Why Most Syndications Fail

Question

Why do most syndicated investments fail to deliver projected returns to investors?

Because the syndicators interests and the investors interest are NOT aligned.

“I only make money if you make money is NOT alignment”.  The RISK/REWARD for the syndicator differs considerably from  that of the investor.  The syndicators interests has a much smaller financial DOWNSIDE, they can take a much higher risk than the investors and still show a positive ROI.  Further, their usual “promote” is a large upside with little if any syndicator capital being risked, which again leads to syndicators self interest being to close deals that investors should not.  How does the syndicator convince investors to do these deals?  Showing projections on the higher side of “reasonable”, and downplaying some obvious risks (although those same risks will show up in the Private Placement Memorandum, which almost everyone either neglects to read or discounts as something done to comply with SEC regulations and having nothing to do with reality (which is true).

Secondly, syndicators are in the real estate BUSINESS; their investors are not in BUSINESS. So, to remain viable as a business, a syndicator must “do deals”. Investors can invest or not; they still remain investors.

How can syndicators align themselves with investors. By taking the very long term view - closing deals that fail to achieve projected returns will ultimately lead to the syndicators inability to rise capital and to the syndicator’s exit from the business.

Investor’s should figure out if the syndicator has enough experience, track record, history, and ethics to put their immediate gratification, and immediate financial self interest aside and align themselves with their investors interests. After 45 years in the business my best estimate is that 2 out of every 50 syndicators are able and willing to do this.

To quote Will Rogers, I’m not as concerned with the return ON my capital as I am with the return OF my capital”.

Brian Burke · Answer

I got halfway through this post and thought "Dang it @Don Konipol this might be a rare occasion where we disagree."  Then I read the second half and said to myself, "nope, Don has it right once again."  (Except that the post title says "why most syndications fail", when I think it's more like "some" fail, not "most".)

I've stressed more times than I can remember, on these forums, on podcasts and in my book, that alignment of interest isn't a thing in passive real estate syndications.  And I've preached that it's so important to emphasize the sponsor's experience, track record, and length of time in business when selecting investments.

Skin in the game is important but I don't define it by how much money the sponsor has invested in the deal.  Real skin in the game is how deeply the sponsor's livelihood depends on their reputation.  As you said, Don, "taking the very long term view".  As a syndication sponsor myself I know that I value my reputation more than I value "doing deals" or even earning fees.  It's taken me three decades to build up a reputation that I can destroy in a second--that's real alignment.

Another important thing to look for (but also hard to quantify reliably) is the sponsor's financial strength.  Are they sound enough to stay in business if they buy absolutely nothing for five years?  This is the problem with moonlighting syndication sponsors who are living fee-to-fee: if they don't transact, they become strained.  If they are strained, they have to look for income elsewhere.  When times get tough this often means abandoning their investors and going back to a W-2 somewhere.

Invest with sponsors who have been around the block, have a reputation to protect, a track record and experience.  Any other sponsor profile is gambling, not investing--which is fine if that is your intent, but see it for what it is and keep your exposure small enough to not injure you if you bet on black and the bead stops on red.

So why do "some" syndications fail?  1. Market failure (adverse market conditions).  2.  Structural failure (bad financing, improper capital stack, paid too much for acquisition).  3. Sponsor failure (lack of experience/skill, partnership breakup, bad management, crime/fraud).  Most often a market failure exposes an underlying sponsor and/or structural failure and that results in disaster.  Strong bull markets conceal sponsor and structural failures really well and allow a lot of these deals to exit and make the sponsor look brilliant when really they were lucky.  Invest with good sponsors using a good structure, and you can survive a market failure.

Stuart Udis · Answer

Another reason many syndications fail to deliver expected returns is that they are built around imperfect business plans designed to produce results within short, fixed timeframes.

Raising capital forces GPs to think transactionally. Most limited partner capital is not patient. Many investors, even those who qualify as accredited, do not have the liquidity or time horizon to let real estate mature, in many instances dismissing the highest and best use for the sake of speed. Most LP's need (emphasis on need & not want) their money back within a defined period because of other pressing financial obligations and are drawn to projected IRRs and short hold periods.

This is met by syndicators relying on high leverage, tight loan maturities, and optimistic exit assumptions. These structures may look attractive in a pitch deck, but they are often misaligned with what is best for the asset. On the property level, costs are cut because the real estate is not being stabilized for durability or long-term operations, its being stabilized for an immediate exit. When that exit is misjudged or cannot be achieved, the property issues are only compounded.

Real estate performs best with patient capital, conservative leverage, and flexibility to adapt based on the market conditions. When speed becomes the priority, the asset becomes secondary. This has only gotten worse with the types of LP's that are often relied upon by the new wave internet syndicators. I suspect most are not even accredited. If many accredited investors lack the ability to invest patiently, the outcome only worsens when LPs are even less financially secure.

Todd Dexheimer · Answer

I think it all depends on the market cycle and the sponsor. From 2015-2022, I would guess that nearly all syndications far exceeded pro forma. I would guess that most deals sold post 2022 have underperformed, and most bought post 2020 are not hitting expectations. My guess is that if we look at deals bought in 2024-2030+ most will end up hitting or exceeding projections.

The ones that are exceeding expectations were bought in well-located areas, with ample reserves, using low-leverage long-term fixed debt. They also had a real business plan and not a pie in the sky pro forma.

Chris Seveney · Answer

Agree 100% on long term approach. I had a conversation with someone today regarding this and the relationships we look to build are long term in nature and not just short term. Back in my w2 days  I have worked with people in the past who only prioritize short term not long term thinking and in many times do not realize they may win those battles but eventually lose the war.

Don Konipol · Answer

Brian, it’s why most syndications fail to deliver projected returns, not why most syndications fail.  I guess my position is that most, while not outright failure in terms of investors losing money, fail in terms of delivering returns less than they projected.  This is  anecdotal and not based on any stats.  Do you have any information you can share on this point?  Has your experience led you to a different conclusion?  You may have experience in a broader range of experience in syndication real estate platforms than I have.  I think investors as well as I are interested in your take on this.

Why Most Syndications Fail

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