Evolution of Syndications

[Stuart Udis]

Syndications and passive investing are frequent topics of discussion in the forums. Over lunch yesterday I  was discussing with a friend how the business has evolved in recent years. The conversation began after we commented  on a teacher's  BP forum post  about paused distributions that he was reliant on for medical treatment. While it saddens me to hear this, ultimately this was not someone who should have been investing passively in syndications in the first place. This leads to the main point of this post which I hope results in hearing other's point of views on the subject.  Historically (with some exceptions), there were two categories of syndicators: (1) The Sponsors who would raise "friends and family" equity and (2) Sponsors  who would raise capital from family offices,  pension funds, insurance companies etc.  for what is often referred to as institutional real estate assets. Transaction sizes and/or total equity raise are what led to the separation. 

 We are now at a place where there are Sponsors who are raising capital to compete for these institutional level assets but rather than filling the capital stack with these sophisticated larger check writers, they are raising the capital in smaller increments.  These Sponsors tour the convention circuits and roll out robust social media brands to get their name out and raise funds from smaller investors. Has anyone stopped to wonder why some Sponsors can secure commitments from the more sophisticated check writers while others have to target less sophisticated investors and spend significantly more time on the capital raising to compete for the same buildings? Keep in mind there are brokers/placement firms  out there who can serve as a conduit to the family offices, pension funds and insurance companies and the cost of those placement services are going to be significantly less than the amount of effort and expense that goes into the this new breed of syndicator. Therefor I don't want to hear anyone argue  they simply don't have those relationships as an excuse.  I also understand there are transactions out there that are too small for the larger check writers and in those cases the smaller check writers are still necessary. I am focused on those out there who are raising $50M+ to buy institutional level assets but do so by managing  500+ separate investor relationships.  I would like to hear other's perspective on this topic.

[Scott Trench]

Boiling down your post, you are asking the following question: 

"Why do so many GPs want to raise capital in $25K - $250K (sometimes up to $1M+) increments from 'unsophisticated accredited investors' instead of from institutions?"

Stuart - You know the answer already, but I'll take the bait. Some of the reasons are as follows:

1) No "Boss" for the syndicator: The GP is often an entrepreneur at heart. A $50M investment from a billionaire's family office means you have a boss. A $50K investment from a psychiatrist who has no idea what they are doing but wants the "freedom" "low risk" and "generational wealth" the GP promises comes with zero power over the syndicator in an incredible lopsided distribution of power not available from most other sources of capital. 

2) Ability to Charge WAY more in fees: A naive accredited investor with little experience in private investments will fork over fees like: 

- 2.5% acquisition fee

- High Management fees (2-5% of rents) 

- 2.5% disposition fee

- 1-2.5% refinance fee

- 20-30% carried interest

The fees that many of these social media influencers charge would get them laughed out of the room by any family office or private equity shop. But, naive instagram followers sometimes send hundreds of millions in cumulative investment dollars to these social media personalities, allowing them to buy their beach/mountain homes just with the acquisition fees. 

3) Ability to make lopsided bets that can't result in losses for the syndicator (only their LPs): 

Because of the naivete of their investors and lopsided power dynamic, the syndicator can pursue strategies that give them the ability to make lopsided bets that ensure generational wealth for their family (their LP investors take all the risk). 

For example, both of the following are possible: 

1) Extreme leverage - an "All-in" bet on appreciation:

 A syndicator can raise capital for multifamily, take out bridge debt on a low-cap rate property, and then lever up again with preferred equity to effectively give the common equity a 90%+ leverage. On a $100M deal, they might get a 2.5% acquisition fee. If the market goes bad, well, they will just be comfortably retired. If the market goes well, they can 5X the initial investment, take 30% carried interest spread on $50M, and buy a ton of luxury real estate to take even cooler pictures of their life on Instagram. 

2) Extreme diversification, sprawling, "strategy and synergy free" portfolios:

The other take that is possible from naive social media followers, but not from sophisticated family offices or private equity shops is one where a syndicator raises a ton of money across multiple different types of asset classes in a seemingly random set of geographies. 

Imagine something like - syndicator buys $100M apartment complex, $100M "diversified" portfolio, $100M in raw land, $100M in retail, $100M development project, $100M in small businesses, etc. The strategies have no alignment, there is no true networking or operational advantages, and no sophisticated investor would ever expect returns in excess of the S&P from an approach like this. 

Well, it really doesn't matter, to the syndicator's family, if most of the bets fail. Only one needs to pan out. If a single deal works out at this scale, the family has problems like estate tax transfer limits ($13M per child) to think through.

Further, as long as the funds/deals are separate from one another, the one that does go well instantly makes the syndicator an "expert" in that specific strategy or market, which then attracts the next 500K social media followers. 

This goes on for as long as it can. 

@Stuart Udis I think you already knew this though. That's why you asked the question the way you did.

The reasons SHOULD be healthier than what I listed above. Small accredited investor capital is a huge capital market that can supplement institutional and public sources of financing and provide narrow alignment on a per project basis. The inefficiencies in this market should be a huge opportunity for folks who take the time to find and vet operators and projects, and come to the table with clear theses, looking for operators and projects that match those theses, rather than reacting with FOMO to promises from the most famous influencers in the industry.

I think it is mission-critical that BiggerPockets and this community shines a light on the industry and exposes the good and bad operators, and steers LP capital away from "lopsided bets" and towards humble, honest, hungry, capital raisers offering solid projects in areas they have clear competency in.