Theoretical Discussion: Progressive Scaling in Syndications

[Jake S.]

Hey community,

I'm intrigued by the concept of progressive scaling in real estate syndication investments and wanted to open up a discussion. In theory, when diversifying a substantial investment across multiple syndication deals, what factors do you believe are crucial for determining the optimal number of deals?

Considerations may include the balance between diversification and quality opportunities, risk tolerance, market conditions, and the potential benefits of progressively scaling down the investment size.

For those experienced in real estate syndication or investment theory, what insights can you share on the concept of progressive scaling and its impact on portfolio optimization?

For example, Investment account starting at say, $1m and dedicating 10% to each syndication and progressively scaling that down to say 3-5% per syndication as one approaches $10m+.

At what point would you consider being in too many? I was leaning towards the idea of 20 max across 5-10 operators.

Looking forward to your thoughts and experiences!

[Chris Seveney]

@Jake S.

Rule of thumb is never to have more than 10-15% of your money in one investment. Where many accredited investors make a mistake is they may be worth $1M or make $300k a year but have $100k sitting around and put all of it in lone investment and it goes upside down.

I was with someone the other day who has 8 figure net worth and is in 30+ offerings and a balanced portfolio of lower risk debt funds getting 8-10 up to investing in VC and everything in between.

[Ian Ippolito]

Quote from @Jake S.:

Hey community,

I'm intrigued by the concept of progressive scaling in real estate syndication investments and wanted to open up a discussion. In theory, when diversifying a substantial investment across multiple syndication deals, what factors do you believe are crucial for determining the optimal number of deals?

Considerations may include the balance between diversification and quality opportunities, risk tolerance, market conditions, and the potential benefits of progressively scaling down the investment size.

For those experienced in real estate syndication or investment theory, what insights can you share on the concept of progressive scaling and its impact on portfolio optimization?

For example, Investment account starting at say, $1m and dedicating 10% to each syndication and progressively scaling that down to say 3-5% per syndication as one approaches $10m+.

At what point would you consider being in too many? I was leaning towards the idea of 20 max across 5-10 operators.

Looking forward to your thoughts and experiences!

Different investors will answer this question very differently because everyone has a different risk tolerance, financial situation and financial goals. So what one investor likes doing will look terrible to another and vice versa. And this is just my personal opinion only (and always consult with your own financial advisor before making any investment decision).

I have a seven-figure syndication/crowdfunding portfolio and am a conservative investor. And I would never feel comfortable allocating my portfolio based simply on splitting it across a  targeted number of deals (and/or trying to making all of them a certain % of portfolio). In my opinion this can very easily lead to a very imbalanced portfolio and taking on risks that I'm not willing to take-on.

1) First, I follow a vintage year strategy when it comes to alternative assets like real estate. The idea is that most vintage years are fine, but some aren't (and no way to know in advance what will happen). If an investor was unfortunate enough to deploy into 2008-2009 then pretty much everything they picked-up may have done poorly. But if they invested in 2010 or 2011 they might have picked up deals of a lifetime, etc.

So instead of deploying my entire portfolio in a single year, I spread it out over multiple vintage years. This is similar to dollar cost averaging in the stock market, where investor reduces the risk of incorrect timing, by splitting their investment up into small pieces and investing over time. 

2) Then I follow a core/satellite approach where the bulk of my assets are in a big, lower risk core. This allows me to take more risk in the smaller satellite portions. So again I'm not just splitting it evenly across a certain # of target deals.

3) I also follow the bucket approach to allocating, where my portfolio is split into several buckets. There is a cash equivalent bucket where I keep cash, CDs, US treasuries for immediate cash needs and reserves. Then I have a short-term bucket for relatively liquid (all funds have lockups, so this can't be treated as cash-equivalent) and up to one year lockups. Then I have a medium bucket for 1-5 years. And then I have a long-term bucket for 5+. And then when an investment comes to completion, that money is redeployed into that bucket.

So again this is not just splitting it evenly across a certain # of target deals.

4) I also do top-down allocation (and not bottom-up)...meaning I don't start with looking at individual investments but instead which asset classes I want to be deploying into (based on where I feel we are in the real estate/business cycle). And only then do I start looking at individual deals. So this can result in more concentration in certain areas and certain years (and is intentional/by design).

5) And finally, as a conservative investor, I may look at a hundred deals each month and then only invest in 3 to 5 at the end of the year because most don't meet my very strict criteria). So I would rather have my money with 3 to 5 sponsors who meet that strict criteria, rather than spreading it out to 10 or 15 (to achieve a target # of deals), when they don't.

Good luck with your investing.

[Evan Polaski]

@Jake S., this is a great topic.  As noted, there is no one size fits all option.  But that being said, there are many risks that need to be balanced:

- Sponsor Risk
- Asset class (multifamily, industrial, etc)
- Position style: debt, equity, pref equity
- Risk Profile of the asset: core, core +, value-add, development
- Hold period
- Geography
- Debt type/maturity

To name a few.  And then you get into broader portfolio theory: how much of that net worth should be tied to real estate, versus stocks, bonds, private equity, venture capital, etc.

If the last three years of these forums are any indication, there are a lot of people that are over concentrated in value-add multifamily.  While I still buy into this business model personally as an LP, as a whole my value-add multifamily LP positions are about 10% of my net worth.  Another 20% is in my retirement fund.  Then I have retail investments, a couple directly owned rentals, cash available for flips, my primary residence, 529 accounts in mutual funds, etc.

The challenge with true diversification is: it is safe.  Safe means steady and safe means lower returns.  Most people don't want to acknowledge this.  Most investors are chasing return, which is fine, but as we are seeing in real time, it means you are going to hit some volatile markets and maybe lose money.  Nothing that pencils to 20% IRRs isn't without risk.  As discusses on @Scott Trench's thread about "pref equity", there are always risks.  If the asset class isn't the risk, the business plan is, or the asset itself, or the financing level.  And if there isn't risk, the return will be much lower.  Econ 101: there is no such thing as a free lunch.

Look at most 9 figure net worth people: they are not chasing 20% returns.  Typically, they want a safe 4-6% over the long term.  Same with pensions and endowments, at least in real estate.  But as you note, if you want a $1mm net worth to grow to $10mm in the next 10 years, you are going to be taking on a good amount of risk to get there.  Some will win, some will lose, and clearly track record is only as good as the market it was produced in.

[Jake S.]

Quote from @Ian Ippolito:

Quote from @Jake S.:

Hey community,

I'm intrigued by the concept of progressive scaling in real estate syndication investments and wanted to open up a discussion. In theory, when diversifying a substantial investment across multiple syndication deals, what factors do you believe are crucial for determining the optimal number of deals?

Considerations may include the balance between diversification and quality opportunities, risk tolerance, market conditions, and the potential benefits of progressively scaling down the investment size.

For those experienced in real estate syndication or investment theory, what insights can you share on the concept of progressive scaling and its impact on portfolio optimization?

For example, Investment account starting at say, $1m and dedicating 10% to each syndication and progressively scaling that down to say 3-5% per syndication as one approaches $10m+.

At what point would you consider being in too many? I was leaning towards the idea of 20 max across 5-10 operators.

Looking forward to your thoughts and experiences!

Different investors will answer this question very differently because everyone has a different risk tolerance, financial situation and financial goals. So what one investor likes doing will look terrible to another and vice versa. And this is just my personal opinion only (and always consult with your own financial advisor before making any investment decision).

I have a seven-figure syndication/crowdfunding portfolio and am a conservative investor. And I would never feel comfortable allocating my portfolio based simply on splitting it across a  targeted number of deals (and/or trying to making all of them a certain % of portfolio). In my opinion this can very easily lead to a very imbalanced portfolio and taking on risks that I'm not willing to take-on.

1) First, I follow a vintage year strategy when it comes to alternative assets like real estate. The idea is that most vintage years are fine, but some aren't (and no way to know in advance what will happen). If an investor was unfortunate enough to deploy into 2008-2009 then pretty much everything they picked-up may have done poorly. But if they invested in 2010 or 2011 they might have picked up deals of a lifetime, etc.

So instead of deploying my entire portfolio in a single year, I spread it out over multiple vintage years. This is similar to dollar cost averaging in the stock market, where investor reduces the risk of incorrect timing, by splitting their investment up into small pieces and investing over time. 

2) Then I follow a core/satellite approach where the bulk of my assets are in a big, lower risk core. This allows me to take more risk in the smaller satellite portions. So again I'm not just splitting it evenly across a certain # of target deals.

3) I also follow the bucket approach to allocating, where my portfolio is split into several buckets. There is a cash equivalent bucket where I keep cash, CDs, US treasuries for immediate cash needs and reserves. Then I have a short-term bucket for relatively liquid (all funds have lockups, so this can't be treated as cash-equivalent) and up to one year lockups. Then I have a medium bucket for 1-5 years. And then I have a long-term bucket for 5+. And then when an investment comes to completion, that money is redeployed into that bucket.

So again this is not just splitting it evenly across a certain # of target deals.

4) I also do top-down allocation (and not bottom-up)...meaning I don't start with looking at individual investments but instead which asset classes I want to be deploying into (based on where I feel we are in the real estate/business cycle). And only then do I start looking at individual deals. So this can result in more concentration in certain areas and certain years (and is intentional/by design).

5) And finally, as a conservative investor, I may look at a hundred deals each month and then only invest in 3 to 5 at the end of the year because most don't meet my very strict criteria). So I would rather have my money with 3 to 5 sponsors who meet that strict criteria, rather than spreading it out to 10 or 15 (to achieve a target # of deals), when they don't.

Good luck with your investing.

 Thank you! This gives me a lot to ponder. Really enjoy your strategy

[Jake S.]

Quote from @Evan Polaski:

@Jake S., this is a great topic.  As noted, there is no one size fits all option.  But that being said, there are many risks that need to be balanced:

- Sponsor Risk
- Asset class (multifamily, industrial, etc)
- Position style: debt, equity, pref equity
- Risk Profile of the asset: core, core +, value-add, development
- Hold period
- Geography
- Debt type/maturity

To name a few.  And then you get into broader portfolio theory: how much of that net worth should be tied to real estate, versus stocks, bonds, private equity, venture capital, etc.

If the last three years of these forums are any indication, there are a lot of people that are over concentrated in value-add multifamily.  While I still buy into this business model personally as an LP, as a whole my value-add multifamily LP positions are about 10% of my net worth.  Another 20% is in my retirement fund.  Then I have retail investments, a couple directly owned rentals, cash available for flips, my primary residence, 529 accounts in mutual funds, etc.

The challenge with true diversification is: it is safe.  Safe means steady and safe means lower returns.  Most people don't want to acknowledge this.  Most investors are chasing return, which is fine, but as we are seeing in real time, it means you are going to hit some volatile markets and maybe lose money.  Nothing that pencils to 20% IRRs isn't without risk.  As discusses on @Scott Trench's thread about "pref equity", there are always risks.  If the asset class isn't the risk, the business plan is, or the asset itself, or the financing level.  And if there isn't risk, the return will be much lower.  Econ 101: there is no such thing as a free lunch.

Look at most 9 figure net worth people: they are not chasing 20% returns.  Typically, they want a safe 4-6% over the long term.  Same with pensions and endowments, at least in real estate.  But as you note, if you want a $1mm net worth to grow to $10mm in the next 10 years, you are going to be taking on a good amount of risk to get there.  Some will win, some will lose, and clearly track record is only as good as the market it was produced in.

 Thank you!

[Jake S.]

Quote from @Chris Seveney:

@Jake S.

Rule of thumb is never to have more than 10-15% of your money in one investment. Where many accredited investors make a mistake is they may be worth $1M or make $300k a year but have $100k sitting around and put all of it in lone investment and it goes upside down.

I was with someone the other day who has 8 figure net worth and is in 30+ offerings and a balanced portfolio of lower risk debt funds getting 8-10 up to investing in VC and everything in between.

 Thanks for this input! I think as my own grows I need to start doing what that 8 figure investor is doing as well.

[Jim Pfeifer]

This is a great topic, with some awesome responses!  

The main thing I would add is that when I started my passive syndication journey my plan was to spend the first 3-5 years investing with as many (qualified) operators at their minimums.  My thinking was these are long-term, illiquid investments completely out of my control and the only way to really know if an operator is worth re-investing with is to put money with them in the first place and complete the cycle with them.  My plan was after this first 5 year cycle, I would know which operators I like the best and I would eliminate all but the top 2-3 operators in each asset class and I would invest above the minimums with these operators.

The recent difficulties that many operators are having has changed my opinion on these.  There are a couple high quality operators who had a great track record, were highly recommended by my Community and were very experienced - but they ran into serious trouble when interest rates spiked.  I don't really have a problem with the fact that interest rates caused some of their issues - that happened to a lot of operators and I understood their strategies with adjustable rate debt going in - the problem with these operators is they didn't properly execute their business plans.  No amount of investing experience with these operators would have exposed these flaws - they were new errors and they hadn't made them before.  This was a big problem for me as these operators met all of the conditions that I look for - track record, experience, highly regarded - and still had problems.

This made me change my thinking - I will continue to diversify by operator and deal and I will probably scale up as my wealth grows - but I don't think I will concentrate on just a few quality operators.  I think I will always diversify among multiple operators.

[Jake S.]

Quote from @Jim Pfeifer:

This is a great topic, with some awesome responses!  

The main thing I would add is that when I started my passive syndication journey my plan was to spend the first 3-5 years investing with as many (qualified) operators at their minimums.  My thinking was these are long-term, illiquid investments completely out of my control and the only way to really know if an operator is worth re-investing with is to put money with them in the first place and complete the cycle with them.  My plan was after this first 5 year cycle, I would know which operators I like the best and I would eliminate all but the top 2-3 operators in each asset class and I would invest above the minimums with these operators.

The recent difficulties that many operators are having has changed my opinion on these.  There are a couple high quality operators who had a great track record, were highly recommended by my Community and were very experienced - but they ran into serious trouble when interest rates spiked.  I don't really have a problem with the fact that interest rates caused some of their issues - that happened to a lot of operators and I understood their strategies with adjustable rate debt going in - the problem with these operators is they didn't properly execute their business plans.  No amount of investing experience with these operators would have exposed these flaws - they were new errors and they hadn't made them before.  This was a big problem for me as these operators met all of the conditions that I look for - track record, experience, highly regarded - and still had problems.

This made me change my thinking - I will continue to diversify by operator and deal and I will probably scale up as my wealth grows - but I don't think I will concentrate on just a few quality operators.  I think I will always diversify among multiple operators.

 I can relate to this. Im currently with a couple operators that I know personally, who do fantastic work but in my gut I know I need to start diversifying across more operators. While also diversifying the other areas such as location/asset type/etc.

Ive been on your site a decent amount in the past and have taken a look at your preferred partners, do you still invest with them? Guessing so. Going to sign up at least for a free account right now!

Also, how is your ongoing experience with Vyzer?

Thanks for the insight!!

[Jim Pfeifer]

@Jake S.

I am a big fan of Vyzer.  It finally allowed me to ditch the web of Excel spreadsheets I was using to track everything.  They are super responsive to feedback - I sent them pages of notes and they have made all of the change requests I made.  Once I got everything uploaded, the process of adding new investments or distributions is incredibly easy - much easier than Excel!!

[Lane Kawaoka]

Just wanted to share a bit of my journey, back in 2015, I was shifting away from my turnkey rental portfolio (11 rentals) towards syndications and private placements. My initial ventures  were with people I thought I knew well. But let's be real, you never truly know someone until you've invested money with them.

As a new investor, I often found myself without accredited investor buddies to help with due diligence. This meant sometimes invest with those who are with great marketers or those with influencer connections, rather than the most solid operators. Honestly, it's a learning curve. I stumbled upon operators with less than $1 billion in assets, and lost money with a few of them. 1 out of 5 were a dud investment.

Over time, you start building valuable relationships with other passive investors, and that's when things begin to turn around. Your hit rate improves, and you gain better insights.

Now, about your idea of spreading investments across 20 deals with 5 to 10 operators: I get the logic. If you're doing a deal every quarter, that's four a year, and in about five years, that's a neat cycle of 20 deals. It's a solid pipeline. 

But managing 10 different operators - that's a lot and my guess is that you are pretty much dating everyone or putting in test bets. In my experience, most LP investors in syndications start by casting a wide net. Then, as they figure out who's really delivering, they narrow it down to fewer than five trusted operators. 

Hope this perspective helps a bit in your investing journey!

[Jake S.]

Quote from @Lane Kawaoka:

Just wanted to share a bit of my journey, back in 2015, I was shifting away from my turnkey rental portfolio (11 rentals) towards syndications and private placements. My initial ventures  were with people I thought I knew well. But let's be real, you never truly know someone until you've invested money with them.

As a new investor, I often found myself without accredited investor buddies to help with due diligence. This meant sometimes invest with those who are with great marketers or those with influencer connections, rather than the most solid operators. Honestly, it's a learning curve. I stumbled upon operators with less than $1 billion in assets, and lost money with a few of them. 1 out of 5 were a dud investment.

Over time, you start building valuable relationships with other passive investors, and that's when things begin to turn around. Your hit rate improves, and you gain better insights.

Now, about your idea of spreading investments across 20 deals with 5 to 10 operators: I get the logic. If you're doing a deal every quarter, that's four a year, and in about five years, that's a neat cycle of 20 deals. It's a solid pipeline. 

But managing 10 different operators - that's a lot and my guess is that you are pretty much dating everyone or putting in test bets. In my experience, most LP investors in syndications start by casting a wide net. Then, as they figure out who's really delivering, they narrow it down to fewer than five trusted operators. 

Hope this perspective helps a bit in your investing journey!

 This helps a lot. I currently have a few very trusted operators and was thinking of limiting it to 5ish. Keeping a balance of +/- 20% with each. Then spread that out over several deals over time/geography and asset type. I am still leaning towards keeping any given deal no more than 5-10% of my overall portfolio. Does that make sense?

Really appreciate your input, Lane!

[Brock Mogensen]

I like the idea of diversifying across several operators, markets..and even asset classes. 

This will also give you clarity into which operators, markets, asset classes are performing the best and allow you to double down into that segment.