and Property Management Company's ability to execute will depend on their ability to find great individuals who can outperform that conservative underwriting. When evaluating opportunities in smaller markets, it is important to factor this into your analysis, and to make sure there is a plan in place to compensate for that risk.
- Real Estate Consultant · Evergreen, CO · Member since 2018 · 1k+ posts · 726 votes7y
Not doing ENOUGH due diligence. You really need a good team. Multi Family is a team sport just like the NFL, if you don't have 11 players who are skilled and know the play your QB is going to get sacked hard. Same thing in Multi Family.
The best teams I've seen have an asset manager, acquisition manager, a numbers guy who has to love spreadsheets and documents, a PR/ Front Man who can host the webinars, events and education programs, a good funnels/ social media guy and a good office manager who can manage flow.
Your acquisition process has to be flawless. Just a mistake of rent being undervalued by $50.00 can kill your ROI. Ideally you want to be able to pay your investors off in 5-7 years so you want to front load as much as possible.
Most of the reasons have already been listed. People use different terminology but it's all the same really!
- Rental Property Investor · Roanoke, VA · Member since 2016 · 69 posts · 94 votes7y
So much great advice here. You are educating yourself which is the first step. Read @Joe Fairless and @Theo Hicks book Best Ever Apartment Syndication Book to help you get started. Remember you are investing in the sponsor more than the property. Do you trust them? Do you know others who have invested with them? Invest the minimum amount with a couple sponsors before investing large amounts. This will help you to better understand the business and how some sponsors will stand out from others. You must do your due diligence on each one of course. Also listen to them being interviewed on podcasts.
- Investor · Phoenix, AZ · Member since 2017 · 583 posts · 919 votes7y
Originally posted by @Spencer Gray:
@Account Closed why would competitors invest in each other's deals?
I'm invested in syndications where I'm not the sponsor. One benefit is diversification (and truly passive income). Another is seeing what colleagues (I don't look at them as competitors) are doing. Call it market research (market being syndications, not the real estate market/economy). I've implemented changes to our financial reporting from what I've seen other's doing.
- Syndication Expert and Investor · Indianapolis, IN · Member since 2016 · 591 posts · 808 votes7y
@Sam Grooms Good point. It's more "friendly competition" that isn't zero sum and a good deal is a good deal. My point was more that it's not a useful litmus test.
- Investor · Phoenix, AZ · Member since 2017 · 583 posts · 919 votes7y
Due diligence is impossible for the average person? I'm pretty sure the average person can look at projected rents and comparables and see if the two are in line. They can look at assumptions used and see if they're conservative enough. They can ask the sponsor for deal history and contact information of current investors. If someone can't do some fairly simple due diligence tasks, they shouldn't be investing in syndications at any point of a cycle.
- 7yBrian BurkePro MemberInvestor · Santa Rosa, CA · Member since 2012 · 2k+ posts · 7k+ votes
I've raised over $100 million from hundreds of investors throughout my decades in the syndication / operator space, and I can assure you, DD is absolutely possible, and mandatory. To this day, we speak with every new investor and most repeat investors before they make their first or repeat investment. I've had investors travel from as far as Australia to meet in our office just so they could see that we were real.
We spend all the time we need to answer every question posed to us. Every sponsor worth the title should be doing the same.
Given that the quality of the sponsor drives the outcome more than the real estate itself in most cases, this level of DD should be performed on every contemplated investment. Even if Ben invests in my deal, you should do your own DD on me because maybe Ben didn't... :)
- 7yIan IppolitoBusiness MemberInvestor · Tampa, FL · Member since 2015 · 1k+ posts · 1k+ votes
@Account Closed,
I agree that doing proper due diligence takes a lot of work to learn how to do, and even more work to actually do it. However, I feel that if an investor is not willing to put this in, then they really should not be investing in real estate, and should consider investing in public markets or something else.
If it helps, below is my diligence process. I’m very conservative so you may not need to do everything. But maybe it will give you some ideas.
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
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