Syndication - The in's and outs of raising private equity
Purchasing a $20,000,000 apartment building can be a daunting task. The biggest question that comes to mind is how do I buy a $20 million building when I don’t have $5-$6 million sitting in the bank? There are a few different answers to that question. First, partner with some friends that have a lot of money and split the deal and tasks to run the building. Second is to dig into your piggy bank, third would be to stop thinking so big and to buy something you can afford, fourth would be to get seller financing and fifth is to syndicate the deal in order to raise the funds to buy the building.
In this chapter, we are going to discuss raising money. First, I will start by saying that I don’t think you should raise money, unless you are ready and understand what that means. Raising money is to be taken seriously and diligently and is not meant for everyone. You are dealing with other people’s hard earned money. They are trusting you with a large portion of their funds and do not expect you to lose it and expect that you will treat it with the highest regard. Even if you can treat their money better than your own, you should hesitate. Can you provide them with solid communication and proper details? Are you experienced enough to perform on your underwriting and are you being conservative enough to be able to under promise and over deliver? To pound the point home if you are going to use other people’s money you need to be sure that you will be more careful with their money than with yours and that you can communicate with your investors timely and effectively.
So what is syndication and how does it differ from a REIT? Quite simply a syndication is when a group of people pool their money together to make a purchase vs a REIT where you are getting shares of a private or publicly held real estate company.
Before going too far, I want to make sure that you understand that you should be using a securities attorney to set all of this up. If you are thinking of partnering or in any way using other people’s money, pay an attorney that is well versed in this, to review your situation and point you in the right direction.
You have two main parties in a syndication and potentially others depending on your needs:
General Partner(GP) otherwise known as the sponsor. The GP is the company that is putting the deal together, including getting the private money for the equity to purchase. The company has the experience to successfully find, underwrite, inspect and operate the deal. They also are in charge getting the financing, implementing a business plan, communicating with investors and selling the asset. They will either do those tasks themselves or hire specialist to do them for them, but either way they are in charge of being sure the apartment transaction from start to finish is a success. The GP will ultimately be the one to bring together the team (Real estate broker, lender, property manager, inspector, attorneys, accountants, contractors, etc).
Limited Partners (LP’s) – Limited Partners are the ones bringing the money to the deal for the down payment, renovation, closing expenses, reserve fees and financing fees. They will receive a certain amount of shares for the dollar amount invested and with the will receive money usually based on the profits. The limited partners have limited liability. They typically have little to no risk of getting sued by a tenant or liability with the loan. Their risk lies in the financial risks associated with the investment. If the property performs poorly, then they are at risk of low or no returns or even worse – loss. Typically in a syndication the GP also invests in the deal alongside the investors as well. Limited partners that are getting shares and paid on performance are getting a monthly or quarterly payment based on the cash flow of the asset and then they get paid at time of sale a lump sum amount based on the profit.
Key Principal (KP or loan sponsor) – Some deals will require a KP, which will be a high net worth individual (or a few) that will sign on the loan in order to purchase the asset. Often the KP’s will also be LP’s, but will receive extra compensation for signing their name on the loan (usually non-recourse). In order to qualify for a loan the general partner will need a net worth equal to the loan amount and liquid capital. If they are lacking on either of those, then bringing in the right loan sponsors (KP’s) will help push the deal past the finish line.
Now that we have talked about who the main players are and the importance of the General Partners experience, ethics, communication skills and diligence, let’s discuss more on how to find the money.
Finding the money can be hard if you have a background like mine. I great up in a middle class home, had middle class friends and parents with middle class friend. I then went to a college that produces mainly middle class employees and I myself became a high school teacher. Needless to say, nearly everyone surrounding me did not have the means to invest $50k or more into a real estate deal.
First things first in my opinion – get experience. I talked about this previously in my first Apartment Series: Getting Started article. Going after an apartment building with no experience is ok, but in my opinion, you should do the first deal on your own dime or with partners, not with other people’s money that are trusting that you know what you are doing. Also, read books, listen to podcasts, attend conferences and go to networking events.
As you are learning you need to be talking. When you go to your local real estate & business meet ups be sure you are not the kid in the corner. Mingle and talk about what you are doing. If you purchase an apartment or partner with someone, work on getting on a panel or standing up and telling your story. Also, get on some podcasts, write blogs about it and mention it on networking sites like Facebook, Linked in and Biggerpockets.
Volunteer with organizations that are important to you. Not only will you help build your character and give back in a positive way, but you will gain trust of others and potentially a few investors or connections to investors.
The most important part is that you put yourself out there. Work on getting to know people that may have interest in investing, but also be aware that your network that you already have may have some unsuspecting individuals that have money to invest. Two of my favorite investors are very unassuming. They drive older cars, live in modest houses and are your typical middle class people, but they managed their money right over the years and now have money to invest. One thing that I do, whether good or bad, is never ask people to invest until they show interest. I may hint at it and talk about what I am doing in a non-braggadocios way, but I don’t come out and ask them to invest without them expressing the interest first.
Always continuously work on building your network. By doing so you will grow your investor base, find more deals, help build your business and create friendships. Just be sure that you are adding value to their lives as well. You should want to give twice as much as you are given!
Understand that syndicating is a business and should be treated as such. If you are going to grow in real estate you can do it on your own and go slowly with your own money. There is nothing wrong with doing that! If you want to grow a large company with a lot of assets under management and get other people involved then read and research more on syndication and take a serious look at it to decide if it is right for you.
To your success!