How do you determine if a syndication make sense for the sponsor?

Question

Assuming the potential deal you are analyzing meets your target IRR for investors (net of fees), what's the best way to determine if the deal make sense from a sponsor/developer's perspective? Is it simply making sure that the deal can afford your management fees and carry/profit split (after the pref to investors) and still achieve your target IRR for investors? Should the Sponsor's IRR be calculated based on the sponsor's investment (ex: 10% of capital), which you would expect to be significantly higher than the investor's IRR? Or should you analyze it more like a traditional business to ensure the management fees cover overhead and a salary for you.

It appears the sponsor would rely heavily on management fees (acquisition, loan, prop. mgmt, asset mgmt, etc.) to cover overhead until distributions to investors surpassed the preferred return and a final sale.

Also, I would imagine you need to have multiple projects (or a few large ones) to live off the management fees until the ultimate sale.

Appreciate any feedback. Hopefully my question makes sense...

Bryan Hancock · Answer

Sponsors make money in the form of a co-investment and in fees, carry, etc.  Sponsors generally try to keep as much as possible so what makes sense depends on:

1.  What they need to function and feed their family

2.  What is needed to attract capital from investors

So in order for it to "make sense" you'll need to figure out Item 1.  I'm no longer starting new projects as a sponsor that I don't think I can personally take home at least $100k doing.  The overhead simply isn't worth my time anymore and there is more to life than making money.

Note that Item 2 goes down as your investor list and track record go up.  With more investors to select from and a better track record your cost of capital should go down and you can keep more.  This, in turn, allows Item 1 to be feasible for more projects.

Craig Haskell · Answer

Hey there Brian:

You can use syndication for almost anything. Most business are some sort of syndication. Look up and down most city streets and you will see shopping centers, office building, apartment buildings and so forth; 80% are partnership / syndications. Most of the businesses - tenants of the retails or office space - are some sort of partnership, whether it's a family business or a sponsor managed business.

If you find a good deal that has solid value, you can bring investors into a syndication whereby you would create a partnership entity where they would own are part of. You would manage the process as the syndicator or sponsor.

And for the sponsors effort, a sponsor can get various types of fees for performing certain work assignments to buy, fix, operate, finance and sell the business.

In addition, you can get a backend profit - a performance profit - for generating profits for the partnership.

When you create your partnership, you will set the profits splits and fees. Typically you'll see in the marketplace a 2-5% acquisition fee (depends on property size), a partnership management fee of 1-2 of the asset value, a construction management oversight fee of 5-8% of construction dollars, a property management fee of 3-8% of property monthly revenues (depends on property size) and a few more. I would not recommend doing the property management yourself if you have never done it before.

On the backend, you can get a piece of the backend profits. Typically, if you have a good deal and put no money into the deal, you can expect 20-25% of the backend. If you find a home run with BIG profit potential and/or you put money into the deal, you can get more backend; somewhere between 25% to 70%. Again, it depends on the deal and the size.

Profit splits are based on all the cash collected over the life of the investment including cash flow and equity upon sale.  When the property sells, net sale proceeds and money remaining in your partnership bank account are disbursed. The first money back is investor capital contributions. Next is any balance of a preferred return not fully paid, if offered. Next, is payment to the sponsor for any fees not taken during the investment hold period. Finally, the money leftover is split based on your predetermined agreement with your investors. There are a few other issues, but just trying to keep it simple.

Syndicators who have been in business for awhile live off the fees and use the backend profits to build their wealth. When you just getting started, I recommend that you will continue to work at your job while putting together syndications. After you get a few properties done, you can begin to think about doing this full time.

I hope you can find some ideas within my comments.

Take care,

Craig

Joel Owens · Answer

Depends on what the goal of the sponsor is. Someone making 50k a year wanting to exit the rat race might syndicate as a sponsor smaller or marginal deals to get acquisition fee and ongoing management fees.

By having a couple of those going they can likely quit that J-O-B and make 50k a year or more.

Now if you are someone already making with your business 500k,750k,1 million in income a year then doing a syndicate has to give you big upside on the back end through ground up development or repositioning an asset for equity. If you are just buying a stabilized property to throw off a dividend to passive investors then you are becoming a glorified property manager.

My deals I need a big payoff for equity or I just keep transacting as a commercial retail broker with clients. The payoff has to be at or more what I am doing with my transactions commission wise for return to look at it.

David Thompson · Answer

Hi Brian,

Unfortunately BP is having problems w/their blog site so you can't access my article there so I'm going to redirect to my website where you can read an article I wrote on 10 tips for vetting deal sponsors. Go to the thought leadership tab and at the bottom you will find this special report. Go to point #6 in the article and you will see what is very common in the syndication industry on structuring your deal.

How do you determine if a syndication make sense for the sponsor?

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