What red flags to look for as a Limited Partner in syndication?

Question

I'm exploring being a Limited Partner in an apartment syndication.  In general, what are some red flags or specific things to consider?  Is there an element of trust that is needed at the end of the day because you are ultimately depending on the General Partners to perform?  Is there an industry of General Partners who go around creating deals to get the acquisition fees but not really follow-through with the overall investment strategy because they made their cut getting the investors on board?  Any other tips on what to look for as a Limited Partner would be much appreciated.

Brian Burke · Answer

@Brian Toy there are red flags to look for during all phases of your evaluation.

The first phase of your evaluation is to find reputable sponsors to invest with. The challenge here is this part is all about character, track record, and experience. I list character first because if the sponsor is a crook no amount of experience is going to save you. You might hear some people say to look for sponsors that are investing money in the deal alongside you, as if that "checks the box" that the sponsor will do the right thing. Completely hogwash. Judging character is a lot more difficult than tabulating how much money they invest in the deal. You should be looking at how long the sponsor has been in business, how many deals they've done, what the outcome of those prior deals has been, have they survived market cycles, do they have a brand to protect, and do their investors say good things about them. "Skin in the game" goes way beyond things that are simple to quantify--you want to look at the totality of what the sponsor has at stake if they screw you over. I wrote a bit more on this topic in my response in this thread:
https://www.biggerpockets.com/forums/432/topics/668408-how-to-determine-the-credibility-of-a-syndicator

After you've located sponsors that you have thoroughly vetted, and you trust, the next step is to analyze the offerings that they put in front of you. You'll need some real estate investment skills for this part, so you can "check their work", so to speak. Are they overzealous in their assumptions? Is their investment plan well thought-out, and make sense? Does the object of the plan fit with your investment objectives?

I could go on and on about red flags to look for in the sponsor's underwriting, but instead I'll point you to this thread where near the bottom of the first page I listed them out. https://www.biggerpockets.com/forums/432/topics/613115-apartment-active-investors-buying-too-many-door-too-quickly

If you really want to go down a rabbit hole with a good primer on syndication, here are a few threads you might enjoy:

https://www.biggerpockets.com/forums/432/topics/587695-asking-questions-to-sybdicators
https://www.biggerpockets.com/forums/432/topics/523686-requirements-for-investing-in-multi-family-syndications
https://www.biggerpockets.com/forums/432/topics/503289-how-to-vet-syndicators?page=1
https://www.biggerpockets.com/forums/432/topics/215958-what-are-typical-apartment-syndication-returns-for-an-investor
https://www.biggerpockets.com/forums/432/topics/736523-what-red-flags-to-look-for-as-a-limited-partner-in-syndication

Enjoy!

Brian Burke · Answer

@Brian Toy, great questions.

1. If you know that properties will go down and vacancies will rise, and when that will happen, it wouldn't make sense to invest.  The rub is no one knows when an adverse cycle will materialize, nor what it's impact will be.  There are defense mechanisms that can mitigate the impact of a downturn, not the least of which is positive cash flow that is stress-tested for adverse conditions.  As long as there is positive cash flow, you can hold and sell at the next cycle peak.  If you stand on the sidelines, you might never get in the game.

2. If you want to be an active investor, there's no reason to invest in syndications unless you are looking for some diversification into a different product type (or geography) or would like economies of scale beyond what you are capitalized for.  Whether you go active or passive is really a personal decision more than a financial decision.  Most of my investors either work too much to actively invest, or don't work at all and have no desire to do so (such as by actively investing in BRRRR).  If you have the time and desire to directly invest, go for it.

3. The draw to being an investor in a syndication follows my answer in #2 above, but I'll add one additional avatar--the investor that tried direct investing and realized how hard it is to find a good deal and gets tired of spinning their wheels.  As the single-family market heats up in the stronger areas, investors get pushed out by end-user buyers, forcing investors to shift to less desirable areas (with slower markets) or into syndications simply to allocate their capital and end the madness.  The second half of your question--why is there a trend of everyone wanting to be a GP--I think the main reason is many people think that investing in real estate with other people's money is both simple and financially rewarding.  They'll come to learn it's far from simple, and the financial rewards are often overestimated.  And yes, a day will come when there will be a "cleansing of the pond," and only the best will survive.  I've been around long enough to have seen this before...

Todd Dexheimer · Answer

I wrote an article on finding limited partners: https://www.biggerpockets.com/member-blogs/10145/83067-limited-partner-s-guide-to-investing-in-the-right-deal

I think it is important for you to connect with 3+ companies, unless you already have a good relationship built with a GP. You want to be sure that they are the right fit for your investing goals. If you are aggressive in your assumptions, then there will be a lot of options for you, if you are truly conservative, then you will have only a few options for GP's to invest in and will not be getting into a lot of deals each year.

Get familiar with underwriting deals and only go with GP's that are willing to share all the data with you. I give my investors everything they need to make an informed decision, but I see a lot of sponsors that only give snapshots. I don't understand how you can make an informed decision with the limited information that some companies provide.

As for some red flags:

1. It's their first deal

2. They are posting the deal publicly and it's not a 506(c)

3. They are not investing their own capital

4. They are doing a lot of deals each year - in this market, that is impossible unless you're being very aggressive

5. Business plan is not clear and well thought out

6. Rent comps don't compute

7. Their exit cap has no thought into it other that "we add 10 basis points each year"

8. They are living off the acquisition fees

The list goes on...

Scott Morongell · Answer

@Brian Toy There absolutely has to be trust when it comes to passively investing. Why? because there is a good chance you will not personally be going around to each and every comp in the market and double-checking their assumptions as to where they think they can push rents. As a passive investor you also probably don't have as great of a pulse on the market when it comes to exit projecting and where the cap rates will be. So yes, you absolutely have to trust the GP on some of the granular assumptions that might not be as easy to rule out.

What's more important than trust? Integrity and Character for sure. Just because you trust them on the deal does not mean they have your best interest in mind. Plan to spend a lot of time with them and see what makes them tick. Past deals and returns and not a complete representation of future results but it will give you a good idea as to how they operate and work through projects. If they have been through a market cycle or two past projects have more weight in my mind. Anyone who has bought and exited a deal on this past upswing could have done everything wrong from UW, debt, structure, capex and still made money because of the market. This does not make them a genius but rather a hazard to future LP's since they will show you projects that went full cycle but surely won't be chomping at the bit to tell you everything that went wrong on it.

LP's looking for investment opportunties should rank in this order: 1. Team/Sponsor 2. Market 3. Deal

Travis Watts · Answer

@Brian Toy Great post! Yes - there are many red flags. I have invested with 14+ different syndications.

A few red flags include:

- Poor communication (there have been firms I've contacted, left voicemails and emails and it look them weeks to get back to me. Not a good sign for a future relationship)

- Can you speak directly with the GP or sponsor? (This may be a personal preference, but I find a lot of value and transparency in being able to speak directly to the one structuring and putting the deal together)

- Track Record (how many deals have gone full cycle? How many deals have been completed so far)

- References (can you speak to other investors in the deals)

- Internet Search ( Did anything negative pop up online? If so, I usually bring it up to the GP directly and get their thoughts)

Hope that helps!

Greg Dickerson · Answer

@Brian Toy the other considerations are how much you have to invest and your experience. Syndications can really pay off if you have bigger chunks to invest.

BRRR can pay off with less capital if you know what your doing and scale that model.

Ivan Barratt · Answer

All good information thus far from a lot of industry titans (dripping integrity to boot!). A simple excerices that many won't do: underwrite/evaluate 100 offerings. Do that and you'll develop a finger tip feel for what a good deal looks like and more importantly what a red flag is.  Aim for 2 or 3 per week.  Small steps every day, taken over time; amount to huge impacts. :)

Chris Grenzig · Answer

@Brian Toy to answer your question on acquisition fees posed to @Todd Dexheimer, find out what they will be co-investing in the deal alongside investors. If it's more than the acquisition fee, they aren't, if they are doing less or none, then they are.

Brian Toy · Answer

@Todd Dexheimer I heard the point about making sure the GP don't live off acquisition fees.  Practically, how would you figure that out?

Thanks everyone for the great tips!

Trevor Ewen · Answer

@Brian Toy

Couple things I would recommend:

1) Always pay the sponsor a visit. It's a small cost compared to the investment itself.2) Make sure they will let you talk to prior investors.3) Ensure that they have transparency on the books and on how things are doing throughout the process of the project.4) Make sure they (or a surrogate) are able to take your calls and emails when you have questions and concerns.5) Make sure they can talk about substantive failures. Anyone who has gotten this far will have a few bad eggs in there, and it's much better if they can be honest and reflective. The flip side of this is not to get scared off whenever someone tells you about a mistake or bad investment. If anything, this should be more reassuring.

What red flags to look for as a Limited Partner in syndication?

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