All Forum Posts by: Jorge Abreu

 Zachary, these are great as well. And you would think if you ask someone for a referral they are going to give you someone that will only speak positive about them, however, this is not always the case. I always ask and call referrals while vetting partners or hiring employees and you would be surprised how many times I hear negative things. 

Experience

• How long has the team been in place?

• How long have the principals been in real estate investing?

• How many assets have they acquired

• Do they currently own, manage, etc.?

• Have they gone through an up-and-down cycle?

• Did they go through the Real Estate Crisis in 2008?

• How familiar are they with the location?

Track Record

How many closed deals?

What was the projected vs. actual performance?

What is their experience and track record?

Can they explain their losses?

Leadership Team

Who are the major players on their team?

What do they do themselves, and what do they outsource?

Any criminal history or financial background issues?

Co-Investment

How much is the company putting into their deal?

Investors often like to see that the sponsor is co-investing along with them and putting their own money at stake. Having skin in the game demonstrates that the sponsor has faith in the deal. Sponsors will usually put in 5-10% of the investment. However, you can imagine that if a sponsor is doing a good number of deals, putting 10% in every deal might be untenable.

Conservative Underwriting

Are they conservative enough?

Another thing you want to look for in a sponsor is conservative underwriting. It helps to first understand things like Internal Rate of Return and Equity Multiples. Ideally, you want someone who will under-promise and over-deliver. You don’t want the old bait and switch. It’s great if sponsors can provide sensitivity tables or analysis. These are different models and projections that are affected by four key variables: vacancy, rent, interest rates, and cap rates. These variables can drastically change your returns. So it’s nice to look at how more conservative assumptions might affect returns, but also at the potential upside.

Sponsor Compensation and Fees

What kind of fees are part of their deal?

When it comes down to it, sponsors usually require compensation in one of two ways:

1️⃣Compensation regardless of performance – encourages operators to just do more deals

2️⃣Performance-based compensation, another name for a “promote” or carried interest – feels more aligned, but also may encourage risk-taking

There are pros and cons to both types. The goal is for the sponsors and investors to be as aligned as possible. This is active management and strategy. In this case, you often get what you pay for.

Acquisition or Organizational Fee

• Earned upon closing of the property. The justification for this fee is that sponsors will see many deals before closing and settling on one. They’ll have spent a significant amount of time and resources on evaluation and cost analysis at their own risk.

• Also, some of the performance or co-investment returns aren’t paid until the deal is closed, which could be 5-7 years down the road. It’s sometimes said that these fees keep the sponsor’s lights on.

• This fee is usually a small percentage of the purchase price of the property – typically 1-2%, but can be slightly higher for smaller deals because the overall dollar amount is lower.

Financing or Loan Fees

• Fees related to figuring out financing and refinancing

• Can be 0.5-1%

Equity or Equity Placement Fees

• Paid to an internal or external team for raising funds

• Usually 2-3%

Asset Management Fee

• To reimburse the sponsor for overseeing management and making sure they’re in line with their projections and business plan

• Usually 1-3%

Construction Fee

• Some sponsors charge this fee if the deal includes a significant amount of renovation or development. Sponsors spend a significant amount of time acting as project managers overseeing the contractors and vendors. I’ve seen this hover around 3-5% of hard construction costs.

Expense Reimbursements

• Simply reimbursement for expenses pre-paid by the sponsors

• Some examples are legal, due diligence including reports, etc

Promote or Hurdles

• This is essentially a bonus for hitting certain incentives

• Example: 20% over an 8% IRR Hurdle and 35% over a 16% IRR Hurdle

• There might be incentive-based fee for hitting certain markers when they refinance. For example, if the sponsors hit a certain refinance amount and are able to get a significant amount of capital return for their investors, the sponsors might get a small bonus.

• Usually 1-2%

Disposition Fee

• For all of the work involved with selling the property

• Around 1%

Fees aren’t everything, but it’s important to take them into consideration to understand how the sponsor operates. Again, the lowest fees don’t always mean the best sponsor. It’s important to know what the fees are for. At the end of the day, if you’re happy with the returns, then the fees are just the cost of doing business. Understanding fees vs. promotes will also give you a good idea of what the incentives are for the sponsor and how they operate.

👉Next: Seven-Step System for Evaluating a Market

✨Without a doubt, the sponsor is a critical component when it comes to real estate syndications. And if we’re exploring partnering with another sponsor, we’re looking for the same things a passive investor should be looking for - the sponsor’s track record, team, knowledge/resources, and trustworthiness.

The sponsor is responsible for many aspects of what goes into a good real estate deal.

• Finds and sources deals

• Negotiate to put the deal under contract

• Does the due diligence on the property

• Puts together all the capital and financing

• Develops and executes a business plan

• Communicates with investors

• Oversees the operation and management of the asset

• Provides updates and financial reports

• Decides how and when the property will be sold

• Makes sure investors get paid

Step 1: Check the Track Record

When checking a sponsor’s track record, you want to see success, but don’t get blinded by impressive returns or projections. You want to understand what drove that success and determine if those factors can be replicated for future deals. Make sure you ask them about challenges in their business and to share with you a deal that didn’t work out as expected. Pay close attention to their response. Do they point fingers and blame others or do they take accountability and acknowledge what they would do differently?

Experience is important, but there is a reason every investment prospective includes a warning that “past performance does not guarantee future success.” There are simply too many factors that can vary from previous investments whether they are related to the market, economic climate, personnel, legislation, etc. With that said, it’s the easiest and most tangible element to lean on. Sometimes operators won’t have a long track record in syndications but have strong success in business or a related field with transferrable skills. Is that experience relevant when it comes to overseeing key aspects of apartment syndications such as project management, budget management, vendor relations and investor relations.

Step 2: Look for an All-Star Team

The sponsor/operator is the point person and their ability to assemble a remarkable team and oversee the business plan is critical. Besides the operator, other key positions we want to learn about are the property management company, contractors, lender, and any advisors/board members (amongst others). If the operator does not have a lot of experience, we’re leaning more heavily on the team they’ve assembled. We want to know they’ve put together an all-star cast with motivation to see the project succeed.

If the business plan focuses on value-add and making renovations to the property, you want to pay particular attention to the property management team and contractor. We want to ensure these teams have the ability to execute the business plan and have the appropriate experience for the project. Often times the contractor will not be selected until after closing, but it’s helpful to understand how the operator plans to approach filling these key roles.

Step 3: Assess Their Knowledge and Resources

A sponsor should have a strong knowledge of their market, deal structure, risks, financing and many other facets that can impact operations.

You’ll want to assess the operator’s knowledge and resourcefulness. What do they love about the deal, what concerns them and how do they plan to mitigate those risks? Have they consulted with other industry experts and syndicators? Do they have relationships with other syndicators? Where will they turn when something doesn’t go according to plan? Have they navigated issues with property managers, contractors, tenants, and even local government agencies? Ultimately, you want to know that the operator is knowledgeable and resourceful enough to protect your money.

Step 4: Determine If You Trust Them & If They Respect You

The last area we look for is character and trustworthiness. I’m looking to understand who they are and what motivates them. What’s their long-term plan? Are they transparent? Are they prioritizing investor returns over their own profits? It’s important to listen to that gut feeling and ask more questions if something feels off. If you don’t generally like them as a person, your not going to want to do business with them no matter how accomplished they are or what team they’ve assembled. You should only do business with people you like and because these investments are generally held for 3-7 years, it’s important to like and trust the people you will be investing alongside.

Even more important than “liking” someone is being respected by them. When you have questions, will they take the time to answer them or simply tell you not to worry about it? Many investors working with a new sponsor (especially those considering their first syndication) are cautious and have lots of questions when exploring an investment opportunity. A sponsor should be able to answer these questions and calm any normal trepidation without “selling” investors on a deal.

One question that investors tend to ask is if the sponsor is investing in the deal. This is a fair question, but should not make or break your decision. We like to see the general partners investing alongside limited partners, but it doesn’t all have to come from the lead sponsor. Ultimately, this is another touch point to validate the operator’s commitment to the deal.

Selecting a sponsor to work with is a critical step for any passive investor. This person should be someone who has a track record of success, surrounded themselves with a successful team, knowledgeable and resourceful, and someone you have gotten to know, like and trust. Once you’ve decided that you want to move forward with the operator, you can turn your attention to the market and the actual deal.

👉Next: Questions You Should Ask The Sponsor

✨When you buy an apartment building with a syndicator, you are not buying real estate. You buy are buying a security. Yes, a security. Sound strange? Perhaps. The reason you buy a security is that the syndicator creates an LLC (Limited Liability Company), which they manage. The LLC owns the property, and each investor owns a portion of the LLC. Since it's a security, which normally requires registration with the Security Exchange Commission (SEC), most syndicators try to avoid going through the registration process, which is long and expensive.

The SEC allows syndicators to “skip” registering their securities if they offer them to accredited investors and use either a Regulation D either 506(b) or 506(c). Agree with their logic or not, the SEC believes that Accredited Investors are capable of accepting economic risks associated with investing in unregistered securities. However, there are specific requirements for those wishing to qualify as an accredited investor. What is an Accredited Investor? Without getting into too many legal terms, according to Regulation D of the Securities Act of 1933, you are an Accredited Investor if you:

👉Made at least $200,000 of annual income in the previous two years, or $300,000 for a married couple.

👉Have a net worth in excess of $1,000,000, excluding the value of your primary residence.

Rule 506(c) allows syndicators to market their deals—but only to Accredited Investors. As an Accredited Investor, you have access to marketed passive investments, which non-Accredited Investors don’t have access to. You will need to prove your eligibility as an Accredited Investor, but you gain an advantage many don’t have. 🙌

What if I am not an Accredited Investor?

The other part of Regulation D—Rule 506(b)—allows investors who are not accredited, to participate in a syndicated deal if they are “sophisticated.” The law defines an investor as sophisticated if he or she has sufficient knowledge and experience in financial and business matters to evaluate the merits and risks of a prospective investment. Last year, over $36B was raised in syndications; and generally speaking, over 85% of all Regulation D offerings are Rule 506b.

The SEC limits each deal to a maximum of 35 sophisticated (and non-accredited) investors. Since syndicators cannot advertise investment opportunities for non-accredited investors, sophisticated investors who wish to invest should be active and network with syndicators to get access to deals. The law requires syndicators to have pre-existing relationships with sophisticated investors; so building relationships with syndicators is key to gaining access to passive investments.🎯

👉Next topic: Four Steps to Vetting the Sponsor

Understanding Potential Returns so You Can Make Strategic Investing Decisions

✨Sponsor-syndicated private real estate investments can be structured in many different ways. Some of the more typical structures used to divide the returns between the sponsor and the investors are as followed.

In most private syndications, the sponsor provides a portion of the capital for the investment but also offers the investment opportunity and the time, expertise, and team members to make the investment successful. The investors provide the balance of the money but also get to take a relatively “hands-off” approach to the project.

✍️For example:

The typical project often has the sponsor providing investors with a “preferred return,” often in the 6%-10% range, before the sponsor gets any proceeds outside of returns on his own personal invested capital and a predetermined split, say “70/30”. With this structure, the investors are entitled to 70% of distributable cash, and the sponsor gets 30% following the say “7% preferred” return to the investors. Most syndicators still focus on transactions where the sponsor has some of “its own skin in the game,” and this means that the investor funds will also include whatever money the sponsor contributes. Let’s look at an example of how this might look:

👉Investors contribute $900,000 of equity needed to close the deal

👉Sponsor contributes $100,000 of equity needed to close the deal

👉Sponsor gets 30% of distributable cash as his “carry” incentive

For a $100,000 distribution:

👉Investors (including the sponsors investment) will receive $70,000

👉Sponsor will receive $30,000 for his sponsorship role

👉Of the $70,000 to investors, outside investors will get $63,000, and the sponsor (in his investor capacity) will get $7,000, based pro-rata on everyone’s invested amounts.

This structure is sometimes preferred for its straightforward simplicity and perceived fairness to all the project participants. Syndicated real estate investment opportunities can be structured in many different ways; the above summary merely reflects one of the many possible alternative methods that investors and operators can use to work together. From investors’ point of view, it is important that investments be made under a structure that helps to keep an operator’s and investors’ interests aligned. Keeping the financing and operating interests aligned is important to the success of real estate projects as well as business ventures. 🙌

Your returns depend heavily on the investment strategy. A yield play will return a lower rate because it is already operating well and there is little upside other than inflation of market rents and perhaps some tweaking of expenses like water conservation. On the other hand, a value play is riskier and has the potential to return much higher rates. You may not see cash flow for 3-18 months on a value-play; however, the overall returns will be much higher. Returns also depend on the area and the ability of the sponsor to either manage the property well or hire and manage a property management company that can capitalize on all up-side potential.

Typically, investors expect the average Cash on Cash Return (COC) to be around 6% to 8% and the Internal Rate of Return (IRR) in the 15% to 20% range, depending on the perceived risk of the business plan. Return of capital in a relatively short period (3-5 years) is also a common goal of most investors unless they are more concerned with long term passive cash flow in which they look for a 5-10 hold.

💥It’s important to know what your goals are so that you can look strategically at each investment opportunity placed before you.

Next topic: Are You an Accredited Investor and Why It Matters

What is Syndication? Who is Involved? What Is Their Role❓

💥What is Real Estate Syndication? Simply put, real estate syndication is an effective way for a syndicator/sponsor and a group of investors to pool their financial and intellectual resources together to invest in properties and projects much bigger than they could afford or manage on their own. Over 90% of large multifamily purchases are made through syndication.

The parties at the forefront of a syndication deal include the sponsor (also referred to as the general partner, operator, or syndicator), the limited partners (or passive investors) and the property management team. There are plenty of other team members involved that make the deal work behind closed doors, including, but not limited to, a commercial broker, a team of attorneys, CPAs, and lenders.

✍️Role of a Syndicator

The sponsor/syndicator is the person who initiates the real estate syndication; they are responsible for identifying the market, underwriting the property, securing financing, overseeing the business plan/renovations and the daily activity of the property management company, ensuring strong investor relations, and managing the asset in general.

💰Role of an Investor

The limited partner, or investor, is the individual (or group of individuals) that provides the equity to fund the deal. The role of investors in real estate syndication is very simple: they invest their money in a real estate project that is run and managed by the syndicator, and they earn a percentage of the project’s profits based on a predetermined and agreed upon rate that is split between all investors and the syndicator.

👉Next topic: Understanding Potential Returns so You Can Make Strategic Investing Decisions!!

💥Today we conclude our series of the Top 10 Reasons Why the Wealthy Invest in Real Estate!

👀Here are reasons 9 and 10

👉9) Principal Pay Down Isn’t it great to have other people pay down your debt? Imagine several hundred people doing that. That’s what happens in large multifamily apartment and self-storage deals. Rental income pays down the debt and builds equity in the property. Through the life cycle of the syndication, rental income from the property pays all debt service. Upon sale of the property principal reductions will be returned to investors.

👉10) Great Inflation Hedge As inflation levels began to ramp up and the purchasing power of each unit of currency begins to take a hit, investors may be wondering how they can avoid this monetary backlash and avoid losing value on their investments to inflation. One way to do so is through investing in hard assets such as apartment buildings. Investing and building wealth through apartment buildings is a great way to hedge against inflation because rents, which is the source of an apartment investor’s gross income in the investment, rise along with inflation. Real estate in general is always a great investment, but the benefits of doing so are greatly augmented during times of rising inflation. Because of the limited amount of land, in certain markets, and rising population growth, demand in the real estate apartment sector is high. This limited supply and high demand means that increased property values offset any deterioration in wealth caused by a rise in inflation.

Talk to you all next year! Next topic, What is Syndication? Who is Involved? and What is Their Role?

✨Happy New Year!!✨

💥Reason 8 on Why the Wealthy Invest in Real Estate!

The long-term performance of commercial / multifamily real estate makes it a compelling asset class for many investors. If I could sum up that performance in two words, it would be consistent performance. 🙌 Consistency is really important. After all, anyone can have a great game, but true greatness comes from consistently high performance over a long period of time.

👉Since the great depression, commercial real estate has had far more up years than down years in comparison to both stocks and bonds. In fact, commercial real estate has three to four times fewer down years than the other two. If you look back even further at the historical performance of the S&P 500 you get a clear picture of the inconsistency of the stock market. In the last 90-years from 1927-2016 the composite index or S&P 500 has had 28 down years. That is one down year every 3.2 years on average.

👉Now there are reasons to invest in the stock market, but it seems that far too many investors throw money at the market like they’re swinging for the fences. Since commercial / multifamily real estate has 3x to 4x fewer down years than the stock market, it too has performed better. That is 3x – 4x more stability that has created more income, more equity, and more wealth for apartment investors.

👀It is that consistency of performance that has more Americans saying that real estate is the best long-term investment and the statistics show it.💥

Reason 7 on Why the Wealthy Invest in Real Estate!

Economies of Scale

✨This one is simple - the more units under management, the higher your ability will be to lower expenses (think cost per unit), thus driving up the NOI. This is particularly true when using a property management company or undertaking renovations.

Property managers will lower their cost of onsite management the more units that you have, even better if they’re in a more condensed area (as opposed to 100 SFHs spread throughout town).

🚧When thinking of renovations, the contractor's price per unit will be lower the higher the number of units, and the same for suppliers of renovation materials – flooring, appliances, doors, siding, paint, etc...

For instance, we order in bulk for all of our renovations and keep inventory and for doing so we get large discounts. We also don't have to wait on suppliers for our materials since we get them all upfront.

In this case, the more units the better!!🙌

Reason 6 Why the Wealthy Invest in Real Estate!

✨ By investing with other investors through a syndicator, that you have vetted and has a proven track record, investment risk is dispersed among all the investors. Syndication allows you to adjust your investment to a more comfortable risk level. 🙌

We all know that using an entity such as an LLC is advisable when investing in real estate. However, when you invest in a real estate syndication, you add another layer of protection between you and any liability resulting from actions taken from the deal sponsor or debt obligations.

In real estate syndications, there are typically at least two different type of shares in the operating agreement: the “B Class,” which lists the managing members who are responsible for the decisions behind the fund, and the “A Class,” which lists the investors who bring only capital to the table. There shouldn't be any circumstance that “A Class” investors would be responsible for making management decisions of the fund, and, therefore, under no circumstance would a judge find the “A Class” investors liable for decisions made during the fund’s performance. This way you are completely removed from any lawsuits that may arise due to fund-related activities. 🙌