Real Estate Individual Syndicators Morphing into Funds

[Duke Giordano]

Hello All,

Thanks in advance for your reply.  As someone who is knee deep into the syndicator vetting process I have come across many of the well known syndicators that are now switching into the real estate fund model grouping 2-10 deals into their own fund at least as an option.  Some still offer single deals, with the fund option.  I feel the fund model adds a layer of opaqueness to the evaluation of the deal although it certainly diversifies things.  

For those experienced LPs out there who have invested in multiple syndications what is your feeling on many of the well known syndicators offering the fund model? Are you looking into them or steering clear?  It certainly makes it more difficult to vet some of these deals in that not all the asset acquisitions are even made at the time of investment draw/call.   

What would you say the pros and cons of investing in individual syndication versus these smaller funds (not including bigger funds like MLG, Origin, Broadstone etc) but mainly talking about the smaller funds individual syndicators are offering.  There is also a tax componet where depending on the number of states this may complicate both K1 filings if there is not a combined K1, as well as, depreciation deployment/treatment across several assets in a fund deal.  It makes it more difficult to predict depreciation timing (as typically in a single deal you can expect most in year 1 if bonus depreciation/cost seg used).  

The obvious answer to the pro is diversity where the con is transparency. Would be interested in peoples experience with these deals. My inclination is to lean towards the individual syndications for the reasons discussed above, but some of the goods syndicators are switching to the fund model or at least as an option.

Thanks

Duke

[Brian Burke]

@Duke Giordano the advantage of identified asset syndications is that you can not only underwrite the sponsor, but you can also underwrite the assets to be acquired. You can usually view the historical financials of the asset, the renovation plan and budget, and future projections before you decide to invest. You can also pick and choose the asset classes to invest in, which properties to invest in, and even which markets to invest in simply by selecting a syndication that is investing in what you are looking for. The disadvantage is that you get less diversification.

Funds are more complicated, but that doesn't necessarily make them less desirable. There are primarily three different types of funds.  A blind pool fund is one where the sponsor raises money and has complete discretion as to what they acquire.  For these funds, you really need to have a lot of trust in the sponsor because you have less (or even no) ability to underwrite the assets alongside the sponsor.

The second type of fund is a semi-blind pool.  In this fund, the sponsor clearly defines a "box" that the properties must fit into.  Such as "value-add multifamily in markets X, Y and Z that are larger than 150 units and built after 1980" for example.  This at least shows that they won't spend some of the money on hotels, mobile home parks and retail strip centers.  You can somewhat visualize what the assets will be.  But you still don't have the ability to underwrite the individual assets in advance.

The third type of fund is a joint venture fund.  This fund is managed by a sponsor that is not the actual operator, instead they invest in properties bought by other syndicators or operators.  The problem with these is they are really blind--you don't even know who the operators will be, let alone what the properties will be.  Worse, they have a double-promote, because the operator gets a split of the profits, then the fund has a split of the profits, so you essentially get a split of the split.  Regardless, they are very popular--maybe just because people don't understand what they are investing in.

But funds do have their advantages. The biggest one is diversification.  Second is cost efficiency.  Let's say a sponsor is going to buy five properties.  They could organize five syndications, or one fund.  The cost to set up a fund is roughly 1.5X that of a syndication, so everyone is sharing in the savings of getting five for the cost of 1.5.  

From the sponsor perspective, as one that is currently doing exactly what you described in your post, the fund makes a lot of sense.  Cost efficiency being one, but it also gives the sponsor the ability to acquire assets in a competitive landscape with "callable capital."  With a lot of groups competing to acquire assets, sellers highly favor groups that they are certain can execute.  All else being equal, if one buyer has callable capital, and the other buyer has to raise the capital, the seller will choose the group that has the capital already arranged.

Another reason (for the sponsor) is that as they grow, they get more deal flow.  I used to do only single-asset syndications because I never knew when the next deal would come along.  But lately, our reputation as a buyer is out there and we get presented with numerous off-market opportunities.  Last year I closed on four properties but did two-asset syndications on both, so only two capital raises and the investors in each got two-property diversification.  This year, deal flow is ramping up and I have more in contract than it makes sense to raise in series, and I don't like to raise in parallel, so it makes sense to raise a fund and have a group of "starter assets" that investors can underwrite, and raise a bit more to have discretionary capital for a couple more future acquisitions.  This is sort of a hybrid approach to the syndication and semi-blind pool approaches.  

I hope that helps to see the advantages/disadvantages/reasons from both perspectives!