Investing in Apartment Syndications for the Passive Investor

Savvy investors look for opportunities with their money that provide three things:

• 1) Solid Returns
• 2) Safety
• 3) Tax Advantages
• 
  

Real estate can hit all those marks.

Then again, real estate can also miss them all.

Success depends upon purchasing an asset at the right price, in the right location, with the right team executing the right business plan.

Between working a demanding job and trying to squeeze the most juice from their personal life, most people simply don’t have the time, energy, or desire to gain the knowledge, research the markets, find the deals, build the teams, or execute the business plan necessary to win in real estate.

But that’s okay because there’s still a great way for even the most time-crunched individuals to get passively involved and put their hard-earned money to work in real estate earning great returns with very little effort.

The Difference Between a Limited Partner and a General Partner

There are two types of partner in a real estate syndication: the General Partner (also known as the sponsor) and a Limited Partner.

Before we can jump in to explain the individual roles of a GP vs LP, it's important to remember that every deal needs three things: Time, Knowledge, Money.

In a syndication, the General Partner chooses a market, finds a deal, signs the contracts, completes the due diligence (inspections, underwriting, etc), builds the team, secures the financing, closes the deal, executes the business plan, communicates and distributes earnings to the investors throughout the deal, and eventually oversees selling the asset.

Simply put, the General Partner’s responsibility is to leverage their time and knowledge to put together and execute a great deal from start to finish.

So what’s left for the Limited Partner to do?

They provide the equity (money).

And that’s it.

Now that’s not to say the Limited Partner has no work to do.

They do. It’s just that the hardest part of the Limited Partner’s role is in finding a great General Partner to work with.

Qualifying a General Partner/Deal Sponsor

The right sponsor will make or break a deal. To protect your investment it’s imperative you vet any prospective sponsor through the lens of the following 7 factors.

Experience

“Success leaves clues.” - Tony Robbins

A sponsor’s history matters. To that end, here are some questions you should ask of any prospective sponsor you’re considering working with.

How have they dealt with investor’s money in the past and what sort of returns have they provided?

Have they successfully completed a deal utilizing investor’s money that’s gone the full cycle?

What kinds of issues have they had to overcome in past deals and how did they handle those issues with their investors?

Perhaps one of the most telling questions is simply: How many investors have done multiple deals with this sponsor?

When an investor keeps coming back to work with a sponsor, it’s a strong indicator of that syndicator’s track-record, trustworthiness, and ability to follow-through. These investors are a source of great information on how this syndicator conducts themselves throughout a deal, so don’t hesitate to ask your prospective sponsor to put you in contact with them.

In addition to answering these questions, there can be a lot of benefit in studying how this sponsor conducts themselves online on social media and on forums.

Do they appear well connected both online and in real life? Do they seem well regarded by other professionals in the industry?

A quick Google search can reveal a lot about a person. A strong track record of frequent posts on industry forums, informational podcasts, and educational blogs can provide tons of insight into a person’s character and knowledge.

The Business Plan

“A goal without a plan is just a wish.”

As a Limited Partner you’re going to be trusting the deal sponsor with your hard-earned money. It’s imperative that individual has a detailed and well-considered business plan.

If you can’t read their business plan and clearly understand why they like the deal, why they like the market, and what they plan to do with the property to make money for everybody involved, then you need to walk away or push them to continue developing their plan.

The business plan should clearly articulate the opportunity afforded by this property.

That is, why is this a great deal?

What problems does this property have that leave room for improvement and what is the plan for capitalizing on that opportunity to provide a great place to live for the residents while also providing superior returns to the investor?

Underwriting

Underwriting only gains in importance as the market continues its upward cycle. Sponsors that project the sort of rent growth that is normal in today’s market, but is very high by historical standards, are failing to consider the bigger picture.

The same thing occurs with sales prices within a 5-6 year hold window. Many sponsors attempt to calculate future sales price by simply adding a few points per year on top of today’s prevailing cap rates (a measure that helps determine sales price), which gives the illusion of responsibility and foresight, but in actuality tells us nothing.

The real question is this: What are the historical cap rates over the past 20-30 years in that market?

Historical data is always the better guide.

Solid underwriting is based on current market conditions, while future projections are derived from historical data.

Following this principle makes it less likely you’ll be caught with your pants down during a downturn.

Another point to consider the amount of reserve capital the sponsor is raising.

A prudent sponsor will allocate 9 months worth of mortgage payment to an initial reserve account.

Which doesn’t take into consideration any capital improvements the property might require. As a general rule, successful sponsor’s raise 10-15% more capital than is strictly indicated by the budget.

Deals don’t always go to plan. That’s okay, assuming the deal sponsor has been diligent in their underwriting and has considered all scenarios that could potentially derail the investment.

If a downturn occurs and rents drop 15% (as well as occupancy), how long can this investment survive? Solid underwriting is the difference between riding out the storm, or flushing all your money down the drain when the bank reclaims the property.

Of course no sponsor can predict every scenario, but you must firmly understand the breaking point of each deal you invest in.

Make sure you and the sponsor both know that.

The Team

“You’re only as good as the company you keep.”

Though the limited partner only contributes equity to the deal, it’s imperative you understand the skills, experience, and abilities of everybody on the team (such as the property manager and contractors).

These individuals will play a vital role in a deal’s inevitable success or failure. Ensure that your sponsor is equipping the team with competent operators capable of executing the business plan.

Sponsor Investment

A sponsor should invest into whatever deal they are pitching. This is the best way to align interests between the sponsor and limited partners as it incentives them to do whatever it takes to make the deal succeed, rather than just walk away, should things take an unexpected turn.

Now, this isn’t to say they should supply the lion’s share of the investment. I recommend, at the very least, they match either the minimum investment or $50,000, whichever is more.

Profit for the Sponsor

Let’s be honest, as the limited partner, you’re here to get paid. But you also want to be certain the sponsor is being fairly compensated.

If a sponsor isn’t making any money, you can bet they won’t be strongly motivated if things go wrong and the deal starts requiring more of their time.

Now, the deal doesn’t have to make them filthy rich, but there should be enough margin and incentive that you feel confident the sponsor will continue working hard for you throughout the engagement.

Alignment

Last, but not least, when deciding to work with a prospective sponsor, make sure your goals align well with theirs.

To that end, it’s my philosophy that you should only do business with people that you like and trust.

If you question their intentions, or have doubts about their honesty or ethics, then do not do business with them.

It doesn’t matter how good a deal looks on paper, real estate is a people business. Doing business with bad people never ends well.

Wrapping It Up

Investing in real estate doesn’t have to be scary, time intensive, or hard. Coming in as a limited partner, and providing equity on the right deal, can be a fantastic way to earn a strong return in a relatively safe investment vehicle.

The key is in finding the right General Partner.

To us, the right sponsor has a strong track-record, well considered underwriting principles, a winning team, and perfect alignment with your goals and interests.

How about you? What do you look for when investing in a deal?