Apartment Syndicators - a call to protect your investors' MONEY

[Michael Ealy]

I see a lot of apartment syndicators lately...of pushing deals that to me - are MARGINAL at best and downright RISKY at worst.

I mean I see deals where the project IRR is only 15%-20%. That level of IRR is MARGINAL and I will explain in this post why I think that is not good enough.

MOST syndicators are giving away 70% of their equity to their investors because if not, with the marginal deals that they have, their investors will not make double digit returns on their money.

I say that THIS practice of being happy with a marginal deal and having to give away a majority of your deal is NOT a good practice at all.

Why?

Because IF bad things happen, the investor will be wiped out or his or her capital will be stuck in the deal. I took a screenshot of the typical deal promised by a majority of apartment syndicators: 

At first glance, the above deal seems good. I mean you get 91.8% of your money back in 5 years, so not bad, right?

Well...not really. I've successfully invested through recessions and market booms and I can tell you that the above structure is NOT a good place to be. Why? Because projections have a nasty way of being wrong, usually on the lower side. Also, the REAL ESTATE MARKET COULD CHANGE - FOR THE WORSE. Cap rates might go up in the next 5 years resulting in lower selling price. If the projections are OFF by 20%, (meaning the sales price is 20% lower than projected and NOI is 20% lower) the investor's money is stuck in the deal as the syndicator will not be able to sell the property at a gain.

If I am the passive investor (which I am in some deals), I will be upset that my money only made 8% per year and it's stuck in the property.

In contrast, we give only 30% of the equity to our investors but we promise our investors double digit IRR (18%+). This means though that we force ourselves to find really good projects, projects with an IRR of 40%+. That superior return will result in the investor getting their capital back and earning DOUBLE DIGIT RETURNS on their capital even if the actual results are 20% lower than projected.

The above is the reason why we've delivered double digit returns to our investors and no investor has lost capital with us ever, since I started raising money from investors since 2006. And despite the crazy buying frenzy that some apartment syndicators are doing, we will stick with being selective by only doing projects with SUPERIOR returns.

What about you? Are you going to be selective to protect your investors and do things differently? Or are you going with the crowd?

[Dave Morgia]

Without seeing a specific deal @Michael Ealy, I would assume a deal with a project IRR of 40%+ would be a pretty intense project with a very high risk profile. In your example, you choose to do a 20% NOI reduction across both investments. To me, the deal with a potential for a 40%+ IRR would have to have a much larger downside potential compared to the first, otherwise the risk reward profile doesn't make much sense. And if that's the case, offering the 70/30 deal for a projected 18% LP IRR with a lower risk profile should be more attractive than the 30/70 deal with the same projected LP IRR. I suppose a higher cumulative preferred return could help mitigate this, but again, hard to say without numbers.

Great discussion though, would love to hear your input on the types of projects you're accomplishing this model with.