8 Questions you MUST ask BEFORE investing in a Real Estate Syndication
There are a few things you need to know AND a few questions that you will need to ask yourself (and answer) BEFORE you invest in a syndication. I like to “bottom line” things a lot! I just believe in taking seemingly complex ideas and reducing them down to fundamentals…blocking and tackling if you will or for you fellow golfers out there, grip and alignment. In real estate investments, like golf, if you don’t grip the club properly (execute the business plan) or you are “lined up wrong”/ “aren’t square to the target” (trying to do the wrong project or in the wrong submarket), you can easily get off track and end up somewhere other than you planned. So, if you are considering investing in a deal, you must know the answer to these questions. You may want to use this as a filter to run all of your possible investments through. Create a spreadsheet and lay it all out. It will help you calm the noise and get down to the fundamentals to help you decide if you should invest a deal or wait for another opportunity.
- What is a syndication?
A syndication is simply a group of investors pooling their capital so they can purchase something much larger as a group than they could by themselves. If I have $100,000 to invest in real estate, I can pay cash for a house, put $100,000 as a 20% down payment on a $500,000 building and get a loan for the balance or I can invest it into a syndication that my $100,000 may only be 2% of the capital invested to purchase an apartment community for $12 Million. Which one has less risk? Most of the time, it is less risky to invest in the syndication with 30-40 other investors each investing $100,000 than it would be for me to buy a $100,000 house for cash and have the risk of that house being vacant.
- What is the minimum I can invest?
The simple answer is, it depends. There are deals that you can invest as little as $5-10k and there are some that the minimum may be $100-250k. What I have found to be true is usually the more experienced operators require a larger minimum. Why? From their standpoint, the fewer investors, the fewer the problems. So, if you see an opportunity to invest $10k in a deal and this is the operator’s first or second deal, you are assuming more risk in my opinion than you would if you invested $50-100k in a deal with an operator that has been doing this for several years and has bought, operated and sold (for profit) several deals.
- How long before I get my money back?
Some deals are bought to flip. Some deals are bought to hold and operate for a very long term (7-10 years). You need to know what the plan is for the deal and decide how long you are willing to tie your capital up. Real estate is illiquid. You shouldn’t invest in a deal where the plan is to hold for 10 years if you think you will need your capital back sooner than that. Only you can determine what time period is good for you.
- When do I get paid? How often? What method?
This, again, can vary. I have seen some deals that start paying a monthly cashflow check the first month and I have seen deals that the first payment isn’t made until after the first year. If you are investing in a deal for appreciation and there is a lot of repairs, renovations, re-tenanting and rebranding, those all take time. There may not be positive cashflow for the first year to 18 months while all of that is going one. But then, after year 2, you can refinance or sell, and both would return capital to the investors. There are some nicer properties that don’t need renovations that make money as soon as you buy them. The operator may choose to pay monthly distributions starting the first month. They can also wait until they operate for a quarter or 6 months before they distribute anything to investors. You need to know what the plan is going in.
As far as the method, the more sophisticated operators will direct deposit and will have an online platform/dashboard for you to view your investments, distributions, tax forms and all other document pertaining to the deal. If you invest with someone who is doing their first few deals, they probably won’t have all of those niceties set up and will do everything manually.
- Cashflow or Appreciation?
There isn’t a right or wrong on this. Do you want ongoing income on your investment or do you want to forego that and have a large bang at the end? If you are retired, you may want the regular income but if you are a 35-year-old professional looking to grow your net worth, you don’t need regular income from your investment. You may be fine with the large increase in appreciation that comes at the end when the asset is refinanced or sold. You may be somewhere in the middle and want some income now and still want the appreciation at the end.
- Once I decide I want to invest, what are the steps?
You will likely somehow see an Executive Summary of the deal. That will be in print form for some and maybe a webinar for others. Sometimes both. The Executive Summary will be all of the data on the deal. It will talk about the plan for the property, go over the numbers, tell why the team likes the deal, give data on the market/submarket where the property is located, give the background and experience levels of the team members and tell who is going to manage and operate the property to interact with tenants, collect rent, deal with maintenance and pay the bills.
You then “raise your hand” to say you want to invest. That can be a soft commit button after a webinar, telling someone face to face or even emailing someone on the sponsorship team to let them know you are interested and how much you want to invest.
The sponsorship team hires an SEC attorney to put together the legal documents. This will consist of a Private Placement Memorandum, Operating Agreement and Subscription Agreement. These documents will spell out all of the legalities around purchasing and operating the property. Once you read the documents, you should get with a team member to get all of your questions answered. You will then complete and sign the Subscription Agreement. This is how you would legally “subscribe” to the terms of the investment. Once that has been signed, the sponsorship team will give you Wiring Instructions and you would take those to your bank to wire funds to be held in escrow until closing.
- Things to think through in order to determine if this deal is right for you
When you are thinking about investing passively in a real estate syndication, you will need to be able to filter through the number of deals brought to you by these teams of syndicators/sponsors. So, in addition to the information above, you need to think about and decide:
- Where should I invest? (market/submarket) – I would suggest researching markets on your own to determine where you want to invest so when a syndicator brings you a deal, you can quickly determine if it is in a market you want to be in or not.
- Who should I invest with? (Sponsorship team track record) – Invest with experience. There is a saying in this business. A good operator can make a bad deal good, but a bad operator can make a good deal bad. Interview the sponsor and find out about past experiences and what they did in a bad situation.
- How do I research the operator/sponsor? – The easiest way is to ask. Ask the sponsor for a list of all of their past deals, what they projected going in and how it performed. It is rare to find a sponsor where every deal has performed just like they projected but I look for the instances when things went wrong, what specifically did the operator do to correct it.
- How can I find out the performance of ALL of the sponsor’s past deals? – Again, ask. Ask the operator but also ask for a list and contact information for past investors. Call them or email them to find out their experience with this operator. The information is out there. Trust me.
- How many properties does the Property Management Company manage for this sponsor and how are they performing? – Why do I want to know this. With my first deal, we went through 4 property managers in less than 2 years. Guess what? That impacted the deal. It hurt our returns. Now, what I look for is a deal where the sponsor is using either their own in-house PM or the same PM that they are currently using on at least 2 other deals. I want the PM to have experience in the market this property is in. In my book, the more we know, the better we can manage the risks.
The final question you need to think through is this.
- Should I put more money in fewer deals or less money in more deals.
This really depends on how much capital you have to invest and how quickly are you wanting to deploy it? If you have $250k to invest, you may want to split that up between 3-5 deals across different markets and maybe even with different syndicators. If you have $1M or more, you can split it into $100-150 tranches and invest in 10 or more deals. That will allow you to diversify your investment portfolio by sponsor, market and even asset class (A, B or C class apartment, self storage, mobilehome parks or even office or industrial types of properties.