All Forum Posts by: Brian Burke

I just wrote a 5,000 word blog post for the BP blog on this very topic…stay tuned. It comes out soon but might come out in pieces. 

Quote from @Lucia Rushton:

Quote from @Brian Burke:

Quote from @Lucia Rushton:

@Brian Burke:

It will be interesting when the syndications deals of the last 3-4 years come to market and they had a dispo fee disclosed in the original deal (if they don't forego them)

If they were part of the original deal, and investors signed on to those terms, it’s highly unlikely that the sponsor will waive them.  But if the investors are losing money on the deal, the sponsor really should waive them even though legally they aren’t required to.  Loser deals require a big deposit to the karma bank, and nothing drains the investor/sponsor karma bank faster than taking more fees while investors lose.

Quote from @Lucia Rushton:

@Brian Burke:

Hi Brian, I am curious to hear why you think that disposition fees are falling out of favor. thanks,

 

Many investors never liked them (not that investors like any fees).  They were a tough sell anyway because selling has historically been a lot easier and a lot less costly for the sponsor. 

Contrast that to buying, which involves underwriting hundreds of properties, traveling to perhaps dozens of properties, spending money on due diligence for deals that don’t close or legal fees that never make it to contract…just to buy one deal.  Buying is expensive and acquisition fees are common (and fair) for that reason, among others. 

But selling costs the sponsor little to nothing.  Plus, at the time of sale, if the sponsor did a great job they will be earning a lot of money via the promote.  Some investors see taking a disposition fee at the same time as double-dipping.  And if the sponsor did a bad job (or suffered a bad market), getting paid a disposition fee while investors lose money is a really bad look.

And here are a couple more reasons:  If the deal has a waterfall where the sponsor is in a 50/50 split tier, the sponsor is effectively paying half of its own fee anyway.  Why suffer the optics for so little?  And, fees are ordinary income, while promotes are (generally) capital gain.  Why convert your sponsor distribution to a higher tax treatment?

Disposition fees are still out there, and sometimes they make sense to have them, but for a typical multifamily value-add or core/core+ investment I’m seeing them less these days.  Perhaps other investors are seeing a different trend.

I hope you enjoy the book, @Chad Childress!  

In theory, returns should be agnostic to single asset vs. funds.  After all, the fund is buying single assets, just more of them.  Funds have the advantage of diversification, which is important in the real estate space where the success of assets can be hit and miss.  Funds smooth that out. 

Debt lenders don’t care if the owner is a fund or a single-asset syndication because they require all assets to be owned by a single-purpose entity anyway, so the availability of capital, or lack thereof, shouldn’t sway your decision on fund vs single, either.

What should drive that decision is sponsor track record and their approach to today’s market conditions.  Sponsors with little to no track record shouldn’t be doing a fund, and if they are, you probably shouldn’t invest in it.  Sponsors with a good track to record that are doing a fund now, and are aggressively buying right now, might be doing so just to feed the beast (meaning, buying to earn fees so they can pay their office rent and payroll).  I’d avoid those, too.  Watch for fund sponsors that are not buying right now (there’s no rush to get in, don’t let FOMO drain your bank account) or who have a very disciplined or unique strategy.  

It depends on the lender. Agency lenders will size to current income. Banks would most likely do the same, but each bank sets their own lending guidelines so this may vary. Debt fund (bridge) lenders often don't constrain to DSCR, instead many of them look at a going in and going out debt yield, which is kind of like cap rate except you substitute the loan amount for the purchase price.

For example, let's say the deal is $10 million and the current NOI is $500,000, which is a 5% cap rate. A bridge lender might size to the lesser of X% LTV or an X% going in debt yield. Let's say it's 80% LTV / 6% DY. That would constrain sizing to $8 million (80% LTV) or $8,333,333 ($500K NOI/6% DY). Lower of the two is $8 million. They might also have a going-out DY test. Let's say for example purposes it's 9.5%. Then let's say you project the NOI in year 3 will increase to $750,000. $750K/9.5%DY = $7,895,000. The lowest of the three is this one, so the loan sizing would cap out at $7,895,000.

Bridge lenders all set their own guidelines so you have to shop around.

Quote from @J Scott:

 Exactly. If this is a multifamily value add, they're being aggressive somewhere.

This is what I'd verify first:

* Proforma rent growth

* Natural annual rent growth

* Expense ratio

* Absorption rates

Something is likely off.

 And one more big one:  Exit cap rate. 

@Jack S., I wrote a whole chapter on fees in  The Hands-Off Investor, but the quicker answer is that some of these fees are a bit on the high side.  The asset management fee is usually the most opaque fee because there are so many different ways to calculate it.  2% of gross income is double what I most often see, and it’s usually of actual gross income not estimated gross income.  Guarantor fees are most often a percentage of the loan amount, not purchase price, so this one is above market.  Disposition fees are still pretty common but are falling out of favor.  The rest of these fees seem fairly typical.

The fees are also related to the promote (profit splits).  Some sponsors charge higher fees and a lower promote, others may opt for lower fees and a higher promote.  For example, one common trick is for the sponsor to offer an 8% pref followed by an 80/20 split in an effort to attract investors who avoid 70/30 or 60/40 splits, but then charge an asset management fee of 1% of the asset value. Depending on how the investment performs, that structure could be way worse for the investor than the higher sponsor split with a 1% asset management fee based on gross income.

If you want to know how your $100K investment will perform, look at the package that the sponsor gave you. If it isn’t abundantly clear, you are investing with the wrong sponsor.  They should be showing you performance projections with the fees baked in.  If they show you projections without reflecting the fees, that’s a problem. 

Now whether those projections are believable or achievable is a whole other discussion.

@Chad Childress, I agree with @Kyle Kovats…investors won’t place Capital if there isn’t a return, so the only option for new deals to get done is lower acquisition prices. I just discussed this at length on the BiggerPockets “On The Market” podcast. If you are thinking about making an investment in syndications, you might want to give that a listen.

Quote from @Gino Hillincci:

 

> Still some meat on the bone?

Yes, but why is there meat left on the bone?  Why not use other money in the fund to clean it up from within the current fund... even if it took a little longer to sell it and exit?

Thanks for your comments.  I apprecaite it.

Because taking the extra time to do it could actually lower the investor’s return, as odd as that may sound.  Time value of money is a real thing, and there is a point of diminishing return.  Typically the tail end of a repositioning takes the longest, often because there are a number of units that don’t naturally turn over.

I know nothing about the group or deal you’re referring to so I can’t speak to this particular instance, but speaking solely in generalities, this is a fairly common practice.  You don’t often see it with smaller groups or with smaller properties, but larger groups do this frequently and it’s even more common as asset sizes get larger.  There is even a name for it: recapitalization.

But just because it’s common doesn’t mean it’s OK, and it doesn’t mean it’s a suitable investment for you.  It doesn’t mean it isn’t, either.  You have to dig deeper.  Investing in a recap requires more thought, more due diligence, and more questions.

The main question:  why?  There are many reasons for doing a recap, but the most common reasons center around capital structure.  Let’s say a group buys a heavy value-add, meaning it requires a lot of heavy lifting but they can get a big pop in the rents, and the value, quite quickly.  They raise money from investors with a high risk tolerance who are expecting high returns and a quick exit (what I call “hot equity”).  For example, maybe they tell investors it will be a 2 or 3 year hold with returns in the high teens or low 20’s.  Such business plans are high risk and not suitable for everyone.

Now, after the heavy lifting is done, the property shifts to more of a market-based play, where the velocity of the market will drive the value, and perhaps there is still some meat left on the bone from the value add plan (for example, they renovated 2/3 of the units during the 2-year plan, leaving upside on the remaining third).  This plan is lower risk, will play out over a longer time, and will likely throw off lower returns.  The original investors didn’t sign up for that, so simply holding isn’t the right thing to do.  Fresh investors, perhaps ones with a lower risk tolerance than the original set, could recap the deal and hold it for some longer period, say, 5 to 10 years, for example.  They might be happy with returns in the low teens.

The challenge with recaps is ensuring that it is a win for all parties.  Assuming the recap is at market price, the outgoing investors could win because they can get a quicker exit and perhaps save some transaction costs.  Incoming investors could win by getting certainty that the deal will close, plus get off the ground running because of continuity of management.  And maybe even get a slight price discount if there is a broker commission savings that could be shared with the outgoing investors.

As an investor (on either side of these deals), your concern is fairness.  How do you know that the sponsor isn’t recapping at an above or below market price?  The truth is you don’t, because there was never exposure to the market coupled with buyer competition and arms-length negotiation.  Even an appraisal, or multiple appraisals, won’t establish the true value, as those valuations are simply the opinion of the appraiser(s). 

Bottom line is it’s important to understand why the sponsor is recapping the deal. And then due diligence and Q&A to ensure that the transaction value is fair. 

And I can add this:  recaps are far more common in the institutional capital space, where the players all do this for a living and are used to it and know how to navigate it.  It’s more challenging to get these done in the private capital space because individual investors, who aren’t entrenched in this business every day, have the same feelings and apprehensions that you do, making it harder for the sponsor to raise the capital for the recap.