How does syndication go wrong?

[Dan Peebles]

Hi all,

I've been looking into some syndicated real estate deals as an investor but am wondering in what ways this sort of thing goes wrong, underperforms, and so on. I'd love to read stories on syndicated investments that didn't go as investors had hoped or otherwise led to undesirable outcomes. I'm also curious how all these things performed during the last big recession.

Thanks,

Dan

[Jay Hinrichs]

well a lot of them failed during the last GFC... especially in hard hit areas of PHX  Vegas FLA central CA  FLA

and around atlanta.. 

no mystery not everyone is a good operator.. and or they get into the deals very thin on capital as the sponsor. 

or its there first one and have no real experince.. especially in bad times.. 

then you have garden variety greed.. Like sponsor missappropriating investor funds..  Etc.

[Brian Burke]

@Jay Hinrichs nailed it. Failures typically occur when inexperienced groups face adversity.  This could be within their control, like they used improper financing or under capitalized the deal or simply blew it with overly aggressive assumptions. Or it might be outside of their control, such as an adverse market cycle that they don’t have the experience or resources to manage through.

This doesn’t mean that failures are limited to inexperienced groups.  Experienced ones can suffer in an adverse market cycle if they got too aggressive or financed improperly. Although if they truly have cycle experience and a solid balance sheet they should be able to weather the storm.  

This is the primary reason why sponsor selection is the most important element to selecting syndication investments. Especially as the cycle matures and the odds of the market bailing out poor sponsor performance becomes more of a long shot. 

[Taylor L.]

Would echo what @Brian Burke said about sponsor selection. I've been involved as an equity partner on a syndication which did not hit return goals at ALL, due to alleged malfeasance by one of the sponsors.

Now that I'm on the sponsorship side, I take the reputability, ethics, morals, and so forth, of my fellow sponsors very seriously.

[Steve K.]

Originally posted by @Brian Burke:

@Jay Hinrichs nailed it. Failures typically occur when inexperienced groups face adversity.  This could be within their control, like they used improper financing or under capitalized the deal or simply blew it with overly aggressive assumptions. Or it might be outside of their control, such as an adverse market cycle that they don’t have the experience or resources to manage through.

This doesn’t mean that failures are limited to inexperienced groups.  Experienced ones can suffer in an adverse market cycle if they got too aggressive or financed improperly. Although if they truly have cycle experience and a solid balance sheet they should be able to weather the storm.  

This is the primary reason why sponsor selection is the most important element to selecting syndication investments. Especially as the cycle matures and the odds of the market bailing out poor sponsor performance becomes more of a long shot. 

it scares me that everyone is a syndicator nowadays

it's like the tech bubble, when the taxi driver/shoeshine guy/etc were always giving you stock tips...

[Chihiro Kurokawa]

I'm leery of short-term loans by which I mean terms of 7 years or less. Unless it is a distressed or heavy value-add deal, a short term loan gives up far too much in disposition flexibility in exchange for leverage. Even if there is a ton of upside, I would be unlikely to invest right now in a deal with short term debt. 

[Ed Matson]

In addition to the other points, I concur with @Steve K. Everybody is a syndicator today. For example, I was speaking with a guy about 3 years ago who had a small fund of low cost SFR's in the midwest. I declined to invest because of their relative inexperience and my concerns about maintenance and CapEx costs hurting returns on $30-40K rental homes. The sponsor kept trying to tell me how my concerns were misplaced. They have now gone away from this model and are in MF. If the original model was so good, why did they pivot? Especially during good times.

[Todd Dexheimer]

Failures for syndicated deals happen just like failures for non-syndicated deals. 

1. Lack of liquid capital and cash flow

2. Over-paying for a deal

3. Inexperience operator or a poor operator

4. Lack of communication

5. Poorly structured financing

[Jay Hinrichs]

Originally posted by @Todd Dexheimer:

Failures for syndicated deals happen just like failures for non-syndicated deals. 

1. Lack of liquid capital and cash flow

2. Over-paying for a deal

3. Inexperience operator or a poor operator

4. Lack of communication

5. Poorly structured financing

Todd in my early years I worked for a company in the SF bay area that by mid 80s had about 1 b in various projects MF  MHP  senior 

student etc etc.. so i was on the inside.. my job was acquisitions in their development arm  IE new home communities they were busting into.  they had 100 plus partnerships.. and probably 5k clients.. of which many were invested in 5 to 10 of their deals.. 

What took them down was they just could not come clean that a project was failing.. they ran their business on the guise that all there deals were working etc etc.. so what happened was when one was leaking oil.. they borrowed from the reserve fund of a good one to prop it up and keep it out of foreclosure.. and to add to it they bought 2 big MF in Dallas that did not work and went into foreclosure.. 

So once you start down that slippery slope there is no going back.. and within about 3 years there was a hostile take over and that new operator just raided the cup boards and while not all the deals went bust o  a bunch of them did because the reserve funds were lent to keep bad projects up and running.. and of course the limited partners never got true financials until they sued. and by then it was too late.   I think if they had just come clean with the first one that was not working. they probably could have worked through it.. but for some reason they just thought they would lose their ability to do new deals..  there was also undisclosed mark ups.. and other malfeasance.. and as the sponsors by the time it was over both of the principals ended up in Prison.. 

So  I always look at these new folks that have never managed others monies and I kind of cringe.. i dont think they understand the risks they take doing this.. deals go bad in the syndication world its not if your going to get sued its when and for how much.. investors ..

[Todd Dexheimer]

@Jay Hinrichs so that hits on #1 and #4 and possibly #2. That is a good story for people to read. My guess was that they thought that they could save the ship, but never could get caught up. Sad deal, but honesty and communication is going to be the right answer 100% of the time. 

[Jay Hinrichs]

Originally posted by @Todd Dexheimer:

@Jay Hinrichs so that hits on #1 and #4 and possibly #2. That is a good story for people to read. My guess was that they thought that they could save the ship, but never could get caught up. Sad deal, but honesty and communication is going to be the right answer 100% of the time. 

it was a MASSIVE rob PETER to pay PAUL  and like I said for whatever reason they just felt admitting one deal did not or is not working.. was just something they would or could not do.. and it cost them everything including their freedom..  Senior partner ended up with 9 years in San Quentin  junior partner 6 years in folsom.. and in the general population.. these were mid 50s successful guys all there lives with nothing more serious than a traffic violation.   I was an independent contractor working as a broker so I just picked up and left but I had back end interest in a bunch of the projects as I took limited pay on the front end and I  lost it all as well.   Well at 30 YO I rebounded and did not get tarred or taken down with them..   

[Chris Grenzig]

@Dan Peebles A lot of people have spoken about market and over leveraging which is true, but I'll avoid adding to that because no ones talked about deals not doing so well in good markets.

Number 1 reason I've found when deals have underperformed is the management that is place. Your deals will live or die depending upon your management team you have in place. That goes for the company, your maintenance guys, your on-site manager, any sub contractors you bring in to do work, etc.

When you buy properties, especially multifamily when you get to over 10 units and even more so once you get buildings 100+, these are actual people and communities and not enough people take into consideration the people factor when operating these things. An on-site that is organized, friendly, fair, tough, no-nonsense, marketer, will take your property over the top.

Case in point, one of our deals in Jacksonville went from 90-91% occupied to 97-98% within a month because we brought in a new on-site who is unbelievable. She is incredibly organized, chases down late payers much quicker, has created a better sense of community, and has just been terrific for several months now. We've also been able to increase asking rents $25-50 without any work because of her excellent work following up on leads and staying on top of everyone.

[Jack B.]

Originally posted by @Chihiro Kurokawa:

I'm leery of short-term loans by which I mean terms of 7 years or less. Unless it is a distressed or heavy value-add deal, a short term loan gives up far too much in disposition flexibility in exchange for leverage. Even if there is a ton of upside, I would be unlikely to invest right now in a deal with short term debt. 

I am too. Unless I'm buying at what it a known or obvious market recession/bottom, then I'd hesitate to do anything other than a fixed loan. At least at the market bottom, you have time to ride the asset up and then sell. If you are buying at a time like now, a short term adjustable rate loan significantly increases your holding risk. If the market turns against you all of a sudden and you can't pay that property off when the loan comes due, sell it, etc., then you are screwed.  

[Scott Morongell]

@Dan Peebles there is a million ways for a deal to do bad. Ultimately, it starts with either an inexperienced sponsor or a group with a large team. I have no problem with an inexperienced sponsor but if they are doing a deal and I was an LP I would want to see them bring in a more experience operator on the GP side for guidance and knowledge when the going gets tough. On the flip side, there is no doubt that larger syndication teams are doing deals right now to rake in the acquisition fees. They need to make payroll and are willing to do skinny deals. Other way deals go to die:

-underestimating CAPEX

-placing the wrong debt on a deal

-buying in bad or small markets

-missing something in DD

-overpaying

-ASSUMPTIONS (most commonly seen today ex. rent growth)

[Jay Hinrichs]

Originally posted by @Chris Grenzig:

@Dan Peebles A lot of people have spoken about market and over leveraging which is true, but I'll avoid adding to that because no ones talked about deals not doing so well in good markets.

Number 1 reason I've found when deals have underperformed is the management that is place. Your deals will live or die depending upon your management team you have in place. That goes for the company, your maintenance guys, your on-site manager, any sub contractors you bring in to do work, etc.

When you buy properties, especially multifamily when you get to over 10 units and even more so once you get buildings 100+, these are actual people and communities and not enough people take into consideration the people factor when operating these things. An on-site that is organized, friendly, fair, tough, no-nonsense, marketer, will take your property over the top.

Case in point, one of our deals in Jacksonville went from 90-91% occupied to 97-98% within a month because we brought in a new on-site who is unbelievable. She is incredibly organized, chases down late payers much quicker, has created a better sense of community, and has just been terrific for several months now. We've also been able to increase asking rents $25-50 without any work because of her excellent work following up on leads and staying on top of everyone.

hope you gave her a nice bonus. !!!  flip side is the on site manager stealing you blind.. I have seen that one.. with friends of mine in Oregon that had MF in the mid west.. they ended up having to move there and manage it themselves it was 300 units.. took them 6 years to turn it around stablize it enough to sell it .

[Chris Grenzig]

@Jay Hinrichs we still own the deal, but there will definitely be a healthy bonus for performance. I've also seen poor management basically steal blind, which is why we take such an active hand in asset management. Another deal we're buying now that is 288 units had about $500k in outstanding payables 2 years prior before a new management company came in, so it definitely happens.

[Luke Miller]

These are all really good points but sometimes, despite your best efforts, deals go bad. There are plenty of examples of experienced sponsors with great track records getting burned because of variables that were never seen. Most good operators can navigate the ship around them, but it happens. I try to prepare LPs that this could happen as any responsible person taking investor capital should. 

[Mike Dymski]

The primary causes of failure:

• Under-capitalized properties
• Untimely balloon payments (poor debt structure)
• Bad locations
• Poor sponsor execution
• Bad management
• Sponsor fraud

Primary mitigants to failure:

• Cash flow
• Good locations
• Add value
• Long-term debt
• Reserves
• Experience/track record

[James Rey]

@Dan Peebles. Something to look at going forward are reversion cap rates. For the last several years the market has been so hot that everyone is a hero. I see a lot of underwriting with reversion cap rates of 1/2 to 1 point over current for when they go to sell in 5 years. Reversion is always an educated guess but I suspect difference in cap rates in 5 years will be more than a point and a lot of syndicator’s estimates of back end returns are going to have been severely overvalued.

[Michael Bishop]

Risk of execution is a big one. If the deal (conservative underwriting, favorable financing, etc) and market (good pop/job growth, strong occupancy rates, etc) look good, your biggest concern is the Sponsor/Operator and how good they are or what kind of experience they have at executing the business plan that they're promising.