All Forum Posts by: Brian Burke

Answers to all that can be found here:  http://www.biggerpockets.com/syndicationbook.  My best advice is to hold off on placing capital into any syndication until reading it at least once.

Funny thing, I did a case study on that same deal with my investor relations team two weeks ago.  This thread was an interesting read but missed a few very important things.

Floating rate gets a bad rap.  In part, justifiably so, and in part by mistaken identity.

Justifiable:  Floating rate debt carries interest rate risk.  And right now rates are at multi-decade highs after a rapid run up, so the wounds are not only fresh, but the bleeding hasn’t been controlled yet.

Mistaken Identity:  If the syndicator on the panel says he prefers floating because he can borrow capital improvement funds, he is talking about bridge debt, which happens to have a floating rate but isn't the primary characteristic nor the reason people use it. Operators use bridge debt because the lender is more flexible as to DSCR and LTV/LTC than banks and agencies. Bridge debt is used to "bridge" a property from its current state to an improved state and by virtue of that purpose, the maturities on these loans are short, typically 3 years with two possible one-year extensions (if the covenants are being met).

The reason this distinction is important is that if rates rise, property values tend to fall.  And with only 3 years to maturity there isn’t enough time for the market to come back.  Thus, when the loan comes due, the property could easily be worth less than the loan amount, leaving the owner with very few options, none of them good.  This panelist says his business model is to hold less than 5 years…until it isn’t.  If the market doesn’t support a sale in that window, what then?

Bridge debt can be toxic.  A lot of the foreclosures and failed / troubled syndications used this debt structure, and people are hearing about it or experiencing it, and loathing floating rate loans when really what they mean is bridge debt.

But floating rate bank or agency debt with long-term maturities is different.  It still carries interest rate risk, but doesn’t have the yield maintenance risk found in fixed-rate loans.  Floaters are painful today, but fixed was painful a couple years ago if you wanted to sell 3 years into a ten-year loan.  Unfortunately there’s no free lunch in commercial real estate finance.  You have to pick your poison.

Should you accept interest rate risk, and are floating rate loans (not bridge) a good option?

Borrowers historically (but maybe not at the present moment) have come out on top using floating rate, in other words, they are getting paid for the risk. A study published by the CCIM institute looked at 50 years of history and reverse-engineered the interest costs of 5-year fixed and floating loans over 562 starting points and found that floating rate borrowers “won” 72% of the time. That study did NOT include the impact of yield maintenance. Had that been factored in, my guess is floating rate “wins” closer to 90% to 95% of the time.  Starting points within the last 36 months could very well end up in the 5-10% of starting points where floating lost.

And I think that’s where we sit today—the inverted yield curve is making floaters difficult to pencil.  With 30-day SOFR around 5.3% and the 10-year UST around 4.6%, floaters have a starting rate considerably higher than fixed debt.  That rate will float down if rates fall, but first-year yields are the toughest and that’s not a good time for the higher rate.  This is making floaters almost unusable right now…but that will change once the yield curve corrects.

And bridge debt?  I stopped using that years ago and have no plans to use it in the future—it’s just not worth the risk.  People use it because the higher LTVs allow them to raise less money (which newer syndicators and “portfolio builders” need), and project higher returns (which attracts capital from investors who might not fully appreciate the risks).  But if the tide shifts, they get wiped out.  I’ve survived this biz for 35 years without losing investor principal, across many adverse market cycles, and I couldn’t do that by taking on much “wipe out risk.”

@Dean Ng your question may be difficult to answer.  If you have enough money to buy 100 loans, it’s easier to answer—you’ll most likely see a default rate in the 3-5% range, with most defaults eventually fully cured.  Maybe you have a couple losers where you lose 10-20% of your principal, which even in the worst case of two 20% losers that’s 40% of 5% which is 2%. If you are earning 10.5% you net 8.5% and have no loss of principal.  A single 10% loser is 0.5% so you net 10%. This range is about right today. If the economy or housing market adversely shift, or if you are buying from a poor originator, or buying loans with low quality borrowers/properties, these results would deteriorate.

But if you have capital for just a handful of loans, overall performance averages don’t apply. You are either lucky, or not. Get one really bad loan, you wipe out a significant percentage of your capital.  Think of this like small vs large apartment complexes—if you own a 100 unit complex and the market vacancy rate is  5%, you’ll probably have 5% vacancy most of the time.  But if you own a 4-plex, you’ll be 25% vacant, 50% vacant, or 0% vacant depending somewhat on luck.

Another risk is the “unintended partnership” risk.  If a fractional forecloses, you now own a property with several other people you don’t know.  You don’t know if you’ll like the decisions they’ll make, nor do you know how big of a pain they will be.  If the deal turns out to be a loser, you could have one co-bene refusing to sell, tying up the deal in a lawsuit to force a sale.  Now you are shelling out cash to lawyers.  If these issues sound far-fetched, maybe they are, but I get this example because I’ve seen it.

These are some of the reasons I like a debt fund. Regardless of how much you invest, your risk is spread among a broad base of loans, allowing you to track overall averages rather than luck, plus you eliminate (or, more accurately, minimize) cash drag.  There is also one decision-maker: the fund manager.

The downside is the fund manager has to get paid, so that’s a point of friction on your return.  But you also get the additional benefit of the fund manager handling everything that you would otherwise have to do, and freeing up your time is worth something.

If there were a default, yes, the lender would foreclose and take the property back.  If that doesn't cover the principal balance plus all accrued interest, exit fees, yield maintenance, prepayment penalties, default interest, advances made for unpaid property taxes and insurance (even forced placed insurance), advances on senior loans, foreclosure costs/fees, toxic waste cleanup, costs of resale, the list goes on and on...the lender can sue each and every one of you for the entire unpaid amount.

The way this would likely play out, should the lender elect to enforce the personal guarantee, is they would file suit naming each partner as a defendant.  When you lose that lawsuit, the court will issue a judgment against each and every partner for the full amount of the damages (which can also include court costs and post-judgment interest and depending on the terms of your loan agreement, maybe even the lender's attorney's fees for the suit).  Then it's up to you partners to figure that out.  Maybe the five of you all agree to cut a check for your 20% share.  

Or, if that doesn't happen, the first one of you to sell a house will have the proceeds of that sale yanked from you by the court before you even touch them, even if it's ten years later.  Or your bank account could be seized.  If that pays the entire judgment, now it's up to that partner to sue the other partners to recover the share of the judgment that they should have been responsible for under the terms of the operating agreement.  

Forget about the lender chasing you each for 20% because that's what your operating agreement says.  The lender isn't bound by your operating agreement, they are bound by the loan agreement, which will most certainly say that you each are jointly and severally liable (which means that each of you and all of you are responsible for the whole deficiency--basically whoever they can get to first, or whoever has the most assets for them to seize).

This is why a wealthy person wouldn't want to sign a PG with a broke partner(s).  The wealthy person would always lose, because the broke partner couldn't pay their share, and the lender will focus their energy on collecting from the person they can most likely collect from.

I've talked to many people over the years with stories of great partnerships at the start, that ultimately failed and one or more partners disappeared after things went south.  Be careful.  Or better yet, seek out a non-recourse loan if you can find one.

I would start by asking the seller (or agent), "Are you (or your client) willing to entertain a joint venture?"  No sense in spending time writing anything if this isn't something the seller will do.

I agree with Robert here, this is a very unlikely scenario.  The way this is more commonly done is to partner with the seller where they contribute the land to an entity that you manage (and the seller becomes a member).  Then the entity can borrow and use the property as equity.  You'll most likely still have to bring some cash to the deal for reserves and perhaps some soft costs, and any gap between loan amount and construction costs.  Then, when the construction is completed and the property sells, the land seller gets paid the value of the lot and typically some split of the profits in the deal.

@Scott Trench there is no single correct answer here because the best course of action depends on the totality of the circumstances.  Not to mention that what is thought to be the best course of action could later turn out to be wrong.

I’ll use some hypothetical examples to illustrate:

1. Phoenix apartment deal purchased in 2021 with 90% LTC 3-1-1 bridge debt. Since, prices have fallen 25% so the property is now worth nearly 20% less than the loan amount. There are 1-year extensions available but the property doesn't meet the extension covenants due to underwater DSCR and debt yield. Lender will grant the first extension with a 20% principal pay down. The syndicate ran out of cash reserves and doesn't have enough to purchase the required replacement rate cap.

Foreclosure/DIL/short sale may be the best option.  With 90% LTC initial debt it’s likely the LPs have about 20-25% of the capital stack. To do the loan pay down for the extension or to get new permanent debt investors would likely be subject to a 100% capital call.  Better to invest that cash into a new deal because even if the value recovers the investor would recover the same in a new investment as in the existing.  Pref equity makes no sense because if the LPs are essentially wiped out already that would put pref equity too high in the capital stack.  Pref equity isn’t priced for that risk—that’s for common equity.

2. Tampa apartment deal purchased in 2020 with 10-year fixed or floating debt (doesn't matter for this example) at 65% LTV. During COVID, evictions stacked up costing tons of legal fees and bad debt. Last year, rent growth fell off, occupancies dropped, insurance skyrocketed 4X, and interest rates rose (if floating). For whatever mix of these factors, the property burned through its cash reserves and has slightly negative cash flow.

In this case, a capital call might be the best option.  The syndicate needs to rebuild cash reserves and bulk up for the slightly negative cash flow enough to get through to the other side of the market cycle.  Because the initial purchase had 65% LTV debt the LPs might have 40-50% of the capital stack, so this might be only a 10% capital call.  Even if the investment ultimately only breaks even after 5 more years, putting in $10K to save $100K is a good return on the $10K.

Pref equity could be an option for example 2 if the investors did not wish to pony up.  But pref is really best as an option of last resort because the current pay makes the problems worse, and pushing back the LPs to a subordinate position isn’t ideal.

There are a multitude of variations on these examples that shift the decision. My guess is there will be dozens, hundreds, or thousands of case studies to examine a few years down the road to use 20/20 hindsight to evaluate outcomes.

On your second question about extending grace vs being tough: that also depends. For too long many GPs and LPs had too cavalier of an attitude for the risks, and too many GPs made poor risk mitigation decisions and the LPs didn’t know any better.  Just last week I saw a deal from a syndicator that was full of misrepresentations and financial manipulation.  This operator will likely implode one day and should suffer every consequence coming their way.  But we are also likely to see experienced, competent groups that get struck by market factors largely beyond their control.  

@Dennis Boettjer be careful about basing your decision solely on past deal performance. Certainly track record is very important, but track record is so much more than deal performance.

The last decade was a consistent bull market so almost anyone could put some runs on the scoreboard while learning little to nothing.  And when a rising tide is lifting all boats, groups that amplified their results by using risky high leverage could score some massive returns until the music stopped, then will subsequently struggle to keep the rest of their portfolio out of foreclosure. There are a lot of groups out there right now that had made-for-TV track records that will likely not be in business in a couple years.

Focus on the experience of the team, how long they have been in the business, how many market cycles they’ve survived, their philosophy on leverage, and how many properties they bought in 2022/2023 (a good answer would be few, a great answer would be none).

And do yourself a favor and read The Hands-Off Investor (in the BP bookstore) before you invest a single dollar in a syndication.

Quote from @Andres Mata:

Hello all!

I have been researching a lot about syndications / investment clubs lately and was getting ready to start investing away, but I have found a couple of posts that mentioned that it might not be the best time to invest in syndications due to the current market conditions (many people mentioning awful returns and many even stopping distributions). I know it's not smart to try and "time the market", but what are your general thoughts on syndications / investment clubs in these current market conditions? I understand that these tend to have a return in 2-3+ years, which I am okay with. 

Am I looking at this all wrong? Any other tips for a new real estate investor? Thanks in advance!

Syndications are simply a business structure where a group of people combine to carry out a business or project. It doesn’t have to be real estate—syndication as a structure is used even to fund start-up companies, oil drilling, and even race horses. So worry less about whether it’s a good time to invest in syndications and instead focus on whether it’s a good time to invest in the underlying asset class.

So if you are thinking of investing in a syndication that is acquiring multifamily real estate, for example, ask yourself if this is a good time to invest in multifamily real estate. If it is, then investing in such a syndicate is similarly well-timed.  

If you are interested in hearing some differing opinions on the multifamily market, check out the BiggerPockets podcast episode I just recorded with Matt Faircloth:  https://www.biggerpockets.com/blog/real-estate-876

Despite my current negative feelings on the large Multifamily market, you’d likely be better off investing in a syndication today than 1-2 years ago—it was the shift in the environment (rent growth, interest rates, etc) that caused the ills in the industry that sparked much of the posts you’re reading.  Done properly, an investment made today should have “priced in” the factors the were previously unexpected and resulted in trouble. 

But before you invest a single dollar, please thoroughly educate yourself on these investments—while they can be great, there are land mines and you need to know how to spot them.  Fortunately BiggerPockets happens to have a book written by yours truly to assist with this knowledge.  You have plenty of time to read it—this is hardly a rapidly-rising market that you’ll miss out on if you take your time…