Advise for a newbie LP in a syndication

[Manoj Narayanan]

Hello, I came across an opportunity to participate as an LP in an syndication deal. As an LP what due diligence is required other than the deal details. Should I be seeking any attorney reviews? What else? Thanks Manoj

[Jonathan Twombly]

First, see whether the syndicator provides you with the actual financials from the seller, so you can underwrite the deal yourself if you want to and see if you really believe the story the syndicator is telling.

Second, see if there is anything realistic about the deal.  For example, a property built in the 1970s or 1980s of 100 units in size is likely to have an expense ratio (operating expenses divided by total income) of 50% or more.  If the expense ratio is below 50%, it's an indication that the syndicator may be overly aggressive on either achievable rent growth or on cutting expenses.

Watch the fees as well.  A deal that is overloaded with every kind of fee you can think of probably means that the sponsor isn't wiling to rely on performance compensation.  Especially at this point in the market, where we are at or near the top of the cycle and the deals are very expensive.  Underwriting may be aggressive and the sponsor knows it, so they want to make sure they get paid lots of fees, which they collect no matter how the deal performs.

Watch out for too much leverage.  At this point in the market cycle you want to be very conservative, not very aggressive.  But the temptation is to be aggressive with debt because it increases the returns to equity investors.  Be wary if they are going above 75% leverage, especially if they are doing it with seller financing or some kind of mezzanine debt.  It means that the sponsor is trying to financially engineer their way into returns, rather than get there on fundamentals - they've overpaid for the deal, most likely,