All Forum Posts by: Steve K.

 Can you explain in laymans terms what MF + storage syndications are? I haven't gotten to read on BP about that yet (I will for sure, it's been a very busy week but I wanted to poke around on here before fully digging in).

Thanks for all the responses.  This is my first passive investment for a multifamily syndication deal.  The property is a B class building complex with just over 100 units located in a B class neighborhood in a large metro area with strong employment numbers.  The buildings need some light exterior maintenance and as tenants vacate the units will be renovated and the rents will be raised.  The collective group of partners includes a local multifamily Property Management company with 30+ years experience and multiple other General Partners.  There are two investment options Limited Partner (LP) and General Partner (GP). LP is a silent investor and GP is a participant in the weekly meetings required to manage the building complex.  If I'm able to raise enough funds, then I may earn a GP role where I can attend the meetings and add my vote.

All sponsors have skin in the game and our interests are aligned, and so far what I know is the GP compensation is upon sale/refinance of the property (estimated in 5 years which is likely to be during a down swing in the market).  The downside protection is the positive cashflow and the loan is for 10 years.  Not sure where the renovation funds come from yet, but that's a great point.  I'll look into that.

So far I like the property and the initial numbers, and more importantly the partners that I've met with thus far seem to be easy to work with and have been able to answer all my questions sufficiently. My initial post was intentionally broad because I don't yet know what I don't know about the pitfalls of a syndicated deal. Where do the partnership risks typically lay, etc.  Appreciate all the comments.  Thanks!

I agree with the others, but adding one thing

pay him and then deposit the max $ in a ROTH-IRA after paying any taxes

aloha

steve

@Steve K. yes definitely repair that hat because I saw that question coming from a mile away.  

The answer is, it depends. There are two ways to define hurdle rates, IRR and annualized return. If the hurdle is IRR the priority won't change the total dollars because by definition achieving an IRR includes the return of capital and the priority of pref vs. capital doesn't matter. But if the waterfall is based on an annualized return the amount of pref due will decline as the capital shrinks with each return of capital distribution.

That said, while the total dollars of pref does decline, the total due to the investor doesn't decline dollar-for-dollar because what happens to the excess dollars is they drop to the next tier. So if the next tier is an 80% split to the investor, you'll get 80% of the extra dollars that would have been pref if the priority was pref first and return of capital later. At the end of the day the effect on the IRR is probably not as significant as one might assume. But the only way to know for sure is to model it because the structure of the subsequent tiers matters and so does the timing of the cash flows, etc.

I'm not convinced that going through the exercise of modeling alternative structures is worth the effort--if the sponsor isn't offering the other structure how does it benefit you to model it out? You model it and find out you could get 50bps in additional IRR if the investment were structured differently, but it's not, so you can't have it, so what do you do? LOL

And yes, requiring fewer dollars to reach hurdles does benefit the sponsor by making it easier to achieve the hurdles.  But again, we're not talking a world of difference here.  Since the tiers only divide cash flow remaining after preceding tiers are satisfied the dollars to the sponsor in this scenario won't be the difference between them retiring or not.  Instead, it'll be the difference on them getting 50% of those last dollars versus say 40% or 30% as the case may be in the preceding tiers.  So, a benefit, yes, but earth shattering, probably not.

This is the dirty little secret in the syndication world--the IRR is really an act of financial engineering because the property-level cash flows can be divided in so many ways and these details do matter. But then again, rather than focusing on the nuances of the waterfall I'd be more inclined to focus on what really moves the IRR needle, and that's the cash going IN to the waterfall. If the assumptions made for rent & expense growth, post-renovated rents, economic vacancy factors and expenses are way off, the IRR you are looking at isn't worth the paper it's printed on no matter how the waterfall is designed. Same goes for sponsors that don't execute well...they won't achieve their projected IRRs either unless the market bails them out. But it's easy to want to focus on the nuances of the waterfall because those things are quantifiable and calculable, whereas sponsor skill, execution, and assumptions are far more elusive.

@Brian Burke I think I need to make a new tinfoil hat, my old one may be wearing out since someone is reading my thoughts and this thread showed up on BP :). I just received an offering where the operator is offering pref as return OF capital two days ago, and I was wondering the effect it would have on IRR and return. the way I see it is that the return of capital would reduce the pref total, while keeping the percentage the same (ie. 100k investment would pay 8k the first year on 85 pref, but the second year would only pay 8% of 92k - $7360 and so on, and so on). what I want to know is what effect that would have on IRR, my thought is that it would make IRR higher, since your initial investment is in for a shorter period of time, so you lose less time value of that money since you can redeploy. is my thinking correct here?

the second thought I would have would be that it would have a huge effect on the waterfall if there are levels (the offering I received was a constant split, and ownership % remained the same even with return of capital). say if there were a second level where the split became 50/50 after 20% return, wouldn't that be really in favor of the sponsors, because it is easier to get to a 20% return if you are returning capital?

or am I way off base here?

mahalo (thanks) for any answer you can give to my ramblings

aloha

steve

1.  Yes, the Sponsor is the Syndicator/promoter/operator—the one who finds the property, puts the deal together and runs it through the hold period. What you are referring to as to the loan stuff is a guarantor, carve-out guarantor or Key Principal.

2.  Pari Passu means that the distribution is proportional to the amount invested. So if the sponsor contributed 10% of the capital, the distribution in the pref and return of capital tiers would be 90/10.  Whether return of capital happens before or after pref depends on how the operating agreement is worded.  I’ve seen it first, second, and unrelated (in the case of return of capital only from capital events such as refinance and sale).  If return of capital happens first it can reduce the amount of the preferred return because the capital account shrinks with every distribution.  Some investors might not like that.  Others won’t care, and others won’t understand the difference.  It’s up to you...

3.  The look-back has the most to do with modeling out the capital account and tracking accruals at every tier.  Think of it this way—how can you promise the investor that they will get 70% of the cash flow until they reach a cumulative 12% if you aren’t tracking how much must have been distributed to get to that 12%?

4.  The best example I can give for a catch up is the one I gave in #4 of my previous post.  How do sponsors justify them?  It depends on the deal. I’ve only used a catch-up once, in a blind-pool development fund where there was a straight profit split but I built in a pref with a catch-up just to give the investors a safety net if the fund under-performs.  And that’s exactly how I explained it. A pref with a catch up is better than no pref at all.  But only use this in very specific circumstances because investors typically don’t like catch-ups, and I don’t blame them.  They tend to disfavor the investor.

5.  As seen through the lens of a sponsor, I suppose you could make a case for them being the same thing.  They are both splits of the profit.  But from the lens of the investor a catch-up is very different than a promote because the sponsor is getting a disproportionate share of the income in the next tier after the pref so it cuts deeply into what would have been the next tier of their distribution, if that makes sense.

6.  How do I present it?  I show the calculations in the deal’s initial slide deck so the investors can see the flow of funds.  Then, it’s broken down from math to English in the operating agreement and PPM. Transparency is key, here.  One of my pet peeves is sponsors hiding fees and splits in convoluted structures and in footnotes to exhibits—I’ve seen some pretty crazy and underhanded stuff. Don’t do that—just keep it simple and understandable, be transparent and clear and your investors will appreciate that.