[Editor's Note: The following guest post comes from a long time reader and paid advertiser on this site. The author desires to remain anonymous. It is written by a financial services professional and investor in syndicated real estate.]
Real estate syndications can be tempting, hands-off, lucrative, esoteric, and dangerous. I have been a participant in many of them. This post will be the first in a series on how to evaluate a syndication. Hopefully, there will be additional posts on the specific results and details of syndications that I have participated in. Briefly, a real estate syndication is where the accredited investor cuts a check to a real-estate operator that uses your money to purchase a multimillion dollar piece of real estate as an investment.
Real Estate Syndications Are Not Exactly Passive
A syndication is passive, and it is not passive at the same time. Let me explain. There is a tremendous amount of due diligence required initially. Before you cut that check, you had better be sure your due diligence has been completed. After you cut that check, your work is essentially done, and you can sit back, relax, and enjoy the flight.
Due Diligence for Evaluating a Real Estate Syndication
Confidential Private Offering Memorandum
Most syndications come with a confidential private offering memorandum. This is going to be your “go to” document for everything. I have a feeling no one reads these. It contains a treasure trove of information. Typically, there is an introductory paragraph that provides a nice summary of the deal. Next, there is a useful frequently asked questions section. The down and dirty is the “risk factors” section. Here is where you want to spend most of your time. No one knows the risks like the promoter putting the deal together. This is typically extremely well written by an experienced attorney. Everything gets put in here because if there were ever a lawsuit, the promoter can reply “I told you that could happen.” In fact, this is usually the part I read first after the introductory paragraph.
Scuttlebutt Method
In his famous book, “Common Stocks and Uncommon Profits,” Phil Fisher talks about how one of the most powerful investor evaluation tools is the scuttlebutt method. I couldn't agree more. For example, during the construction phase of one project, I went by every couple of weeks and asked the workers hammering the nails how things were going? Is there a cracked foundation when you poured it or was it done appropriately? You would be surprised at what you might learn. More importantly, track down the angriest investor from the syndicators previous deal. Ask the syndicator to provide you with his most unsatisfied customer. If the syndicator does not like your question or declines to answer it, move on to a different syndicator. Your goal is to bring due diligence to a new level. Talk to the secretary of the syndicator and ask what it is like working for him? Speak to the accountant that handles the books of the syndicator. Speak to the tenants. Fly down and meet the team.
What are the loan terms?
This is key. What kind of loan did the sponsor get? What is the interest rate? How long is it fixed for? How much money was put down? I have seen proformas that show an interest rate of 5 percent that changes after 5 years, yet the proforma assumes the rate will be fixed for 25 years. Of course, that is revealed in the fine print. Is the philosophy to pay down debt and then distribute money? Or is there a teaser return that can change after 5 years? Is there an interest only loan?
Other Items
Take the proforma with a grain of salt. Even more importantly, jump down and look at the FINE PRINT in the proforma FIRST. Literally, go to the bottom of the page and read the assumptions that they are trying to hide from you. Make sure you know what the management fee is. To paraphrase a risqué supreme court judge, I don't know how to find an inappropriate management fee, but I know one when I see one. 5 percent is too high. 1-2 percent might be reasonable. Most investors don't pay attention to the disposition fee. That is the fee the sponsor gets when the asset is sold. Is it a reasonable 1.5 percent, or is it 5 percent? Ask for any lease agreements between the tenant and landlord. Have fun reading that, if you know what I mean. The lease is about as entertaining as studying the proximal convoluted tubule and loop of henle. Ideally, discuss the prospectus with a colleague who is also thinking of investing. The creators of these deals are often talented salesman. They will use every trick in the book (flattery, using your name, inflating your ego, scarcity principle, reciprocity etc…). As a skillful salesman once said, “It’s not what you sell 'em, it’s what you tell em.” Another tip is to track down the competitor of the outfit that you are buying from. That competitor is more likely to provide you with what you really need to know than the syndication outfit you are purchasing your shares from.
Diversification Equals Less Due Diligence
A recent prospectus that came across my desk asked for a minimum investment of $75,000. If the astute investor wants to give syndications a try but does not want to do due diligence (pardon the pun and alliteration), a good trick would be to purchase smaller units in larger quantities. Three different syndications at $5,000 each may be more palatable and more educational than one syndication for $15,000. As the investor develops confidence in the provider, additional syndication projects could be purchased.
An Important Esoteric Pattern
Let's face it. Medicine is all about pattern recognition. When 60-year-old hits the ED with a productive cough, elevated WBC, fever, and a RLL infiltrate on x-ray, bingo community-acquired pneumonia with standard antibiotics. Investing is the same way. I have noticed a pattern with my experience, and I wanted to share it with the WCI community. An early operator just starting out, like Fundrise years ago, can be a slam dunk investment. The just-formed operators are eager to make you happy, provide overly favorable terms, and in many cases, take a loss on you just to simply get your business and referrals again! Searching out a new player with the above due diligence can be a superior combination.
Conclusions
Syndications are not for the faint of heart. Although I am in them and have had favorable results with all of them, they require a lot of work before you cut that initial check. These products are for the investor willing to put in the time and effort required to perform the due diligence. They are completely optional in the sense that a busy physician can achieve her goals with 3 or 4 index funds without a fancy syndication. For the casual business enthusiast that wants to get her feet wet, diversification over a few inexpensive syndications would be reasonable, educational, and most importantly fun!
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What do you think? Have you been involved in a syndication? What were your results? Comment below and join the conversation.
Featured Real Estate Partners
You said exactly what I was thinking at the end of the post… if I can get to my goals with passive index fund investing, then why do this?
Is it because there is little correlation with the stock market and I can expect my real estate syndication to zig when the market zags? Does it offer consistently higher returns? How is this different than doing your “research” on an individual stock before purchasing it and hoping for the best?
I’d be really curious to know two specific things:
1) How often do people get burned (i.e. not make anything or lose money) that put money in on these deals?
2) What is a typical return from this kind of investment? Is it worth all of the effort in reading through all of these documents with a fine toothed comb and taking flights to meet people?
It seems like an enticing concept, but anytime something sounds sexy or fancy that is usually when I remind myself to run the other direction for the simple passive index fund investing philosophy. However, I am very interested in getting into real estate investments of some kind once my student loans are paid off. So, I don’t want to write something off simply because it sounds like a little bit of work.
TPP
I think your question # 2 is exactly the point- it’s all over the map. There is no typical return. Sometimes it’s 3%. Sometimes it’s 25%. Occasionally, money is lost. But every deal is different so there is no typical.
A related question: over what period of time would one expect a return on average? I suppose it matters whether it is intended as a long term property in which the returns are rents. But my impression is that most of these are sold at some point and funds returned. Any data on how long on average?
nice article. There is so much to review. A checklist would be helpful.
I have ton a lot of these myself. Great topic and these have great potential. As the author said I can’t emphasize enough that one needs to read the offering memorandum and the operating agreement in full before pulling the trigger. Also look at all asssumptions in the proforma and ask if they are reasonable. There are so many places to hide critical assumptions you have to be careful.
I was probably spending about 8 hrs evaluating every deal before I invested and declined about 80% of what i started this process on (so I might pass after spending 1 hr or 8 hrs). Bottom line is this was time consuming !
I finally addressed this by finding and joining a group of like minded investors who do this due diligence as a group. We find more deals, we assess more deals, and we avoid more bad deals with far far less time spent!
Do WCI rules allow us to share how to become part of this group? For serious accredited investors who are willing to spend time on this only (you have to both contribute and receive).
Yes. I think I’m already in the group you’re talking about and I’m okay with you mentioning it.
So the group is called:
https://506investorgroup.com
It is a affiliated with crowddd.com
If you go to https://506investorgroup.com and click “join” one can fill this out and become part of what is a private google group of accredited investors mostly discussing real estate syndications.
The group leader requires a short phone call before joining to verify everyone is suitable. Be prepared to contribute, as well as learn from everyone else; and mostly to save yourself a bunch of time performing due diligence on syndications.
The phone call must be new, but it’s been a long time since I joined.
I’d be interested to know what group you are in. I have done 5 deals so far but it’s just been myself picking and choosing from various crowdsourcing sites.
What group are you guys referring to and how does one learn more about it. I like the idea of sharing the due diligence with a group of smart investors.
Would like to know the group too. I’m about to get start with syndications as a way to diversify from index funds
One major challenge in reviewing the “risks” section of the offering memorandum is that the enumerated risks are often very similar. What you can’t discern is the likelihood of a particular risk occurring. In a solid project the risk of occurrence might be 3% and in a poorly conceived project the risk of occurrence might be 30%. A huge difference but difficult to discern from the documents.
I assume this is where the scuttlebutt method kicks in to try to sound out the likelihood?
Thanks for this! I need to go back and read some fine print. I don’t remember paying attention to the loan terms in particular. I have a lot of trust in them, but I need to take Reagan’s advice, “Trust, but verify!”
I understand that this is a sponsored/guest post, but can you tell us who the author is? Who s/he works for? There’s a lot of discussion about real estate syndicators, and then there’s a plug for Fundrise at the end, which is a real estate crowd funding outfit. If I’m not mistaken, these are not the same things. More detail here would be useful too.
Oops. Just read the editor’s note that author wants to remain anonymous. The question about crowd funding vs syndication still stands though.
This is NOT a sponsored post. This is a guest post, chosen purely on the merits of the post. I was neither paid for nor did I pay for this post. I don’t know anyone but Fundrise (or even them) would pay for this post anyway. Who would pay for an anonymous post that doesn’t even mention their company?
In fact, I don’t know who wrote this post (I’m not currently managing the guest posts, that’s in Jill’s department now), but I have an idea from the line about Fundrise and the writing style. I’m pretty sure the author does not currently work for Fundrise. I have an affiliate partnership with Fundrise, but I don’t think I ever made much from it.
At any rate, I disagree with you that there is a huge difference between a syndication bought through an online crowdfunding company and a syndication bought directly from the syndicator. I own both. The big advantage of going direct is that you cut out a layer of fees. The big advantage of going through a crowdfunder is that the minimums are often $2-$20K instead of $50-100K.
Fundrise has basically transitioned to the eREIT business, discussed here: https://www.whitecoatinvestor.com/real-estate-investment-trusts-reits-everything-need-to-know/
One thing I do is look at the track record of the syndicator. I always ask for the numbers on every deal the syndicator has ever done. While past performance does not guarantee future success, a solid record goes a long way for me. If a deal didn’t perform, I find out why.
I also like to see where the deals are. If the syndicator has done eight deals in Texas and now they’re trying one somewhere else, I’m a little weary.
Finally, the shorter term nature of some of these deals is what scares me most. With an index fund, I can just ride out the next recession. You may not be able to do that with a syndication deal.
I definitely love this topic as I have slowly focused my future investments into this arena (I had been previously putting all my money in stocks/bonds/reits and a little bit of crowdfunding).
It was actually an old White Coat post by Dennis Bethel that opened my eyes to this in the first place. I liked the concept and the subsequent discussions that followed that post.
My colleague always extolled the virtues of real estate and the tax benefits and since I didn’t want to be an active landlord I thought this was the best compromise I could find.
The syndicator I use is 37th Parallel (and Jim I just noticed your name on the investor list of the last offering so I’m glad to see that it met your criteria to invest) and have developed a lot of trust with them, about to enter my 5th deal bringing my total investments with them to $500k.
I will tell you that it is initially scary to send a large amount of money ($50k minimum) to someone you never met face to face but I did research on them as best as I could and since Dennis Bethel seemed like someone who was in my situation and I could trust I went ahead and committed.
I’ve only been investing with them for less than a year, but have had no issues at all. I do hope to continue and build up my investments to a level where I can have a decent amount of passive income yearly just from distributions itself (typical distributions based on net cash flow range from 5-6.5% in the deals I have been in). Anything over that from refinancing/sales/1031 exchange from the increased equity is just bonus for me (they typically state they shoot for around 13-14% yield with all factors involved).
I’m sure you can lower your risks by diversifying among different syndicators as well but I personally think I will concentrate with just the one.
You can go meet them face to face if you want.
Thanks for outing me. 🙂
My experience has been identical to XRAYVSN except that I have been investing with them for 5 years. I have had no issues at all.
For people interested in these types of RE investments, I recommend the book “Investing in Real Estate Private Equity: An Insider’s Guide to Real Estate Partnerships, Funds, Joint Ventures & Crowdfunding” https://www.amazon.com/Investing-Real-Estate-Private-Equity-ebook/dp/B01IW0G0S0
One thing he, and other experts, often say is if you could only do due diligence on either the sponsor or the deal, pick the sponsor every time.
I am in several private real estate syndication deals, both individual deals and funds. It’s not a completely passive investment. There is quite a bit of upfront due diligence and the investor needs to educate him or herself about that. That involves asking a lot of questions and talking to fellow investors. You are investing in the sponsor as much as you are investing in the actual property. The sponsor should come first in your due diligence. You can Google the company, and each principal member and see if any fraud/ lawsuit/ complaints pop up. Crowdfunding sites do series of background checks which helps. And the sponsor should be transparent and answer any questions. If not, then that’s a red flag and I’d stay away.
After that, the deal itself needs to pass a lot of other due diligence.
The investment group mentioned above is a fantastic resource and the book mentioned above by Sean Cook is a must read. I wouldn’t recommend investing in this space unless someone has the time and inclination to really learn about commercial real estate. It’s definitely an optional part of a portfolio.
Something I’ve never quite understood about RE syndication is if the tax efficiency is similar to REITs or to owning property outright. Basically, can you do a 1031 exchange with a syndication or not ?
Its way better because in single asset syndications on big deals it make sense to do a cost segregation which equals bonus depreciation.
I think it’s closer to owning outright, but you don’t have as much control. Yes, sometimes you can do a 1031 exchange, but not always. The most recent deal I bought into some of the other investors were exchanging in.
I am selling my turnkey rentals for syndications in this market.
Four ways I find diversify in syndications:
1) Different leads/operators
2) Asset classes such as MFH, self-storage, mobile home parks, assisted living
3) Geographical markets
4) Business plans (5-year exits vs legacy holds)
*Usually I see investors place no more than 5% of their networth into any one deal
5% is a big chunk for one deal, but I agree more than that is probably a mistake.
Jim, I believe in January you stated that you were considering investing with 37th Parallel Properties. Did you ever pull the trigger? Why or why not?
Yes, I own one property in Texas through 37th Parallel that closed last month. I’ve been happy so far, but it hasn’t paid me a dime yet. If their returns are as good as their communication, I should be very happy over the next decade with this investment.
…Oh, and I see from XRAYVSN’s post that you did, so what do you like about them??
My thoughts on real estate investing: in terms of timing, now is probably too late to get started. The real estate market has cycles, just like the stock market and other financial assets. It’s been a big 10 year boom on real estate, which implies that we are towards the end of this cycle.
Excellent information/blog post. I can’t believe this is about 4 years old now. I’ve went to multiple Real Estate Investors meetings and nobody has ever heard of this method. I just keep it to myself now since it’s worked so well for me. In my county the records are free. I take the parcels to find the address/phone number then google earth each house. After that I decide to do a drive by and look at the property. Then if I like it I’ll simply knock on the door and talk to the person and if they’re not their I leave a letter with my contact information. So far I’ve acquired 5 total properties this way in 2 years. All of them were under 10k and the property taxes, insurance, utilities, maintenance, property manager, rehab, upgrades, services etc. was all paid by tenants plus I made on average 2K after expense since I added on 2-4 more rooms to each property. I’m still shocked nobody in my county and knows about this. I’m now starting to branch out into other more effluent counties and eventually I will start acquiring apartments. All houses and taxes are paid off and I have sufficient passive income to not only cover my lifestyle but I have extra to invest into my business, stocks, bitcoin, travel etc.
Thanks again,
If one downside to private syndications is a larger minimum investment, what is to stop a group of investors from pooling their money together to gain access to the deal?
For example, why couldn’t 5 investors form an LLC and put $20k apiece into a syndication that requires a $100k minimum?
Is there some kind of universal rules against this?
Nothing. That’s exactly what the crowdfunding companies do. Or were you expecting someone to do this for free?
I think you misread or misinterpreted my question.
You have to be an accredited investor to participate in these investments. At least one of the 5 would have to serve as the accredited investor. I’m betting that investor could be liable for some sort of securities fraud.
Who said anything about anyone in the group NOT being an accredited investor?
I’m sure that vast majority are. However, I’m sure there are rules related to proving it.
People do what describe all the time.
Some syndications are set up so this can be done and some are not. You have to ask.
To make it work you generally need a 3rd party as it can get complicated
What exactly do you mean by needing a “3rd party”?
See assure.co
then click on the SPV link.
This is what I am talking about.
Thanks.
Hey “The White Coat Investor”,
I’ve been reading your material and just wanted to say great work!
Additionally I’m a 24 year old entrepreneur that has invested about 800k into real estate syndications spread out across several different sponsors. I’m looking to expand my network of sponsors and wanted to see if you’d recommend any that you had the pleasure of doing good business with.
Thank you!
I’ve used a half dozen crowdfunded companies listed here:
https://www.whitecoatinvestor.com/recommended-real-estate-crowdfunding-companies/
I actually had a really good experience with RealtyShares too, so was disappointed they’re headed out of business.
I have also invested in three funds and a fund-like RIA. There will likely be more. More details here:
https://www.whitecoatinvestor.com/real-estate-update/
@Kamil
There is consolidation in the crowdfunding space and ultimately there will be one “Amazon” or “ebay” for now its the wild wild west.
It’s interesting to watch, but unnerving when you end up with money invested through a losing firm.
I’m a big proponent of cutting out the middle man (crowdfunding site) and meeting operators face to face.
Hey Guys,
Any update on this since its been over 6 months on further experience with 37th Parallel or the 506 Investor group?
Duke
I’ve got an update coming in July on my real estate experience.
The theoretical aspect is very well elaborated, is there any place I could also find a sample calculation for the same?
Definitely appreciate the content.
A lot of talk about 1/3 of it which is deal structure but missing on 1/3 which are the numbers (revision Cap rates, economic vacancy, and what the model spits out) the other 1/3 is building up your network with personal relationship of people who have actually investing in these deals. My rule is never work with anyone you don’t know personally.