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Updated 12 months ago on . Most recent reply

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Jenny Milu
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Evaluating Syndication Questions

Jenny Milu
Posted

When evaluating if a real estate syndication is right for you, what are some of your best questions you've asked or regret not asking?

  • Jenny Milu
  • Most Popular Reply

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    Scott Trench
    • President of BiggerPockets
    • Denver, CO
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    Scott Trench
    • President of BiggerPockets
    • Denver, CO
    Replied

    Some questions for the sponsor (this is even more important than the deal to me): 

    - Will you be operating this deal? Working in it and on it, full-time, for the life of the deal, as part of a concentrated portfolio? I'm looking for someone concentrated on a small handful of bets where they can truly bring their attention to bear. I am looking to avoid someone with 5 or more active deals/funds. I personally believe that I am paying high fees to a syndicator for concentrated expertise in a specific market and niche. I can get diversification, and know I will average better returns long-term with a REIT index or stock market index fund. The bet is on concentrated expertise

    - What are your fees? Lots of answers to this. But, "good" looks like their fees in essence amounting to a living wage ($100K-$250K annual income across their dealflow) prior to their carried interest. If the fees reward the purchase of more and bigger properties disproportionately, I'm wary and likely out - depending on, or in conjunction with the next point...

    - What are you investing in the deal? I want to see them putting their own capital, earned from stuff outside of the acquisition fee (sometimes, sponsors will buy $100M in real estate, earn a $2.5M acquisition fee, "invest" this acquisition fee alongside LPs, and claim that this is a co-investment. No joke). I want this amount invested to be material - if the deal goes south, they should lose, and the amount needs to be large enough and meaningful enough to them that they will have a healthy fear of loss, not just optimism for upside. 

    - How long have you been executing this strategy in this market? I'm looking for a sponsor that has been in a market for ideally 10+ years, has had multiple exits, and has not doubled down in the last 3 years. Demonstration of the ability to find a niche and exploit it. I'll let other LPs fund a Boston multifamily expert's likely expensive education on the challenges of the self-storage business in Nashville. 

    - How are the deals you purchased in the last three years performing? Asking about a track record in 2024 is dangerous. Everyone had huge outcomes on anything they sold prior to 2021. Sponsors will sometimes talk about the huge IRR from their most recent exits (in 2021). However, nobody is exiting in the last two years, and lots of deals are underperforming, likely to lose invested capital, or are even underwater. Since then, many investors have been getting wrecked. Anything other than a direct answer is a problem. I expect to hear, and can work with a sponsor who bluntly acknowledges that they are behind on their NOI targets, and need to move forward from here. I expect and require humility, fear, discussion of lessons learned, and a cautious rationale for why and how htey will move forward. I instantly distrust sponsors who paint a rosier picture than the reality.

    The Deal: 

    - Need a growth story that is believable (value-add plan makes sense in context of asset and market.

    - Financial models need to  assume exit cap rates are the same or higher than purchase cap rates.

    - Comps support both acquisition and exit cap rate assumptions. No comps means you are buying a "unique" asset, or taking a huge pricing risk in current market. I don't trust any syndicator without my money without crystal clear comps. 

    - Capital stack needs to be clear, with preferred equity (if part of the stack) clearly represented as what it is - second position debt that multiplies leverage on common stock. 


    Also an item to be very suspicious of right now: "Preferred Equity" 


    Really, I think preferred equity is not represented accurately (it is not "safe" or protected really in any form) by many syndicators, and I own no second position debt or preferred equity personally. I believe that it is the "hot thing" right now, and it's recent use case in "rescuing" deals is both misleading and dangerous. Many deals have seen NOI collapse due to falling rents and rising costs. These deals no longer meet DSCR requirements (which skyrocketed with rising interest rates).

    To fix this, the sponsor / capital raiser can do one of three things: 

    - Capital call existing investors (who hate this and it is often perceived as a black mark on a sponsor's track record)

    - Let the bank foreclose, wiping out essentially all equity (obviously, this is also not a great resume builder)

    - Raise exceedingly expensive second position debt at a 12-15% interest rate. This is "preferred equity". Positioned to prospective investors as a "protected" or "safer" investment, it is really being injected, in many cases, into underwater deals that can't be valued in today's environment. 

    The sponsors love it right now, because it is allowing them to delay, and therefore giving them a glimmer of hope that something unoforeseen (rising rents, lower interest rates) will rescue their deal. 

    I shake my head and pass. Sure, there are use cases for preferred equity. But, today, they seem few and far between. 

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