What are the reasons syndicators fail

21 Replies

What are the top reasons apartment syndicators fail? Please provide specific examples of those who have failed. Thank you.

@Bryan Mitchell , the way I see it, you can break down risks of a syndicated deal into 3 pillars.

  1. The Deal. Is it conservatively or aggressively underwritten? Are there hidden costs that aren't underwritten to that destroy cash flow? If it's a value-add play, is there enough meat on the bone and are rent premiums at the top or middle of the market (unlikely that they'll be at the bottom)?
  2. The Market. Does the market have strong fundamentals? Rent growth, population growth, job growth, occupancy, etc. Is the Operator making conservative or aggressive assumptions based on historic market performance? Is there one major employer that, if they left, would sends jobs and population for the market in a downward spiral? What is the competition like?
  3. The Operator. How experienced are they / what is their track record? Do the key partner's skill sets complement each other well? Do they have a background that lends well to successfully syndicating commercial real estate? Are they all over the place with their strategy (i.e. one deal they're doing core plus and the next deal they're doing deep value-add). etc.

This is all high level, and there are a lot more factors to consider for each pillar. That said, if one of these pillars is off the deal can be a total flop.

@Mike Dymski , you’ve made some excellent points. No one wants to be a victim of fraud especially! Are there any real estate examples that you can think of?

Originally posted by @Bryan Mitchell :

What are the top reasons apartment syndicators fail? Please provide specific examples of those who have failed. Thank you.

Lately, I've also been seeing a lot of "positive mindset" newbies with little to no experience/education coming into the space and then complaining that they failed. They are typically weekend warriors.

No amount of positive thinking is going to save you when math is working against you. 

 

@Bryan Mitchell

While you received a great response from @Mike Dymski and @Michael Bishop , what a lot of passive investors omit to do is to conduct their own due diligence. 

So if you're looking at it as a passive investor, always ask an operator about their own failures and be on the alert and if they say "...None ". While not impossible, everyone has at least some small failures.

If you're an operator, looking to learn from other people failures, then you got to read up a few books and network extensively to gain the knowledge from those who have failed.

Hi Bryan,

Thanks for posting! You've received excellent perspectives already; I would add a few items (and potential thought processes) that have the ability to present challenges:

1) Poorly Drafted PPM - a well-written private placement memorandum becomes an appropriate reference when potential challenges arise with investors. I remember a time there was a question as to how the calculation for a quarterly distribution should be prepared because the PPM included a clause that intended to account for when the funds were received (during the subscription period). Because the PPM was not explicit in how the distribution was going to be prepared and account for when funds were received, I made a judgement based on what I believed was a substantial interpretation. This will typically not surface, unless you have an investor who is very keen in analyzing financial reports ;).

2) Inadequate Property Insurance - as a risk management measure, the property insurance is an important part of potential crisis mitigation. You can include insurance premiums in the initial underwriting models, but it's wise to ensure there are standard things covered by the insurance company, like 12 months of lost rental income, etc. It's also good to consider if the state you are investing in provides protection again insurance company insolvency, to be safe, in case they go bankrupt (like AIG, for example).

3) Desire to manage a fund first, as opposed to a specific deal -  perhaps not as common, but I've encountered those who are more interested in starting a fund and deploying capital when the appropriate deal is available instead of sponsoring on a "deal by deal" basis. Syndications are generally more practical, whereas a real estate fund is a better choice if you have consistent deal flow and capital.

You will do well! Please feel free to reach out to me directly if I might be of assistance to you.

All the best,

Daniel Reyes

 @Bryan Mitchell , great question! A few reasons are as follows ... 

1.) Don't raise enough capital going into the project, so they come into the deal under capitalized because they didn't take into account for unexpected repairs. Then even worse they take it out of the cash flow. The whole biz plan goes out the door at the point.

2.) Don't take into account, reassessment of taxes in year 2, in their proforma.

3.) More into making the fees upfront than establish a long term relationship. Operating with principles and morals is actually a good thing

@Tj Hines , ah yes, unexpected repairs. That’s a great one to point out. Also, the adjustment for increased taxes somewhere in year two. Both of those also exist in single owner smaller deals. However, you’d expect more from a seasoned professional syndicator. Thanks for offering your insights!

Everyone has made great points regarding a few specifics but I would say no matter how good a deal appears you can never discount the experience, skill sit and focus of the syndicator/ operator.


A great operator will make a half decent deal great no matter the struggles but a novice operator can make a great deal sink at the end of the day.

I worked directly with syndicator clients and for a top notch syndicator for four years and what I learned from him is the team and system he had created to cover all ends is what led to his unmatched success and sticking to doing only one thing better than anyone else which was medium size value add deals although everyone will have their own definition of value add.

lack of experience in managing People and peoples money..  this part of the business is an acquired skill

not something you pay a guru 50k for and wha la your a syndicator.

were I have seen them fail is this.

1. competition from newer units raided older units property DCR fell below loan covenants and cash calls were needed to pay down debt.. investors were not willing or able.

2. Moving money between projects to prop up one that is not doing well.. You know rob Peter to pay Paul. 

3. Poor choice out of the gate.

4. lack of experience dealing with multiple investors and their monies.. bAd accounting and reporting and communications. 

I'll add one:

--Not properly structuring the deal (and disclosing all the ins and outs of the structure)

--Bringing in bad business partners/co-sponsors or bad investors

Originally posted by @Amy Wan :

I'll add one:

--Not properly structuring the deal (and disclosing all the ins and outs of the structure)

--Bringing in bad business partners/co-sponsors or bad investors

back in the 80s I did site procurement for a large syndicator.. and when you talk about bad investors.. this is very true they had some issues with tax reform and then the market cooling in 1989.. one investor basically went bonkers and long of the short of it.. between him and his attorney torpedo'd numerous projects that could have been saved..  not that the syndicator did not have issues they did.. but doing a hostile take over and then bringing in an attorney who started billing like crazy just sunk a number of the projects.. 

 

I believe that some syndicated deals will fail because of too many (inexperienced) cooks in a kitchen.

I see it more and more often when 4 or even 5 newbies (or semi-newbies) partner with an experienced (after 2010) sponsor (usually a guru or an advanced student of a guru) to do a deal. The "experience" partner is usually too busy to operate the deal and that responsibility falls on one or two junior partners. I wonder how this large sponsor group would behave in an adverse situation...

A few more to add here

  • Underestimating the CapEx needed to take the project to stabilized status
  • Poor Property Management Company
  • One Man Band Sponsor (Syndication is a team sport)
  • Poor Investor Relations (in the front and back end)
  • Mismatch in loan product to asset requirement

To conclude, Real Estate Syndication is complex with a lot of moving parts and having a team is essential to executing a business plan in order to meet or exceed investor returns.

Tons of great responses above.  I think the two primary reasons are lack of experience (which leads to most of the above more specific reasons) and lack of moral character (which leads to fraud and theft).  The former is far more common than the latter, but it's harder to quantify moral character than it is experience.

Here are examples of each of the two.  

I was once looking at a property that was part of a 2,000+ unit portfolio sale.  The operations were a total disaster and the financials were a mess.  The sponsor had an institutional equity partner that was forcing a sale because of total mismanagement.  The sponsor had bought his first multifamily property and in the three years that followed he bought 25 more--we are talking thousands of units and hundreds of millions of dollars. After two years this guy thought he was a genius and started his own management company to manage this huge portfolio.  It only took one year to blow the whole thing up. There was a revolving door of senior executives in the management company, no one stayed longer than a few months.  Bills went unpaid, to the tune of 300 invoices found unpaid in a file drawer.  Tenants stopped paying, and they couldn't evict because the management company hadn't paid the bill to the eviction service!  There was constant turnover at the property level, and deferred maintenance was stacking up. There was a good chance that the forced liquidation of the portfolio would lead to the non-institutional investors getting wiped out, or at least taking a big haircut.  And these were quality assets in some of the strongest markets in the country!

Another example is a guy that amassed a 7,000 unit portfolio in several states.  He over-leveraged the whole thing, financing with mezzanine loans for extra leverage.  Some of the properties weren't even habitable due to hurricane damage while others were stabilized and performing, but needed upgrades.  Using these bridge and mezzanine loans he leveraged up to finance the renovations, but instead of spending the money as it should be, he absconded with the rehab money and was in the wind.  Eventually the lenders forced a bankruptcy and held a huge bankruptcy auction to recover some of their loan proceeds.  The investors surely lost everything and the lenders didn't come out smelling like a rose either.

Passive investors looking to invest in syndications need to look to the experience and moral character of the sponsors they invest with.  Stop thinking that "good deals" are what spells success, or that sponsors investing money in their own deal creates an alignment of interest that prevents incompetence or dishonesty.  The age-old question of "is it the horse or the jockey?" is easily answered in the real estate syndication space.  It's all jockey.  Carefully examine the experience and character of the sponsor and you'll tilt the risk curve in your favor.

Originally posted by @Bryan Mitchell :

What are the top reasons apartment syndicators fail? Please provide specific examples of those who have failed. Thank you.

Many of the reasons behind the failure are the same reasons individual investors in SFR get burned. Syndication allows for a bigger hole to be dug before the situation blows up.

The devil is in the detail. You can not go against the market and expect great results most of the time. Almost never works when you do not have the capital to see it through. 

@Bryan Mitchell all fantastic responses below so thank you for starting an awesome thread. I'd love to know the % of failed deal for sponsors who are full time vs those who are part-time "think they can do this as a side hustle". If you're the real deal sponsor and truly understand that you're using other people's hard-earned money to go buy real estate, I don't know if working a 40 hr 9-5 is going to help you succeed.

@Bryan Mitchell There are many ways a syndicator can fail, most have been covered in the comments. The one I have had the most experience with as a limited partner investor is the lack of experience on the team. I spend most of my time these days vetting out the team, track record and completed deals. I recognize that everyone has to start somewhere, but in my personal experience of "failed deals" it was because of the syndicate group had too much confidence and not enough experience.