Why Do Synidcations Exist? Why Don't They Just Use Banks?

Question

Why do syndication sponsors go to all the trouble of working with LPs to incrementally raise funds?  Why don't they just develop a relationship with a bank (or banks)?  Wouldn't it be easier?

Thank you

Brian Burke · Answer

Any good syndication sponsor already has solid lender relationships. But a lender will only go so far on the risk spectrum in exchange for a 4% to 6% return. That means they’ll loan the syndicate 60% to 75% of the purchase price. That contains the downside risk.

So where does the remaining 25% to 40% (plus closing costs, renovation costs, etc) come from?  Passive investors who are willing to go out further on the risk spectrum, in exchange for higher potential returns.

Short answer: banks won’t give all the capital needed to execute no matter how good your relationship is. That’s not their business model.

JD Martin · Answer

I would always refer people to trusted sources like @Brian Burke , who have a good reputation and while they have their own products to sell can help evaluate the claims made by another fund. It's not a zero sum game and they don't have anything to gain by telling you straight, ie they're not going to tell you it's a chump fund if the underlying structure is solid. Investing in syndication deals is pretty much like any other RE, you tend to get better at it the more you do it. The reason you can generally only participate if you are accredited is because regulators know that it is easy to get taken in these deals and it is assumed (wrongly so IMO) that if you have a higher net worth and can plunk down a big chunk of cash that you have the sophistication to understand the investment.

Brian Burke · Answer

1. Banking regulations won’t allow this, nor is it prudent. Equity investments can suffer a 100% loss—the FDIC doesn’t want to pay this claim.

2. They do.  HNW and family office are major sources of capital for syndicates.  BUT, a sponsor doesn’t simply “connect with a family office and get funding.”  If only it were that easy….

Evan Polaski · Answer

@William Coet

The Hands Off Investor by Brian Burke is a great resource.

Passive Pockets is another.

Aleksey Chernobelskiy is building an entire business about advising LPs.  he is very active on LinkedIn.

And then there are these forums, too, and asking questions.  At the end of the day, there is no formula to it.  Each deal is going to have its own unique pluses and minuses, and in reality it is all about risk and reward.  The thing that I would start with is: talking to a lot of syndication sponsors before you choose to invest any money.  Try to find those that align with your goals.

I.e. there are a lot of sunbelt, value-add multifamily syndicators.  Most will be 3-5 yr holds.  Some may state they are 3-5 yr holds, but then take on floating rate debt with a 3 yr cap on the interest rate.  All good, if rates drop a lot and/or they can get out in under 3 yrs.  Others are 3-5 yr hold but take on 10 yr fixed rate loans.  This plan hedges the downside if an exit is not possible within the anticipated timeline, but may cost a lot for yield maintenance to get out of a loan in 3 years.  Which is better?

The biggest thing I see new investors do, which JD calls out in his response to me, if you are simply going to invest in the deal with highest projected yield, you can generally assume you are taking on the most risk.  Low projected yields, generally, mean lower risk.  Real estate is, generally, a pretty efficient market, so you can generally assume that if a syndicator is presenting a deal with a 25% projected return, they are doing something in the deal, that makes it higher risk than the group with a similar deal projecting 15%.

Maybe it is more aggressive exit assumptions, aggressive rent growth, under forecasting renovation costs, taking on higher risk debt, etc.  And you can only start to understand those through seeing how a lot of different groups underwrite different deals.

Allan C. · Answer

@William Coet the other driver is lower recourse. It’s the same as why corporations list shares on the stock market. If you lose LP/shareholder money then only your reputation is at risk - and many sponsors care more about making $ than their reputation. If you lose bank money then you have financial consequences. I’m simplifying to make a point.

JD Martin · Answer

I don't think we are in disagreement here. An institutional investor with a history of working with syndications in these kinds of deals is going to have a much better handle on fair and realistic fees the syndicator should be collecting for those services versus a bunch of lps that may be working on the first syndication deal and frankly glosses right over those issues when they see 15% annual returns and a nice fat cash bonus on the planned exit. Though to be fair there are probably more than a couple of pension plan managers that are probably crapping themselves right now. It's just easier to snow a bunch of small fry LPs in general.

Chris Seveney · Answer

@William Coet

We run a mortgage note fund buying distressed mortgages / do you think a bank would

Lend on defaulted loans?

As mentioned banks have very strict underwriting requirements and will finance but they have limits to what they will finance.

Reality is banks actually finance less than 50% of mortgages. Most are non bank lenders nowadays which sell them off to Wall Street.

Evan Polaski · Answer

@William Coet, to add to Brian's comments:

Banks, partly due to the regulations they are subject to, tend to fall low on the risk spectrum.  You saw a lot of that start to go away leading into the financial crisis, as more traditional retail banks started acting like investment banks, hence a lot of the regulations placed on them.

And, as for "why not connect with HNW and family offices", most do.  Whenever you see a syndication directly marketed, it is only open to accredited investors. By definition, these are investors with $200k+ annual incomes or $1mm+ Net worths.  This is exactly who most syndicators target.

Then you get into family offices and institutional money, who can write $5mm+ checks.  There are not a lot of groups, in the grand scheme, that can do this.  And to get their attention, you need a long track record and infrastructure, as well as the right deal(s). Large investors are much more of a B2B sales approach, while the typical accredited investor is a B2C relationship.  There are certainly pros and cons to each.  Having a single source of capital is great, and "easier" in terms of relationships to manage, but it is also high risk.  If that single investor stops funding your deals, your business is basically done growing.

Brian Burke · Answer

Thanks for the kind words, @JD Martin.

William, I don't have anything to sell, but BiggerPockets does--I wrote a book for them on this very topic:  www.biggerpockets.com/syndicationbook.

Why Do Synidcations Exist? Why Don't They Just Use Banks?

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