Many syndicators/sponsors are offering a "waterfall" payout arrangement to their investors, whereby the investor first gets a "preferred return "of 8%, and then 75% of any cash flow left over after the preferred return is paid, plus 75% of the equity upon sale or refinance. An internal rate of return may also be mentioned...after the investor hits the promised IRR (15-23%), the split might change to 50/50. The sponsor gets the other 25% (or 50%), plus a 1-3% acquisition fee, a 1-3% disposal fee, a 1-3% annual asset management fee. If they have a property management arm, then they get 6% for management. If they're a broker, then they get to keep any brokerage fees.

It sounds complicated, because it is. I am invested in 5 passive deals, and each has a little different waterfall and fee structure. And uses different language in the Operating Agreement to explain the distributions. I can't really tell you that I understand all the terms...and I'm in the business! How is this investor friendly at all?

Meanwhile, for the sponsor, the 8% payments commence within 30-60 days of closing on the property...regardless of the property's actual performance. It's like paying interest on a note: No flexibility. If it's a value-add deal, it's quite possible there won't be sufficient cash flow to cover the preferred return for 6, 12, 18 mos. Meaning it becomes like a ponzi scheme: You have to raise enough from investors to pay those investors their promised returns until the property can do it! (I'm surprised the banks even go for it, frankly, as it is like a seller-carry 2nd for 8% interest-only...equivalent to a "no money down" deal.

I would sure rather not have required 8% payments hanging over my head as I concentrate on remodeling and turning around the building.

I heard one syndicator on a Joe Fairless podcast (wish I could find it...are you reading this Joe?) say he does it differently: He takes 20% of the cash flow if there is any, and 20% of the equity on resale or finance. THAT'S ALL.

It's sort of the Hedge Fund model (except those rarely get 20% of the profits...it's ALL in the backend except for an annual management fee.) No preferred return. His investors share in the pain of having no cash flow during the startup months, but they don't have to pay out acquisition or asset management fees. It all seems so clean and simple...so why doesn't anyone else do it?

Happy Super Bowl Day!

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