How to vet syndicators

[Account Closed]

For those of you who invest with syndicators, what is your vetting process? Analyzing a deal seems pretty straightforward to me, vetting a syndicator, not so much. 

[Brian Burke]

@Account Closed you’ve been given some great things to look for already but I saw a few things that haven’t been mentioned (or I just missed them).

• Ask to see the performance of their full-cycle deals.  Compare the actual performance to the projected performance so you can see if they achieve the results that they forecast. If they haven’t had any full cycle deals, they might not have enough experience to justify investing with them—they are untested if they’ve never sold a property.  Unless you are a test pilot, you wouldn’t fly in a plane that has proven to successfully take off, but has never proven it can land, would you?

• Ask to see comparisons between actual and projected performance of properties in the portfolio—this gives insight into how well they are managing currently. How many properties they are buying or the returns they are projecting are not the yardsticks for their success. The Measurement should be if they achieving the NOI and distributions that they had forecasted on the stuff they've already bought.

• Ask about the worst deal they’ve had or one that didn’t perform according to plan. What you are listening for is how they handled it. Their real character is revealed when things go wrong, not when things are going right. If they say they haven’t had one, they just haven’t been doing it long enough. So, will the one you invest in be “the one”?  

• Ask if they are obtaining financing based on their own cash reserves and net worth, or are they relying on “loan sponsors” to bring the financial strength needed to qualify for debt. Lenders require the borrower’s key principal(s) to have a specific net worth, such as 1:1 on the loan amount, and cash reserves, such as 10% of the loan amount. If the sponsor has to bring someone in to meet those requirements, you might have an undercapitalized sponsor. 

• Visit their office.  You might find that some don’t even have one. Are they working out of their bedroom?  Have no staff?  You’ll find out, plus you’ll get to look them in the eye and shake their hand (even in today’s world of email and text messages, this is still relevant). Not to mention, you’ll find out if they are even willing to carve out that slice of time for you. If they aren’t willing now, they won’t be later when you have questions after you’ve made your investment. 

• Ask about their team. Is this a one-person shop?  Key man issues could be a problem if the only guy that knows what’s going on dies.  So ask about the depth of their team and staff, and succession plan in the event that something unfortunate happens to one of them.

Finally, I’ll offer a contrasting point of view on the “skin in the game” topic.  For full disclosure, my point of view comes from two decades of being an investment sponsor so it wouldn’t surprise anyone that my opinion is that this topic is highly overrated. 

Investors are misreading the psychology if they think that having my own personal cash in a deal is going to cause their investment to perform any differently.  Or that I could walk away and risk nothing if I have no cash in a deal.  

I invest in my deals when I can, because I want a return on my money just like anyone. But I can’t invest in all.  To qualify for loans I have to have very specific cash reserves.  To get deals in contract I have to put up very large earnest money and financing deposits (can be $500K or more in some cases). Plus I have to front upfront costs for legal, inspections, etc. and if there is more than one property in contract you can double that capital outlay.

So I say that my cash is the spark, your cash is the fuel.  I’ve had investors opt out because I didn’t have 10% of the equity committed from my own cash.  I’ve raised over $75 million, if I had 10% in every deal that would be $7.5 million. Investors are sensitive to how much sponsors charge in fees—but how much would I have to charge in fees to have an extra $7.5 million laying around?!  The math just doesn’t work.

Instead, I see it this way:  I have cash reserves so I’m never in a position to feel like I have to do a bad deal just so I can earn a fee and make a living. And I’ve been the first one to take a bullet for my investors, sacrificing my own financial well being to protect my investors. If I walk away from a deal, the last thing on my mind would be my $100K skin in the game.  If I ever did that it would be the last time I’d earn the trust of the very folks that provide the lifeblood of my business.  So this means I have more like $75 million and my future income stream at risk at all times. 

I get it—if you are investing with a first time sponsor (why would you?), having skin in the game gives them something to lose. But an experienced sponsor (which is what you are looking for) has so much more at stake. 

I hope that helps!  Good luck in your search.  With the collective total of the advice in this thread, you are very well equipped to avoid mistakes.