Thoughts on ethical concerns regarding syndicated deals

[Kurt Granroth]

This topic may be a bit more esoteric than most on this forum, but it does matter to me, and it stands to reason that it might matter to others. I posted a quick comment related to this in another thread and got a thought-proving response. I'm hoping that we can get some good viewpoints here in a dedicated thread.

Okay, so we all live in a capitalist society and thus we make money because somebody else willingly gave it to us. My goal for these transactions, though, is to hopefully be win-win in that the person or entity giving me the money benefits from our deal just as much as I'm benefiting.

The easiest example might be this: I still have a day job as a principal software developer where my employer pays me a LOT of money. They are happy doing so, though, because my work makes them even more money. Thus, it's a true win-win where both parties are making a lot of money by this transaction and so both are equally happy with the arrangement.

Let's apply this style of thinking towards the three most common syndication classes we see here on BP: multi-family apartments (MF), self storage (SS), and mobile home communities (MHC).

Starting with multi-family apartments. A typical deal will invest some amount of money to renovate the property and then raise the rents by varying amounts, culminating with a hopeful sale in the future to close it out. That sale is going to be to more investors, all of which are similarly wealthy and are buying it because they think they can make even more money off of it. True win-win. In fact, the final sale is going to be a win-win in all three classes, for the same reason.

Raising rents is in a mild grey area, to me. If the apartment is an A grade, then it's totally fine since anybody in an A apartment is already more well-to-do and is willing to pay more than necessary for the nice things. They aren't going to be hurt by higher prices. B grade apartments aren't far off. C grade apartments and below, though... that's where a closer look is necessary. People in the C grade apartments are there because they don't have high incomes and are far more vulnerable to price changes. If you push the rates into B territory, then it's very likely that the existing tenants will all be (practically) forced out in favor of more affluent tenants. Where do they go? I am far more likely to be okay with this if there are multiple existing comps in the area where the previous tenants can afford to move to. But if this is the last affordable complex in the area and the price increase to "market rates" causes them to move much farther away and uproot any connections (like daycare and the like) that they have in the area... well, I'm not a fan of that.

Moving on to self storage. These are the easiest sell for me, ethically. Almost nobody NEEDS self storage. People have self storage because they have too much stuff and that, by definition, means that they have disposable income. This is a class where almost everybody involved can trivially weather any price increases. There are those edge cases where they need storage very temporarily while moving, but even then, it's the cost of only a month or two and that's not going to bankrupt anybody. So yeah, this is an ethical clean slate as far as I'm concerned.  Unless I'm missing something?

Mobile home communities, though... man, that's one that I really struggle with. Until just a day or so ago, I would say that I was completely against investing in that class due to how destructive and one sided I considered the deals to be. I see now that it's not that black and white... but nonetheless, I'm going to mostly describe that line of thinking with this post and hopefully the alternative thought processes will come out in the discussion.

Okay, I live in an area with a staggering number of MHCs and from what I can see, there are two main classes of residents. The first are the "snow birds" -- retired people who come here in the winter to escape the cold. They are not all wealthy but the fact that they have what amounts to a second home means that they clearly have money to spare (relatively speaking). Notably raising the lot rent could potentially cause some of them to sell their winter homes and not come here anymore... but they still have their regular home to go back to, so no real ethical concerns there.

The other class of MHC residents are those that live there full time and are there because they can't afford a traditional single family home. Many of them cannot afford even an inexpensive apartment. Even though they are all "mobile" homes, for a lot of them, they are as rooted to their lot as a house with a foundation, either because the house is old enough that it cannot be moved without falling part or it's simply too expensive. The following article isn't (as of when it was published in 2015) about a syndication, but it does show just how desperate and just how vulnerable some of these residents are: https://www.azcentral.com/story/news/local/mesa/2015/06/15/mesa-royale-mobile-home-park-decision-human-cost/71235678/

So let's say I was part of a syndicate that bought Mesa Royale (from the article) and fixed it up to match code. We raise the lot prices since this is an investment... and now what? Even in best of cases, we are now making our money off of people are are essentially trapped there and have no choice but to pay. That's as far from win-win as I can think of. Worst case is that the raised lot prices are too much for a resident to afford. Homelessness is a very real concern in that case. If making money off of the most vulnerable is already super problematic to me, then being the cause of somebody becoming homeless is utterly unacceptable!

I'm going to leave it at that because I don't want to do all the talking, here. I want to hear what other people have to say about this topic.

[Ben Leybovich]

Interesting thought process. Some of the conclusions are wrong, though. For instance, there are generally two approaches to investing in apartments. One is to provide the market with a very high-priced item, but one that the market would consider the absolute best product available. I call this the Donald Trump approach. In this case, we recognize that vast majority of the of the audience cannot afford this product, and safety (staying power) resides in the fact that we are not trying to cater to them. We are catering to people who are not impacted by the economy, and who are used to spending whatever is necessary for the best product.

Another approach is to see safety (staying power) in terms of expanding our audience to the largest possible pool, and finding the balance between good enough yet affordable enough. In today's economy, in most municipalities in this country, this is $800 - $1,200. But, you can find that golden mean in any market. For instance, in a market that rents between $400 - $900, you likely want to be in $600 - $750. In a market that rents at $1800 - $3000, you likely want to be around $2300 - $2600.

In either case, you want people who are stable enough to manage, but not the absolute top of the market in a given market, because there are more of them...

Further, there is a price-point that is too low from an operational stand-point - regardless of anything I wrote above, we don't want that. We'll define this as a structural Class D.

In addition, it likely is a very good idea to be at a significant Delta to Class A. Why? Because they can build Class A, and you want to stay away from that basis. This, in fact, is where all of the building takes place, and this is likely the highest risk profile. Eventually, the rents go too high, or the supply does.

Put all of this together, and Class C that can sustain re-positioning to Class B is where you want to be. The upgraded units are almost nice enough to compete with Class A, but at a much lower basis. The rents are within that golden mean I described above. The asset attracts people who are stable but not rich, which makes them manageable. 

This is precisely what I, for one, do. We closed 2 weeks ago, and the manager sent out 8 non-renewals. There was 0 vacancy when we took over, and we need to get units to begin remodeling. 6 residents out of 8 requested to have their units remodeled - they want to stay. The remodeled units look like this:

The prices we are achieving on these are lower than Class A, but not terribly lower. Yet, our all-in basis is a lot lower.