How do I vet a syndication as an investor?

31 Replies

Hi all! I'm interested in passively investing in large apartment deals. I already have connections to a few operators and have browsed their packets but haven't pulled the trigger yet. 

Does anyone have any recommendations for educational resources (books, podcasts, courses, etc) for how to vet the operator and the deal itself? I understand the math but need more information on what to look out for as red flags. 

I'm seeing returns of around 18% IRR for a 5 year hold- is that in line with what most are offering?

Thanks!

Great question Kayla, it can be a tricky business to vet.

I always advise that people do their research when it comes to sponsors and deals. When you’re considering an investment sponsor, do due diligence. Keep in mind to always:

  • Ask for references: Email references and set up a time to call them. Ask some open-ended questions and find out what they have to say about the sponsor.
  • Look at the team: Is the sponsor a one-man show? If there’s a team, what do they bring to the table?
  • “Stalk” the sponsor online: Do some basic internet searches. If you’re not finding much about the sponsor, that could be a red flag.
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an 18% IRR isn't out of the range for a 5 year hold, depending on the market and type of deal.

Here are a few red flags I look for -

High occupancy assumptions

Low exit cap rate

Short term or variable interest debt

Overly selective comps

No or little experience in the market (not a deal killer but must have plan)

New strategy for the sponsor (is it a total reposition/re-tenant and they have only done light value add)

Low payroll assumption 

No PM fee

If they require you to guarantee debt (it's ok to be asked but you should be compensated)

No expense growth

Compare year 1 GPR with the T-12 GPR

If sponsor refuses to give you T-12 or rent roll

Expense / Income ratio under 40%

If the deal relies on an early refinance 

Hope this helps!

Hey @Kayla V. there's some great resources available listed above, but ultimately it comes down to a few things: 

Comfort with the deal (does the location, business plan, strategy, etc... make sense)

Comfort with the returns (does it fit your investing goals)

Comfort with the sponsor (how's their reputation, what are they not telling you, etc...)

Once you get over those, it's as simple as finding a deal/sponsor that meets that. To educate yourself, there are several podcasts (mine included) and books to help you understand things.

@Greg Scully Thanks! I've attended Joe's conference here in Denver and have listened to his podcast so knew of him but hadn't dug around his website. I'll spend some time there!

@Andrew Hogan Asking for references is something I hadn't thought of - good point. As for having an online presence, do most sponsors make an effort at digital marketing (have a podcast, blog, etc)?

@Spencer Gray Thank you for this list! That's very helpful. 

@Lucas Miller I figured part of it was just finding someone you trust but as an engineer, I like using data and numbers to convince myself. I'll definitely check out your podcast. 

Most great sponsors do not have podcasts or similar digital presences (that doesn't mean the ones who do aren't legitimate). The best sponsors are focused on running their real estate deals. It's an intense business. You want your sponsor operating real estate and finding good deals--that's a 60- to 80-hour per week job.

First, you should be comfortable doing due-diligence on the deals and verifying the sponsor's assumptions in the model. For some context: in deals with sophisticated LPs, sponsors will send their model and the LP will then pick apart that model. LPs often underwrite the deal with their own model. 

Underwriting takes practice. If you can, ask for trailing-12 expenses from a current property they own so you can verify that their model's projected operating expenses are in line with their current market operations. Sponsors are in the business of doing deals and they need those deals to look attractive to investors so they can get their fees. Thus, assumptions may get a little ambitious-- but that's for you, the LP, to determine. Some sponsors are conservative, some are aggressive.

Second, in respect to the sponsor as an individual or as a team of individuals, you want to see a track record of successful deals--and preferably successful exits. If they've just started but have 2-3 deals under their belt in the past year, it's too early to know if those deals are making money or will make money in the future. That's not to say you shouldn't invest with new sponsors, but it does mean that you need to spend more time diligence-ing the deal with your own assumptions and market research. Further, you need references--including character references--for newer sponsors.

Finally, and I've mentioned this in other posts, you want to make sure the sponsor has incentive to work hard to achieve outsize returns, but you don't want them taking too much of the deal. So, if a sponsor sends you a deal in which you're projecting an 18% IRR over 5 years to yourself, the sponsor shouldn't be receiving 50% of the total cash flows from that deal--that would be well-above market. You want a structure in which they're receiving 20-30% of the profits when you hit your 18% hurdle (as an engineer, you'll get this math relatively quickly). Structures in which the sponsor receives more than those percentages are often imbalanced and result in the sponsor making a lot of money even if the deal doesn't meet your return thresholds.

Understanding the fee structure dovetails with this: Sponsors can't be "feeing up the deal" so they get all their capital back before a check is delivered to the LPs. You also want the GP to have skin in the game until you get your initial invested capital back.

Regarding your returns: an 18% IRR over a 5-year hold period is not unreasonable but will take skill to achieve. It's a competitive market and sponsors can only achieve returns like that through heavy value-add programs. Make sure the construction budget reflects this. And if they're using bridge financing, make sure the deal isn't too risky because those are the first deals to go underwater when a market corrects.

@Kayla V.

My feedback is pretty much in line what others are saying:

1) start by vetting the sponsor. Ensure their strategy is in line with your expectations and resonates with you. 

Here's a list of questions to ask them:

https://www.biggerpockets.com/member-blogs/10850/76728-questions-to-ask-a-syndicator

2) You need to move on to evaluate the market they're investing in to ensure it fits your criteria. Several book resources that will guide you in the right direction in terms of MFH:

"Multifamily Millions" David Lindahl; Steve Berges book on "Buying and selling large apartments..." PM for my library if you'd like.

Podcasts:

1. Syndication show by @Whitney Sewell

2. Jake and Gino podcast

3. Rod Khleif's podcast

4. Joe Fearless podcast

3) Once the two steps above check off, you have to move on to the deal itself.

Evaluating a deal takes practice. Here's an article that will give you some understanding of the commonly used terms.

https://www.biggerpockets.com/member-blogs/10850/79257-deciphering-syndication-investment-terminology

As @David Almeida mentioned, 18% is achievable, but I would triple check the underwriting as it sounds a bit too aggressive given what where we're at these days.  

Bottom line, educate yourself first, look at a bunch of deals prior to deciding to invest.

Best of luck!

Originally posted by @Kayla V.:

Hi all! I'm interested in passively investing in large apartment deals. I already have connections to a few operators and have browsed their packets but haven't pulled the trigger yet. 

Does anyone have any recommendations for educational resources (books, podcasts, courses, etc) for how to vet the operator and the deal itself? I understand the math but need more information on what to look out for as red flags. 

I'm seeing returns of around 18% IRR for a 5 year hold- is that in line with what most are offering?

Thanks!

Have a look at this book too

https://www.amazon.com/Passive-Investing-Commercial-Real-Estate-ebook/dp/B07MYCK56B

@Kayla V. from my perspective, the sponsor matters a lot less than the underlying economics of the asset. 

Put another way, an incompetent sponsor can ruin a great deal, but a great sponsor can 't turn a ruinous deal into a home run. 

As Warren Buffet has said: " When management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact." 

The underlying economics of the asset, its location, ability to scale or change with the demands of the area, the demographics of the MSA, the growth potential of the MSA ect, and the the economics of the deal, loan terms, price, deal structure, ect play a far larger role in driving the returns of a syndication than any sponsor could ever hope to. 

So I ensure that the LPs are complete morons, have some track record of success, and aren't' likely to torpedo the deal, but once I've cleared that admittedly low bar, I focus all my efforts on ensuring the fundamentals of the asset and the terms set me up for success. 

In terms of resources, I'd look at Joel Greenblatt's "The Little Book That Beats the Market" and  Tren Griffin's "Charlie Munger: The Complete Investor"

Hi Kayla,

Besides fact checking their track record and speaking with current investors, it really comes down to their character, which you can get a feel for when speaking with them on the phone. If they won't speak with you on the phone, that's a red flag for sure.

@Kayla V. some good advice above. Just to add a few things. I have had luck using some of the crowdfunding sites to find good sponsors. I especially like Realcrowd and Crowdstreet so far. Realcrowd has some great educational material on their site and a good podcast. The nice thing with them is you can get started with a smaller dollar amount an if you click with a particular sponsor then you can continue with them.

The last comment I would make is you specifically said 'apartment deals'. Why is that? I look at a lot of offerings in many different areas of commercial real estate and of all of them apartments scare me the most at the moment because of the price sponsors are paying for some deals.

@Kayla V.

Definitely go to meet them. See the market. 

18% IRR does sound a bit high for a 5-year, but it's not out of the question. People who've seen my comments around here know this, but I always say: "I would rather take bad numbers from a good operator than good numbers from a bad operator." It's ALL about the operator and their ability to deliver and protect on the downside.

IRR can be manipulated depending upon the future value (FV) of the investment. Make sure to find out what they're exit assumptions are and if they are in line with the market increases.

Originally posted by @Kayla V.:

Hi all! I'm interested in passively investing in large apartment deals. I already have connections to a few operators and have browsed their packets but haven't pulled the trigger yet. 

Does anyone have any recommendations for educational resources (books, podcasts, courses, etc) for how to vet the operator and the deal itself? I understand the math but need more information on what to look out for as red flags. 

I'm seeing returns of around 18% IRR for a 5 year hold- is that in line with what most are offering?

Thanks!

For vetting deal, 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.

I was reading in a "prospectus" of a Mutual Fund Passive Investment Fund that they do not go by "The Investment Act of 1940" nor are they subject to SEC oversight. Is this normal? 

Do individual firms that sponsor Passive Multifamily Deals need to go by these rules?

@Kayla V. @krishan Singh can speak to this specifically. He's a passive investor in a lot of deals. He's on facebook and has talked about this topic specifically on a lot of podcast. Mainly Whitney Sewells podcast (the Real Estate Syndication Show) Search for Krishan there to as well.

@Kayla V. ,

With my firm we are very, very discriminating regarding what sponsors and offerings we will recommend, and I personally inspect all multifamily and student housing myself. You might consider using an investment advisor to evaluate which offerings are suitable and promising. In regard to institutional real estate investments, the advice of an expert who works in the industry every day, knows all the players and their track records, and performs due diligence on each offering is a great benefit to you.

I'd recommend meeting the players, checking their track records, their debt service ratio and to see if they have skin in the game. Choose cities in safe and economically diversified areas with above-average income and population growth. It's can also be safer to diversify your investment properties across the country.

@Kayla V. Hey Kayla. I primarily invest my money passively along with putting together 1-2 syndications a year. But after investing nearly $1,000,000 passively here are the main questions you should ask sponsors to vet the deal.

• Are you putting your own money into this deal? Not from an acquisition fee but are you putting current liquid capital into the deal and if so how much? Reason: I want to make sure they have at least some skin in the game

• Will there be an acquisition fee? Reason: I understand a nominal flat type of fee, it's a pain in the *** to put together a syndication. However, when syndicators are buying communities for $40 mill., beating out other syndicators and institutions and then on top of it asking their LP's to pay them an extra $800k-$1.6 depending on the acquisition fee I want to know why you think you've earned that. I think is is a conflict of interest as they know all they have to do is push the deal across the finish line and whether it winds up being crap or great, they've made a good nut up front. 

• What is the asset management fee? Reason: Ideally I want to see 1.5% or under. I also want to know if they plan on re-investing any of that into the property. 

• Is there a preferred rate of return or straight equity split? Reason: I personally am not a fan of the pref structure, I think it doesn't keep LP and GP interests lined up. What if there's an 8% pref and year 1 is only 4%? Year 2 is only 5%? Now in year 3 the GP is starting the really get behind the ball and if they can't catch up I worry they sell at an inopportune time. Also, usually when there's a pref there's usually waterfall structures on the back end. I prefer just a simple straight split no higher than 20GP/80LP. 

• At the time of sale, do I get my initial capital back before you get a dime? Most of the time the answer is yes for obvious reasons. 

• Have you personally “shopped the comps” and visited them and why are you confident that this property is comparable or better? Self-explanatory. I want to make sure they honestly know the market and didn't just underwrite from another time zone and have never visited the property. 

• What is the number one concern you have with this deal? There should always be a concern or two that the sponsors have, if not they're lying. I appreciate the honesty and want to know how they plan on tackling this concern. 

• How did you come up with your numbers for property taxes on the pro-forma? Depending on the state this can make or break a deal. 

• Does your insurance policy cover loss of rental income in case of a fire and does your insurance policy cover the FULL cost to rebuild in the case that 5 or 25 units are damaged by fire? very very very very important that the property has comprehensive insurance. I want there to be code upgrade insurance, replacement cost, debris removal, business interruption, etc. 

• I’m not going to hold you to it but what upside is there that wasn’t spoken about? Sometimes there's some real nice value-add components that the GP's don't talk about because they don't want to set expectations too high so I always like to ask this one. 

• What Is your relationship like with the property management company and how many properties do they manage in the area? Also are those comparable properties? Extremely important. The PM company will make or break the deal. 

• What is the most recent deal you did and how is that performing? Can I see the webinar/projections of that deal along with your most recent monthly report to compare it with actual performance? I want to see how they're on previous deals they've done. Are they the type to over promise and under deliver or vice versa. 

• Are any of your family or friends investing in this deal? I know it's a weird question but I think it's important. If there's one group of people you don't want to let down it's your family and friends and I feel GP's feel an extra level of accountability to family and friends. 

The best way to vet the operator is to speak with them. Phone call is the easiest but I know some passive investors actually fly out and meet the sponsor in person. The purpose is to gauge their character.

Another way to gauge their character is to speak with people who are currently investing in their deals.

@Kayla V. Your question is a great one. Vetting syndicators is crucial and in my opinion it helps if you have a checklist to use or some kind of process. There are certain types of syndications, teams, deals, etc, that I personally won't touch. Here is a list of questions that I think will be helpful in developing your own custom check list. 

https://www.biggerpockets.com/member-blogs/10553/80873-the-best-questions-to-ask-syndicators-when-evaluating-deals