Dangerous Syndications!

I recently received a newsletter from the SEC attorney that I had used to try my hand at syndicating a deal. She typically doesn’t send mass emails to her clients so I figured it was important and I should read it. I’m really glad I did.

Why?

Because it made me realize how many people are starting dangerous syndications and how many investors are probably investing their hard-earned money into some of these. The more I thought about it, I realized I’ve been offered to participate in quite a few of these dangerous syndications and I chose not to, due to my own experience and understanding of the market and of the process, but there are many within my network that probably did invest.

As you’ve probably noticed, syndicating a large multifamily deals have become the new hot strategy for real estate investors. There are more gurus popping up daily. There are more podcasts, blog posts, and 3-day seminars that you can pay to attend than ever before. There are more new investors that are trying to take their shot at investing by doing a syndication without the experience, knowledge, and network that they should have. And they are creating dangerous syndications.

Kathy Fettke, professional investor for the Real Wealth Network, called it out on her 2019 midyear review. She said, “there are some scary multifamily deals out there; the scariest thing is that the people that are teaching a lot of these multifamily bootcamps, that are packed full, are people that have only been doing it for a few years. And I’ve run into so many new investors that have raised millions of dollars from investors on their first multifamily deal and they’ve only been in the business for a few years and they don’t know anything other than an expanding market”. That’s dangerous!

So, here are some dangerous things I’ve seen recently that you should look out for when you are considering investing as a limited partner on a multifamily syndication.

1. The General Partner (GP) having a specific ‘Capital Raiser’ on the team, solely to raise the money for the deal. This is the article that I received from the SEC attorney. Doing this is actually illegal and the GP could get in a lot of trouble from the SEC. Read more here: Let’s Talk About The Real Estate Syndication ‘Capital Raiser’ Trend
2. The GP solely planning on adding value to the deal by banking on increasing rent. This is great in an expanding/increasing market, but many are saying we are at the peak of the market and a downturn is on the horizon. Planning to only add value by increasing rents could possibly get the GP in a lot of trouble if the market changes. Vacancy could increase really fast if the GP tries to increase rents in a down market and the market doesn’t allow for it.
3. The GP doesn’t plan for a decrease in occupancy, increase in vacancy, in year one, especially if the value-add plan is to rehab units. Changing ownership and management regularly will cause for increased vacancy and if the GP doesn’t plan for that, they are just ignorant. GP’s must do a ‘stress test’ to ensure the rents at a higher vacancy will still be able to cover the expenses.
4. The GP doesn’t raise enough money to have a large enough ‘emergency fund’ for unplanned expenses and capital expenditures. I’ve seen this a lot recently and it could quickly cause a capital call from the limited partners (LP) if there isn’t enough money sitting in reserves.
5. I’ve seen a lot of deals where the GP receives a large ‘acquisition fee’ immediately after closing the deal (i.e. the GP is going to get their money right away, but the LP has to wait to see how the deal is going to perform). This tells me that the GP doesn’t have a lot of confidence that it will perform and they want to get their money right away. Don’t invest in a deal like this, especially if the GP is new to the game. Now, if the GP is someone who has been in the business for 20-30 years and has a proven track record, that may be different, but don’t get fooled by someone who has only been in the game for 0-5 years.
6. I saw a Private Placement Memorandum (PPM) recently where it estimated the preferred return. This is dangerous. This shows that the GP doesn’t know how the deal is going to perform and is just guessing; they don’t have a plan. There should be a precise preferred return listed on the PPM for the LPs.
7. I’ve seen a lot of over-leveraged, high interest rate, short term lending being performed on deals. Many are trying to get into deals by using short-term bridge loans, or higher interest private loans to close the deal. The GP’s plan is to the refinance once they ‘add value’ and ‘stabilize’ the property, but that has a lot of risk involved in a market that is already starting to peak and slow down. Being over-leveraged is dangerous!
8. There are a lot of new investors syndicating large, multi-million-dollar properties with very little experience. Many have never actually completed a deal (i.e sold the property once they’ve capitalized on their value-add). One thing to ask the GP is if they’ve actually SOLD a deal and returned investor money. If so, ask them how it went. If not, buyer beware; this will tell you a lot about the experience level of the investor.

So, I write this because I want the Military Investor Network to be smart and be cautious when thinking about either starting a syndication, or investing passively into a syndication. If you are a GP and are doing the things listed above, shame on you. If you are a passive investor and have invested into deals that are doing things listed above, I pray that you get out unscathed; don’t do it again. And if you are thinking about investing into a syndication as a passive investor, ask the hard questions and ensure the GP knows what they are doing.

Be smart investors!

Written by Stuart Grazier