Public-private investments are now a hot item due to recent SEC rule changes to private offerings making them more accessible. And, according to a 2019 SEC Report, capital raised through private offerings now exceeds capital raised through IPOs. This has created a feeding frenzy attracting companies of all types competing for your investment capital—many credible and many not so credible.
As such, numerous investors have set their sights on real estate syndication opportunities, which are real estate deals in which a group of investors pools their capital together to purchase a large real estate property. This is done to pool together not only fiscal resources, but other types of resources as well, like knowledge of the market or property management experience, to ensure stable investments.
There are typically two diverse roles in a property syndication deal: syndicator and investor. For those who are interested in investing in their first syndication—or even for those who have been around the syndication block—I’d like to offer some helpful insights from my own experiences into how to navigate the syndication labyrinth and come out alive. Here’s what you should know.
Two rules for vetting syndication opportunities
“Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.”
– Warren Buffett
Warren Buffett’s first two rules for investing are pretty good starting points for vetting the syndication opportunities presented to you. If you proceed cautiously and ask the right questions, you’ll improve your chances of not losing money in a syndication.
Three questions to ask yourself before investing in a syndication
Before we get into the top questions to ask a syndication partner before investing in a syndication, there are essential questions you should ask yourself, which are outlined below.
It’s important to ask yourself these questions prior to vetting any partners or potential deals. After all, knowing your personal investment objectives is crucial to not only finding and vetting a syndication partner with investment objectives that align with yours but also deciding if syndications are even suitable for you to begin with.
1. What are your investment objectives?
- Cash flow?
- Asset preservation?
- Tax benefits?
- Wealth accumulation and preservation?
Determine what your investment objectives are well before vetting any potential deals or partners. That way, you’ll know whether your objectives align with theirs—which will tell you whether the deal is a good fit.
2. What is your investment timeframe?
Do you value liquidity, or are you comfortable with illiquidity and locking up your capital for extended periods? Knowing your ideal investment timeframe beforehand will help you choose the right syndication investment opportunities for you.
3. What is your risk tolerance?
Are you risk-averse, or are you comfortable with opportunities that many consider high-risk—but where the risks can be mitigated? Your risk tolerance will play a significant part in the deals you choose to take part in, so be sure you know what yours is before vetting any of the possible opportunities or partners you may encounter.
Three questions to ask potential syndication partners
Realizing your own objectives isn’t the only crucial factor at play. You should also ask the right questions of any potential syndication partners. These include:
1. What is your exit strategy?
I start with this question because the answer will tell you a lot about your syndication partner.
Suppose management gives you a clear timeline and provides insights into how they came up with that timeline. In that case, this information will provide you with valuable insight into their experience, their financial savvy, their investment objectives, and their business plan.
For example, consider the following two potential responses to this question:
- Response #1: “After the capital raise, we expect to be profitable within one to two years. Our exit strategy is to sell after six to 10 years of operations, depending on the market. Investors will get half of all the profits.”
- Response #2: “We have set a drop-dead date of raising our target offering six months following the launch of our private placement. Once we achieve our target offering, we will mobilize and allocate the proceeds outlined in our Private Placement Memorandum (PPM) and proforma. We expect to cash flow one year from the launch of the offering. Our plan is to operate for a period of five years—providing investors with a Preferred Return of 6% per annum and 50% of profits from operations and from the sale of the asset at the end of five years. Based on our experience, we project to improve the cap rate from the acquisition of 7% to 10% at disposition. Can investors expect average annual returns of 19.44% with an IRR of 16.76%? Our projections are based on the following assumptions…
Which response gives you more confidence? You may laugh at the first response, but don’t be surprised when you encounter that type of response. I certainly have.
2. What is your investment strategy, and why are you pursuing this strategy with this particular asset?
If the syndication partner is pursuing a core or core-plus strategy, ask them why. Is it based on their experience of dealing exclusively with these properties? Or, is it because they’ve never done this before—and this is a conservative strategy?
I’m interested in the value-add and opportunistic plays—but more interested in why the syndication partner is adopting this strategy and why they think they can pull it off.
If the syndication partner rattles off their experience, infrastructure, personnel, professional support connections, and resources as reasons they’re comfortable with a value-add or opportunistic strategy, this would give me the confidence that my capital would be in the right hands.
3. Do you have any skin in the game, and how will you be compensated?
You should be leery of any syndication partner who doesn’t put their guts on the line—but still gets all of the glory. In other words, they have no skin in the game but get paid no matter what. In those situations, it’s you, the investor, who pays the price.
What the syndication partner puts into the syndication—and what they expect to get out of it—will tell you where the syndication partner’s priorities are.
The more telling question to ask would be, “If I lose money, do you still get paid?”
If the syndication is thick with upfront management fees, I would be concerned. On the flip side, if investors are given preferential treatment over profit distributions—and management is only paid if you get paid—then I would be less concerned.
Management is entitled to reasonable reimbursement for typical business expenses. But, you should always weigh investor compensation with the management compensation and see where the scale is tipped. It should tip in favor of investors.
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Final thoughts on vetting your syndication partner
Many investment experts consider private investments such as syndications to be high-risk. However, many don’t realize that with private investments—unlike public equities—a substantial amount of risk can be reduced by investing in the right partners or managers.
The ones with experience, a defined exit strategy, a clear investment strategy, and a precise business plan that put the investors first will typically offer the best odds to help keep you from losing money and fulfill your investment objectives like creating and accumulating wealth through long-term cash flowing and appreciating assets.
And, asking the right questions—both of yourself and others—will go a long way in vetting your next potential syndication partner.