Multi-family Syndicate Investing … is this madness?

Question

So I follow the news and listen to the BP podcasts and the signs are clearly flashing danger for MF syndications - high interest rates and short-term debt coming due, constrained bank lending, slowdown in rent increases and tons of new projects coming online to soak up demand. Cap rates still heading up and getting more difficult to grow NOI. Valuations going down.

But - I am still getting inundated with 503c offerings still telling me I'm going to get that 15% IRR and 2.5X multiple in 5 years.

Is investing in MF syndications the foolishest thing to do right now? Is a massive collapse on the horizon or is this just a cooling down period? If the cap rates peak out in the next year or so wouldn’t it make sense to invest in fresh deals at that time that can take advantage of the higher cap rates?

Please convince me one way or the other ? Is love to hear what the BP community is doing in this space right now.

Trevor Richardson · Answer

It’s only going to collapse if the demand collapses. Have we solved the roughly 5 million housing unit shortage in the US? No.Even with the inventory coming I highly doubt that. Struggles with debt, returns etc affect the ownership. Jobs, economy, housing units affect apartment demand for tenants. None of these three are cracking.

Ian Ippolito · Answer

There have been more than a few syndications that have been running into problems recently due to floating-rate debt issues like you mentioned (and either have to call new capital or default and wipe out all equityholders). Also, depending on the offering strategy, inflation has caused problems for overrunning of expenses on ground up construction and extreme value-added etc.Personally I deal with the first issue by sticking with sponsors that lock in long-term fixed-rate loans. It costs more but it mitigates interest rate risk. And, I also look very skeptically at any deal that is doing more than value add. And personally I avoid those at this stage of the cycle...but I know others who are okay with this but require a significant buffer in the pro forma to cover unexpected price increases.Also, I personally avoid short-term flips (and I would consider a five-year deal to be too short-term) and instead prefer long-term investing (7 to 10 years or more). That gives additional time for short-term cycle issues to work themselves out.

Evan Polaski · Answer

@Steven Rosenfeld, while all markets have cycles, I agree with many of the posts here. There are always risks. One that I recommend is look at some of those "successful" deals. In the height of values and peak rent growth, I know of syndicators that were able to exceed projections on LP returns (30% IRR vs projected 18%) but they were 20% behind projected NOI. As others noted, you cannot truly predict the values in 3+ years. But, the strong sponsors are fully controlling their process and NOI. If you are looking at sponsors, be sure to not only ask about track record LP performance, but actual operational performance. Ask them to send their initial underwriting/proforma on past deals versus their sale T12. Generally, as an LP, I look for well capitalized groups. Not just in the deal, but where the GPs can fund their own rescue capital versus going to market. An established sponsor is more likely to be able to cover cash shortfalls through their own balance sheet versus smaller groups.I look for vertically integrated groups, that control all aspects of their operations. Asset managers only have so much say on third-party property management and construction management. And it is a lot of work to fire and rehire management teams. Groups that have their own management take a big variable out of the equation, generally. I learned early in my career that there are too many moving parts with value-add deals to let someone else control the ship.At the end of the day, being an LP in real estate is just an investment. You can do it in REITs, you can invest in angel funds, you can invest in mutual funds. Being somewhat agnostic is typically best. If you feel the return projections are overly optimistic, then steer clear. If you think value-add multifamily is still too hot and not commiserate with the risks, look for something else.

Dan H. · Answer

I am still investing in syndicators that have either a sophisticated value add or a preferred equity position. MF Syndicators that simply plan to rehab units and improve management while recently (last decade) providing good returns I feel may not meet their pro forma going forward especially if their financing is variable and cap rates increase. In the last 1.5 years I have seen some syndications seem to have been formed to bail out the GPs. they bundle a bunch of projects into a syndication that is larger than the syndicator has ever performed on. They have no track record of performing at that scale and the timing is horrendous (which is why t seems the syndication was created to bail out the GPS). One in my market has as one of the GPs one of the primaries (the RE agent) from a tv show on finding luxury properties. I have known this person ~25 years. This syndication is multiple times as big as his biggest ever. The time you could pick virtually any RE syndicator and get near 20% annual return are likely over. Do your due diligence and be careful. Good luck

Kyle Curtin · Answer

Hey Steven! Great thought. There is no doubt that there is billions (if not more) of bridge and variable rate loans coming due now -the next 36ish months. For the past few years, it can be argued that it was very difficult to lose money as an operator with debt rates being a fraction of what they are now and a very bullish aura in the general environment. The environment has changed significantly, but that being said, a lot of opportunity is coming to the marketplace. There are absolutely still deals now that pencil out, but I think that it is very important to really study the operators and opportunities that are here today before placing capital. Our team has only ever used fixed debt when doing mf syndications, and are sticking to that strategy for the foreseeable future. Given it is harder to find deals that are worth pursing from an underwriting perspective, but we are not comfortable with gambling with our investor's capital with that uncertainty. Fortunately our partners have very strong relationships with credit unions and we are still able to leverage more inexpensive fixed rate debt than most of the buyers in the marketplace. Long story short, in my opinion I think it is still a great time to be bullish on syndications in the current environment, but you really need to double down on operator & project due diligence before placing any of your capital :)

Caleb Bryant · Answer

I haven't been getting any with return estimates this aggressive. Most I've seen are around 5-6% COC and are 1.9-2x in 7 years. I'm also seeing a lot more newer product then class C stuff like I used to see. I'd only be invested in syndications with strong track records right now and I'd be calling people who are in current deals to see how things are going, what communications are like, etc. The LP positions I've had were all purchased before 2018 and I've been lucky to have found some solid operators with good communication. Some of them are paying less than originally projected quarterly but are in strong overall positions as far as debt and property condition.

Brock Mogensen · Answer

DD on the sponsors current portfolio and track record is key right now.

Joe Archbold · Answer

There are always good times to invest. Are there arguably better times? yes. But those interest rates are gone. There are still economics that make investing a good idea. The Average home prices are through the roof while interest rates make them even more unaffordable. Certain markets have job growth and population growth that will create more demand. Experienced operators are using less leverage, buying discounted projects from failed operators, or at least underwriting conservative deals and financing is a key component. If their strategy includes renovating 100% classic units in a 250 unit complex do they have the tools and resources to accomplish that? Do their target proforma numbers make sense?As an investor, your investing out 24-60 months. The operator's experience from prior art as well as knowledge of their market sandbox will still put excellent projects together with investors and bring in strong returns. If you sit on the sidelines with your powder dry, what will be the trigger to get back in or are you going elsewhere?We share vetted syndication offerings with our investor community. Glad to share any data if interested.

Benjamin Aaker · Answer

Those syndicators who do nothing but syndicating are getting squeezed right now as deals are hard to find. Be wary right now. The front end returns are being offered lower, with higher promises of returns on the back end when the place sells. I'm seeing them take less of a split on the back end now and this can be enticing to investors. The back end is much less predictable, and if they can't show evidence of good return now, it's guesswork on what the future will hold. Good deals can still be found, but you'll need to take a closer look at the numbers in this market.

Chris Seveney · Answer

@Steven RosenfeldAnyone can say anything in a ppm for returns. The questions that should be asked is how are they getting there?1. What is their leverage look like and the rates on the loan.2. What is the t12 on the property and noi3. What is exit strategy and time periodIf they are exiting at todays or lower than todays cap rates, then ask what if it sells for a cap rate 1% higher than today - what do returns look like etc