How Would a Recession Effect Real Estate Syndication Deals?

Question

Hello All,

Thanks in advance for your reply.  I have several hundred K to invest, have vetted syndicators for the last few months and I am at a point where I know I am coming into the real estate syndication market its just a question of when and how.  I have two questions that I have been pondering that would appreciate some help with:

1. As I stated I have several hundred K to invest, and the ultimate goal is to cycle/ladder 5-7 syndication deals diversified across asset class and geography.  Taking into consideration where we are in this real estate cycle my main question is whether or not I come into these 5 to 7 syndications all at once at this time (as deals arise) or whether not I come and gradually sort of wanna time to get a better idea of where the market is going to go. Obviously coming in gradually would not give me complete diversity across asset classes and geography but it would give me a little bit of a guard against an impending recession.  It seems fairly universal speaking with the syndicators the markets are extremely tight and competitive right now and finding a good deal it is not so easy to do especially in the multi family world. Every scene preferred returns and I are projections start to decrease of the last six months or so.

2. Question 2 is more of a projection/ prediction.  For those who have experienced recent recession's (2008 etc.) even though past recessions does not predict future lines I'm curious how the recession itself affects real estate syndication deals in a concrete practical sense. What makes deals in a recession better for a LP?  Obviously I think the cost of the investment/asset would go down but I'm curious as to what components of a specific deal are effected directly.  Meaning does it affect the cap-rate?  Does it affect the preferred return?  Hold time?  Projected IRR?  Since there's less competition, do syndicators have to make the rate of return more competitive for investors?

Mainly I am trying to get an idea of what the true value of waiting or coming in to RE syndication market more slowly on these deals, in that what would be the big back end benefit for me if I were to wait a year or come in slow versus coming in all at once now.  I have spoken with several advisers who pool investors for syndicators and a few of them have said they are waiting on the sidelines for the last year or so since the market is way too tight right now to get a deal.  Saving cash on sideline.

Thanks in advance,

Duke

Luke Miller · Answer

@Duke Giordano Unfortunately, those are questions that play into many factors. There are several syndicators purchasing assets right now that have no qualms about the current state of the market. Others are saying the sky is falling. There are also some that say because of massive economic shifts and quantitative easing, we won't see a correction in commercial real estate for a long time. Let's look at a couple of factors that could impact a deal.

Financing.

This is probably the biggest part right now. Rates are low, money is cheap and I personally think it's a mixed bag for multifamily. Rates and debt service are low, but that also means that it's easy to over-leverage on a crap property. Personally, i'm only looking at 10 or 12 year Fannie loans with a long runway to ride out any storms. A higher than average DSCR means that when valuations drop, we'll be able to maintain payments. The only exception to that rule is with VERY obvious value-adds where the business plan is clear and the bridge debt is competitive. There are some operators that will use bridge lending, but you have to know what you're doing.

Occupancy.

I think it's a bit of a myth that "when the economy goes down my occupancy goes up." It's not that simple and if you talk to folks who went through 2008, they weren't making tons of money. Apartments can be recession resistant if you are in a good market, underwrite conservatively and understand historical trends. I think the break-even occupancy is going to become really important in the coming years.

Location.

I'm sticking to bigger name markets. Tertiary markets can provide yield, but I don't want to be holding them when there's a correction. Not because they won't cash-flow, but because if I need to sell them I don't want to compete with location as well as everything else. I tend to follow my gut more than anything on this (assuming jobs, population growth metrics, affordability, etc. exist). If I would live there, I would invest in it.

Operators.

This is probably just as important, if not more important, than financing. People of strong moral character and ethical values will work hard and be good stewards of your money. People that quit and throw in the towel when hard decisions need to be made will fail. I don't buy into the idea that you HAVE to invest with someone who went through 2008, but it probably helps to have their experience. I didn't go through 2008 with apartments, but it seems like (non-coincidentally) the people with strong character and ethical values made it through while everyone else quit. If I'm taking investor funds, I won't be quitting.

That's a long-winded way of saying that no one knows when the recession is coming, but you should probably always invest and underwrite as if a recession is coming.

Duke Giordano · Answer

Thanks for input guys.  I think the RE market moves slower than the equities so I am curios when deal dynamics will change and become more favorable as cash dries up.

Whats your thoughts how current market dynamics will effect deal flow, Pref, IRR etc.  When do you think we will start to see deal parameters/dynamics change in the syndication space?

Mark Allen Kenny · Answer

@Duke Giordano

A lot of foreign money is coming into the U.S. real estate market right now because of the global economic slowdown.  And a lot of that is going into multifamily.Why multifamily?  Because the coronavirus (although temporary) is shutting down retail and restaurants.  Offices are having their staffs work from home.  Those asset classes will suffer longterm.Now, will the coronavirus problems be solved in the next 12-24 months?  Probably yes.But a lot of businesses won't be able to recover.  And so we'll see more empty retail and office buildings.However, multifamily (in my opinion) is the SMARTEST place to put money right now.  Interest rates are low.  We all need a safe place to live (and for some their home is now their new office).  Rents in B and C class neighborhoods will hold strong when you find the right submarkets.Now, will some tenants lose their jobs and be unable to pay rent?  Yes.  But that's why it's important to choose deals based on the current market conditions.  For instance, I'm under contract on a property right now and its main economic drivers are an army base and 3 major health care companies.  Those are tenants with stable jobs even with the coronavirus and recession.With that said, I also agree that it's a great time to stockpile cash.  If you are considering waiting a year before investing several hundred K, you may want to consider the stock market as part of your strategy.  You'll be able to buy companies at a steep discount in the next 8-12 months (probably a better discount than multifamily syndications).Multifamily syndications probably won't fall as drastically as other asset classes because they are so stable.  Again, a lot of investors are looking to move their cash into apartment complexes right now BECAUSE of the recession.

Jennifer Bourdeau · Answer

@Duke Giordano, We seem to be in a similar situation, just a few months apart, and seems that recession may be starting now. What did you end up deciding?

I've pulled 200k in equity out of one of my properties, and me and my money are sitting on the sidelines while I learn as much as I can. You seem to have been pretty active in educating yourself on the topic, and you mention speaking to a few advisers, anyone you would recommend?

Adam E. · Answer

@Duke Giordano

Deal flow could very well increase, though default rates are minuscule for multifamily and hardly change in recession so it won't be from that as it is in single family. What will happen is that cap rates will increase, so more deals will work, then cap rates will decrease again as the properties begin to stabilize, then the profits for GPs and LPs alike will be fantastic.

Honestly I don't think preferred returns will change much unless an individual syndicator is desperate (and I would personally never give a desperate person my money). Sydicators and investors alike know that you don't need a bigger piece of the pie when the pie is getting bigger.

Money may dry up, but any good syndicator worth investing with will have enough investors lined up to keep funding deals in a slow market. Those investors know that the slow market means better deals and better deals means better returns. Better returns will come with the better deals, they won't come from changing deal structures. That would translate to that syndicator devaluing his or her services, which would hurt their reputation and their incentive to perform.

I would highly recommend finding a syndicator who you know can do a good job in a tough market and getting your money with them as soon as possible, because by the time you are able to do so, any good syndicator will already be capitalizing on any market shift we experience.

Good luck!

Adam E. · Answer

Take a look at the last thing Mark said; many many investors know that a recession means stellar returns for multifamily, so I think you would be doing a disservice to yourself by waiting for deal structures to change when they very well may never do so.

Adam E. · Answer

I agree with @Mark A. Kenny that multifamily is the best place to put money into right now. He spells it out very well so I'll save you the extra reading, but check out MultifamilyU.com if you want more info. Neal Bawa with Grocapitus run the tightest ship I've seen in the Multifamily world.

Good luck!

Duke Giordano · Answer

Hey Jennifer,

Sat on the sidelines for a bit.  At his point earmarking 50% for Dollar cost averaging into market on drops and 50 syndication deals.  Question is when the syndication deal metrics will start to change as cash dries up.

Sam Shueh · Answer

I can only tell you during the recession and job loss you are faced with late payments, demand to reduce rental income and no rent from those out of a job. That is especially true in an area the major industry put their employees on furlough. Suggest you construct the model with higher vacancy rate than normal and have ample reserves.

During the recession business, office, storage etc are the first place the owner need to focus on as often there is no enough rent coming and have to default themselves. Hope that helps.

Alina Trigub · Answer

@Duke Giordano

I think a lot depends on the individual's long term goals, aggressiveness level and personal (aka family) situation. I'd personally spread out the risk and diversify into multiple assets and markets long term (think Warren Buffet.)

Happy to chat more offline if you'd like feel free to PM.

How Would a Recession Effect Real Estate Syndication Deals?

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