What is the best way to vet syndications?

Question

Hello

I want to invest into syndications.

1.) Anyone have any tips on vetting them?

2.) Anyone have any specific ones they'd recommend?

I realize I have a  lot of work in front of me, but just looking for a way to get a head start on this.

Thanks a ton Friends.

Ian Ippolito · Answer

For vetting a syndication, different investors do it differently because every investor comes from a different financial situation and has different goals and risk tolerance. For me, I'm a very conservative investor and may look through a hundred deals a month, and at the end of the year only invest in 4-5. So things that are a red flag for me may be fine for someone more aggressive. Here's how I do my due diligence:

1) Portfolio matching: (takes 30 seconds per deal)

a) Have an educated opinion on where I think we are in the real estate cycles (financial and physical market cycles)

b) Then and only then do I pick the strategies, capital stack, and specialized asset subclasses that make sense for that opinion. For example, I am a little concerned about some aspects of the business cycle recovery and a potential for a double-dip so I lean toward the safest part of capital stack which is debt (or low-debt equity). I won't go with the riskiest opportunistic strategies, and will stick to core and core plus mostly with some value-added. I won't be investing in the riskiest/most supportable asset subclasses such as hotels, and tilt my portfolio the ones that have historically been more stable such as multifamily and single-family housing. I also don't want refinancing risk, so any deals with only 3 to 5 year debt are out for me. For someone that's not as conservative, or a different view on the cycle, they might have a different opinion than me on all of this.

2) Sponsor quality check: (takes about 45 minutes per deal)

I believe that a great sponsor can take an average looking deal and make it great, and that in mediocre sponsor can take a fantastic looking deal and make it bad (especially if there is a severe recession). So I start with the sponsor first. Again, others might disagree.

a) Track Record: Get the entire track record for the strategy. As easy as this sounds, it's not simple and usually like pulling teeth. Many times they will claim it's wonderful and then try to hide their worst deals by only showing completed deals. Make sure to get unexited deals. Or if they are doing value-added multifamily, they will show you their hotel experience. That doesn't cut it for me. I want a specialist that's an expert, and not a jack of all trades and master of none. Also, in a mainstream asset class like value-added multifamily, I see no reason to take a risk on a sponsor that doesn't have full real estate cycle experience or that lost anything more than a small amount of money (and prefer no money lost). Again, other might feel differently here.

b) Skin in the game: as a conservative investor, I understand that the dirty secret of industries that the waterfall compensation is in the line with me and incentivizes sponsors to take more risk. So I require skin in the game (average is 5% to 15%) to offset this. Contrary to popular belief, this is not set because I believe it will give me a higher return. I believe it tends to give me a slightly lower return, because the sponsor is going to be more careful, and if there is a severe downturn will prevent me from taking catastrophic losses. Someone that is more aggressive, may want lesser even though skin in the game. Also, if the sponsor is new, I am fine with less skin in the game as long as it is significant to their net worth. On the other hand if they are a sponsor that is experienced in stopping a skin in the game, that's a huge red flag for me.

c) how open to scrutiny are they? I always discuss investments with others in an investor club because other people might think of things that I might miss. And even though virtually every sponsor agreement allows me to share investment information with others who might be advising me on it (especially when club members are bound by an NDA), I still ask the sponsor if I can share it, because it's a test. Most are fine with that, but a few will have problems with it and claim there are legal issues, etc.. That's a red flag for me.

d) death by Google: I Google everything I can about the sponsor. I check the SEC, FINRA, ratings websites for inside information on the principals in the company. I also look for lawsuits and see what happened in them. Many times it's an easy red flag. Sometimes it's ambiguous, but even then, why should I bother with the company that has numerous unresolved lawsuits, versus another company that is virtually the same but has none. Again, others might feel differently here.

3) property level due diligence: (takes seconds to weeks per deal): here is where I drill in with the low-level details.

a) pro forma popping: I examine all the assumptions, and see if they are overoptimistic or not. I look at every single item in the pro forma and imagine that it is complete BS, and see if I can challenge it. If there's a hole, it may be a red flag.

b) sensitivity analysis: I examine all the assumptions, and make sure I can live with the worst case scenarios.

c) "Stall and see": if they are getting money over multiple years, and there is no penalty for investing later, I would usually wait so I get some real performance data, versus having to look at theoretical pro forma information.

d) Recession stress test: I will not invest in anything, until I subject it to recession level stress and see if I can live with the result. And I take the worst recession I can find in the recent past. Sometimes there is only great recession data, and that recession was pretty mild on some asset classes, versus previous recessions. So I will usually 1.5x or 2.0x the stress. If the deal collapses and I would lose everything, I'm out. Others might be fine with taking risk, but least by doing this a person can get an idea of what might go wrong.

e) Legal document analysis: it will usually take a few days to go through the legal document properly, as almost inevitably there are tons of gotchas that either have to be explained, or mitigated with a side letter.

That is the very short summary of what I do. If you want more information, p.m. me and I can give you a lot more details.

Paul Moore · Answer

@Naomi Moore, I agree with @Jim Pfeifer that joining a community will be one of your best avenues. In addition to left-field investors, I would recommend the large group run by @Ian Ippolito, The Real Estate Crowdfunding Review.

And you should definitely get the @Brian Burke BP book. Good luck!

Sam Silverman · Answer

1. Track record -- what is their history of performance, see full cycle exits in terms of actual returns vs projections.

2. Have they had to do a capital call ever? This is asking investors for a second round of funding after closing the deal.

3. Have they ever missed a distribution?

4. Distributions and reporting -- monthly/quarterly

5. Fee structure (acquisition fee, asset management fee, disposition fee) -- what do they go to? If they are a one man stop, far less compelling to pay than if they have a full time staff where this is going to salaries and future ernest money deposits to win more deals in a competitive market.

6. Preferred return and GP/LP splits (along with any additional hurdles based on performance)

7. What is the worst deal they have had? What did they learn from it?

8. What % of the capital stack is from the GP?

9. What type of loan product are they using and why?

10. How long until first distribution?

11. What percent of their investors are repeat investors? If they haven't had a chance to have repeat investors it may be too soon.

12. How do they evaluate deals and with what assumptions? Rent growth, economic vacancy, renovation budget, exit cap rate etc

13. Flow of cash -- is there pref equity, different classes of shares etc

14. Always ask for references -- happy to help if I can

Duke Giordano · Answer

@Naomi Moore

Hello Naomi, its great that you are asking the questions and taking the time.  I agree what others have said in that joining communities will certainly provide value.  In addition, you should consider investing in some great books such as "Hands off Investor" by Brian Burke, and James Kandesamy also has a good book geared toward syndication investing from a passive investor perspective.  Lastly there are websites where you can also find specific tools and vetting materials geared toward helping passive investors invest in syndication deals that can be used as an adjunct to the aforementioned options and resources.  Focus on education first, and take the time to do so.  You won't regret it.

Jim Pfeifer · Answer

I think the best thing you can do to find quality sponsors is to build a network and join a Community. Syndications are long-term, illiquid investments. You won’t know if it’s a good deal or a quality sponsor possibly for years after you invest. I have found the best way to find great sponsors is to be referred by people you know, like and trust who have already invested with the sponsor. You will find many like-minded people with experience if you build a network and join a Community!

Brock Mogensen · Answer

One quick tip to fact check the numbers on a syndication.  Ask what their exit cap rate is.  If it isn't higher than the cap rate they bought the property at..it means they are not being conservative in their underwriting which is a red flag.  Lots of other things you should be looking at when vetting a syndication but that one is huge.

Ian Ippolito · Answer

I personally don't feel comfortable outsourcing this to another person. If I don't know enough to be able to double check what they're doing, then I would have no idea if they're doing a good job or not. And it could end up being a very expensive mistake. Also, these are illiquid investments that typically last for years. So, I would be potentially stuck with these mistakes for a very long time.So I can't recommend anyone. But others may completely disagree with me. So maybe someone else can make a recommendation for you.

Jim Pfeifer · Answer

I run a group called Left Field Investors, another group is 506 Investor Group, and Wealth Formula Network - I am active in all three. There are also quite a few groups who focus on medical professionals. I think the most important thing is to find a group that fits with your personality and style. I hope that helps!

Shafi Noss · Answer

I'll add in some thoughts.

Risk analysis is complex and unsolvable, and a certain level of risk is acceptable.

You can evaluate an investment by having data about the sponsor, deal, market, etc. and then some reasoning about how that data predicts success (however you define success). Risk comes from imperfect data, and imperfect reasoning. Risk also comes from incomplete data. Even with perfectly accurate data on the project and excellent reasoning, outside factors like viruses and changing market predictions can throw a wrench in things. I personally happen to believe that market downturns will decrease in frequency over time.

Perfecting your data and reasoning costs time, expertise, and mental energy, which are all sort of the same thing.

Then you then have 2 options. (1) is to take @Ian Ippolito's strategy of maximum risk reduction without worrying about mental energy, this will create the best investment outcomes. (2) is to try to optimize time/effort/energy-adjusted-risk, which can be appropriate for people who are looking for a passive experience, and maybe is appropriate for you.

If you are in search of the best risk control, Ian has excellent advice for you. If you are in search of the best effort adjusted risk control I believe the 3 most efficient things you can look at are (A) Track Record, (B) Intelligence/Hard Work, (C) Trustworthiness.

Investments are long term and complex, and trustworthiness really matters. As someone with your own successful career, I suspect you have the skills to evaluate trustworthiness and competence in others. Use those skills, keep your standards high, and form partnerships with sponsors who you can trust in the same way that you deserve to be trusted by others who rely on your expertise.

Naomi Moore · Answer

Deeply appreciate your points.

I know this will sound incredibly lazy..

But here goes:

But are there any people I can HIRE to vet syndications for me?

I am really passionate about my entrepreneurial projects and my time is sacred to me (and I don't trust myself with analysis in a field like RE).

I realize I should know a little bit, and I plan to...

But just wondering if there are experts out there that I can hire to vet syndications for me?

What is the best way to vet syndications?

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