Many who look to real estate investing begin with the notion that they must find the right property, in the right location, at the right moment. All of these components are important but to the passive investor, answering these questions is the last place they will want to waste their valuable time. The critical question that the passive investor needs to ask is, Who is the sponsor/syndicator? In this article, the words sponsor and syndicator are used interchangeably as they refer to the same.
Commercial real estate investing is a very competitive industry. To find profitable deals and bring them to closing is anything but a passive endeavor. Finding commercial real estate opportunities that provide excellent returns for investors is a full-time job requiring diligence and a high degree of expertise. Sponsors of syndications also need well-developed relationships with commercial real estate brokers, lenders, attorneys, CPAs, and many other connections. It is not a passive industry.
Even though the commercial real estate industry is not passive, investing in real estate syndications provides good returns on investment while giving investors a hands-off passive investment. The passive real estate investor will not spend their time searching and vetting properties. They will find a competent syndicator who will find, close, manage, and profitably dispose of the real estate asset.
The passive investor does not have to leave it to chance as to what makes a good syndicator. This article provides the information you need to know to ensure that you are placing your money with a competent syndicator.
Before considering a specific investment, the passive investor will want to know the structure of the organization. Who is on the management team, and how is the team structured? The smallest to the largest syndicators will have a team. Whether the team members are all outsourced or in-house, there will be a team. As a passive investor, you’ll want to know that the structure in place defines each role and a chain of accountability.
A question to ask is, who is guarantying the debt. Institutional lenders vary but often require that the sponsor have a net worth equal to the loan. Some need evidence of liquidity for up to six months’ worth of loan payments. The requirements vary from lender to lender and loan to loan. There will always be an expectation of collateral.
Not all new syndicators will have the net worth or liquidity. In such cases, the syndicator will have an individual or entity with the net worth and liquidity to guarantee the loan.
The guarantee is not unlike a co-signer on a personal loan. The guarantor will not do this for free but will expect a fee or a percentage interest in the deal. This practice is not unfair to the investor. It is a relatively common practice, but it is something a passive investor needs to weigh in considering the investment.
It will be useful to know how long the team has been together. How many deals as a team have been transacted? If the team has just recently formed, that is not necessarily a bad thing. Still, it is an issue to be considered, along with all other factors. A newly formed team could be composed of very experienced syndicators but could also be composed of all newbies. As an investor, you’ll want to know.
All things considered, though, the syndicator’s moral and ethical character is one of the more challenging aspects to ascertain. If the syndicator is unknown to you, how will you know?
Everyone you meet will attempt to portray themselves as ethical and moral. It is not easy to determine whether any person is or is not. The newer the syndicator is and the younger the team, the more important character is, and the less evidence there will be to validate their real character. If you don’t know the syndicator personally, get references, preferably from someone who has done other real estate transactions with them.
A crucial element that should be clarified is the ascendancy should the key person die or become incapacitated. In such an event, who will take over management? With a well-established team with well-defined roles, the ascendancy could be almost unnoticed by a passive investor. With a small, less established syndicator, a traumatic life-changing event could be devastating to the investment. Before placing your hard earned capital in a real estate investment, know the path of ascendancy.
A team member critical to a passive real estate investor is the member responsible for investor relations. As a passive investor, you’ll want to have a person within the syndication organizational structure that you can quickly contact for up-to-date information. This person will be responsible for your inquiries and be responsible for providing regular reports that keep investors abreast of what is going on with the investment. As a passive investor in a real estate syndication, you will not be receiving up-to-the-minute updates as one does with a stock. Still, you should expect, at the very least, quarterly reports. The investor relations team member is responsible for seeing that you receive the reports and understand their contents.
Unless you invest with a large and well established real estate syndication team, there will be outside consultants. In-house attorneys are expensive, and few real estate firms can handle such an expense. Attorneys are most likely not the only outside vendors that will be consulted.
There will most likely be construction vendors providing consultation regarding renovations. There could be consultants who specialize in market research and local demographics. Several outside vendors could provide either services or consultation. Before investing, know who they are.
Your Financial Advisor
The team is a critical consideration, but also the time that the syndicator has been in the real estate business is essential. They may have been in the real estate business in some capacity for a considerable time, but this could be their first syndication. They may have a lot of experience with fix and flip single families but none with buy and hold for cash flow. It may be their first experience with tenants. As a passive real estate investor, you’ll want to know the history.
On what areas have the syndicator focused? Do they generally concentrate on multifamily with complexes from six to twenty units? Has their focus been on multifamily complexes of 150 to 500 units? These are very different investments and probably different directions by the syndicator. The focus could be on mobile home parks. The focus could be mini-storage, industrial, retail, or mixed-use. All of these can provide excellent returns if the syndicator knows what they are doing. It isn’t a bad thing to see sponsors investing in a variety of strategies.
Many successful syndicators are intentional when investing in different strategies for the practical purpose of diversification. The passive investor’s concern may arise, though, if the syndicator has a history of jumping from one strategy to another without a clear plan or consistent practice pattern. The best syndicators know their strategy and generally stick to it with a reasonable variation for diversification.
One marker of experience is the number of units under management. In multifamily residential terminology, a unit is an apartment and is referred to as “doors.” One apartment within an apartment complex is referred to as a “door.” A syndicator who owns 800 doors may own 8 apartment complexes, each with 100 units (doors) in 8 different locations. Retail, industrial, and mini-storage generally are measured in square feet. A syndicator focusing on mini-storage could have 170,000 sq ft under management. These are rough indicators as more clarification is needed when it comes to making the actual investment. Still, industry jargon brings the passive investor a general idea of the extent of the syndicator’s depth and breadth of experience. 4 doors or units under management are considerably different than 6000 in terms of a syndicators experience.
Does the syndicator know their market? Everyone has heard the term location, location, location about real estate value. Every market is different. A short five minute drive through any major city will reveal how just a few miles can make a significant difference in property value. The passive investor will want to know if the syndicator has experience in the market they are proposing an investment. Tons of market data can be investigated. However, data can be understood differently by the syndicator deeply familiar with their particular market and quite a different way by the syndicator less experienced in the market.
Perhaps for good reasons, California is a state that many real estate investors avoid like the plague. Scott Choppin, Creek Side Chats #64, has been investing in southern California real estate his entire career and doing very well. Scott knows his market inside and out. He consistently works the strategy that has proven to be successful time and again.
A newer operator in southern California is Andrew Thomas Greer (Creek Side Chats #88). Though he hasn’t been in the real estate business as long as Scott, he does have an established record in the state. He intimately knows his strategy in the market and sticks to it. Scott and Andrew Thomas apply very different strategies in a state where few dare to tread. Both, though, have a proven record based upon knowledge of their particular market and their specialty within the market. Scott and Andrew Thomas are examples of sponsors that can be relied on to perform to the projected investor return on investment.
The stock market fluctuates by the minute. The real estate market also fluctuates but considerably slower on its own cycle. This is one reason real estate provides an excellent non-correlated investment for portfolio diversification. A prudent investor will discover whether the syndicator has been through a market downturn.
How did they handle the downturn, and what did they learn? The most experienced syndicators have been through full cycles. They don’t get too excited during the boom, and they prepare for the bust. Experienced syndicators are on top of market trends and prepare for the cycle highs and lows.
The number of units under management, as mentioned above, is an indicator of a sponsor’s experience. Still, it doesn’t tell the whole story. A syndicator may now hold only 20 units, but they may have just in the last 12 months liquidated a portfolio of more than 10,000 units. When assessing experience based on the number of units, the syndicator’s history needs to be considered. Their current portfolio could be leaving out a much broader picture.
A capital call is a call to current or even prospective investors for additional capital beyond the initial investment. There are several reasons a syndicator needs additional capital. It could be because the market unexpectedly turned down. It could because renovation costs exceeded projections. It could be because of unforeseen maintenance issues. Whatever the reason, there isn’t enough capital in cash flow or reserves to meet the expenditures, and the syndicator must call on investors for more capital.
At first glance, the passive investor may be prone to think that they never want to invest with someone who had to make a capital call. That probably is not, though, is not a very sound judgment. Most likely, the only syndicator who can say they’ve never made a capital call is the inexperienced syndicator who has not as of yet had to deal with a bad situation.
The most important question surrounding the question of capital call is, How did the syndicator handle the call? Did the syndicator preserve the investor’s capital and, in the end, deliver the projected internal rate of return? The passive real estate investor will want to evaluate the answers to these questions carefully.
Assets under management are a concept that a passive investor will want to have clarified as there are a couple of different meanings that refer to very different things. One refers to the value of the property under management. This gives a dollar value to the number of units or doors under management.
The other usage refers to the amount of investor capital that the syndicate manages. You can see that this could portray a very different picture of a syndicator’s net worth and possibly their experience.
Experience matters in many ways, but the big question always is, Does the syndicator have the capacity to execute? An experienced syndicator will have a track record of raising money.
There are considerable expenses incurred before a property goes to contract and then sold. Is the syndicator funding these expenses, or is an investor funding the initial cost and covering all the deposits and upfront fee from investor funds. Can they raise the money? It is perfectly legal to use investor funds for upfront expenditures. Still, these expenses must be disclosed to all investors.
The ability to close goes beyond just the interests of investors. Real estate brokers want to know that the buyer has the money and the capacity to bring the deal to closing.
How Real Estate Syndication Sponsors Do Wonders for Your Rate of Return with A Proven Process
The team made up of people is of paramount importance. Still, there is more to consider when evaluating a syndication offering than just the people. The track record of the whole process can be assessed and should be readily available.
Michael Becker, our guest on Creek Side Chats episode 111, stated, “You are not an experienced sponsor until you’ve had a fire, a person die on your property, and been sued.” Though all three are inevitable, experienced sponsors like Michael know how to deal with these. The best syndicators do their best to mitigate before the tragedies occur.
They do this by taking the time, putting in the effort, and building systems that deliver a thorough and complete analysis of a potential property before the purchase is concluded.
These days even the smallest of operations should have a website. The website is probably one of the first places a prospective passive investor will learn about the syndication. A good website will be informative of the historical record and current standing. There you will find biographical information about the principles and partners. You’ll learn of their backgrounds and their significant accomplishments.
The website should have examples of the historical as well as the current portfolio. There will be examples of projects completed and how the sponsor met the projections. Before and after photos will often be available. A good syndicator will show models of rates of return and internal rates of return from previous projects. They will be able to show the results in comparison to the pre-project projections.
To get to know the sponsor offering the syndication, a passive investor will want to dig a bit deeper than a website. As a passive investor, you do not want or need to dive deep into the details of the sponsor’s financial analysis process, but you do want and need to know that they have a well-developed systematized approach for analyzing an investment opportunity.
Invest in No Syndication — Until You’ve Seen How the Sponsor Analyzes The Financials
You’ll want evidence that they have a systematized process for conducting thorough due diligence. A competent syndicator will validate that they have been on site and have viewed every unit’s interiors. They will provide a complete third-party interior inspection and make the report available to prospective passive investors. There will be on file a full audit of every single lease and validated that the leaseholder is the person residing in the apartment. A thorough financial analysis will include an audit of the maintenance record with validation that the work was done and the contractors paid. The maintenance record will be conducted alongside an inspection of the HVAC and any other mechanical systems on the property.
It isn’t just the physical plant that requires a complete analysis. The current management team must be analyzed, and this requires individual interviews to get to know them. It is essential to know them as people, but the interview will reveal how they operate. The interview will allow the sponsor to see firsthand the management systems in place and evaluate them for effectiveness. These interviews are not job interviews, but it will indicate whether the onsite management team can stay in place or whether they will need to be replaced.
The analysis will include demographic information about the community, region, and state. It will provide population data with income per household, average residents per household, population age range. The analysis will provide growth trend data and employer information. Information on schools, shopping, medical and health care facilities, and access to recreation will be included. There will be a crime report for the immediate area and surrounding areas. An excellent demographic analysis will give the sponsor more information on the communities and region than what most of us know about our communities where we reside.
How Good Syndication Reports Shed Light on Your Investment Gains
While reassuring that the sponsor can conduct thorough financial analysis on all prospective investments, it is somewhat meaningless to the passive real estate investor if the sponsor does not have a systematized process for reporting the financial analysis, operations, and progress toward projections to the investor. As a passive investor, you can quickly determine their capacity to report by requesting reporting samples from previous or ongoing projects. You can relatively quickly determine the quality of their reporting system by viewing a sample report.
As you are viewing, ask yourself, “Is the report understandable?” If you don’t understand it without extensive explanation, it probably isn’t a very usable report. It should be presented in plain English without a lot of industry jargon.
The report should be clear of extraneous detail but should be thorough in reporting the information that matters. As an investor, you’ll want to know whether the project is meeting the projected targets. If not, why not, and what are the remedies? A good report will show occupancy rates. Is occupancy increasing or declining? The report will provide a summary profit and loss statement with the net operating income. A good report is a transparent picture of the operations of the project. As a passive investor in the property, you need to know what is going as planned and what needs attention. The report should be as direct and straightforward as possible to explain.
The tax reporting system concerns everybody. The best syndicators have the best methods and have the best CPAs to certify the tax reporting. Real estate investing provides the best tax protections of any other investment. When handled within regulations, the tax advantages are tremendous. There is nothing tricky about the tax advantages. Without straying one bit from IRS regulations, the real estate investor will find substantial tax benefits. With all these benefits, it is surprising that some sponsors don’t think they are sufficient. They stretch the boundaries to the point of putting not only their reputation at stake but jeopardize the capital of investors who have placed their trust in the sponsor. As a passive investor, be sure that the sponsor has all tax filings completed by competent CPAs who can, without concern, place their certification on the filing.
The passive investor is looking for excellent returns on investment that do not take their time and attention away from the meaningful things in their lives. Finding an experienced sponsor is the key to successful passive investing in real estate. An experienced sponsor will consistently bring investment opportunities that generate excellent and consistent returns on investment. Putting forth the necessary effort to find the right sponsor will pay off not only in exceptional returns on investment but also in finding the time freedom to live abundantly the life you desire.
With so many investment options, confusion as to where to invest leads to inaction. Schedule a FREE – NO OBLICATION – NO STRINGS ATTACHED call. Or email me with your questions and thoughts at allen@SteedTalker.com. I’ll help you sort it all out, and you’ll soon be on your way to prosperous investing to live more abundantly in all areas of life.
About the Author — Dr. Allen Lomax
With careers in academia, podcasting, and real estate investing, Dr. Allen Lomax inspires us to break open our minds’ secrets to discover individual and universal well-being. Through passive real estate investments, he helps enlightened investors create time freedom to live abundantly in all life’s areas.