By Dr. Jim Dahle, WCI FounderWe write about real estate investing, syndications, and private real estate funds around here all the time. However, a lot of our writing is theoretical, since these illiquid investments take years to go full circle. There is no central database of their returns like there is for mutual funds (Morningstar) either. While projected returns on syndications are nearly always higher than the expected returns on stocks, bonds, and even publicly traded REITs, the actual returns people achieve are much more opaque.
I think it is useful to provide an illustration from time to time on how these investments actually perform, so whenever one of my investments goes full circle, I write a post about it.
That is not what today's post is, however. Our text for today's post comes from a recent quarterly update I received from one of my equity real estate funds. I committed $100,000 into this fund in 2017, and the capital was called from 2017-2019. Capital started being returned in 2020 and then accelerated through 2021 and 2022. Most of the capital has now been returned although the fund probably won't wrap up until the end of 2023 or even 2024. We're not going to spend a lot of time talking about the overall return on this fund, at least until it goes round trip.
We're just going to focus on one of the 17 properties in this fund.
Syndications Do Go to Zero
This particular property had a complete loss of capital. Here is an excerpt from the quarterly update email from the fund with some more details:
“Dear Investors,
We are pleased to provide you with an update on your investment in the Fund. As of Sept. 30, 2022, the Fund is projected to generate a 57.5% gain on invested equity, reflecting a 14.1% total return over the prior 12 months. Assuming a full liquidation as of Sept. 30, 2022, the Fund generates a 12.9% internal rate of return. As of Sept. 30, 119.8% of invested equity is returned to investors through distributions of operating cash flow and asset sales . . .
Only one office investment remains within the portfolio. Due to significant adverse changes in the capital markets for office assets over the past quarter, the value of the asset has fallen below the outstanding debt amount. A continued hold of the asset is possible but would require a debt restructuring alongside an injection of additional equity. Despite strong recent leasing activity and the lender’s willingness to entertain a discounted payoff, a new equity investment would not produce a satisfactory risk-adjusted return. As such, the net asset value is reduced to zero, reflecting the full loss of the Fund’s initial investment.
Notwithstanding the further write-off of equity, a 12%-13% net IRR and 1.58x-1.60x net multiple is projected. A full and final liquidation of the Fund is expected by the end of 2023 or early 2024; however, the ultimate timing of final asset sales could change based on strategic decisions to optimize value creation by adjusting to property and market conditions.”
Lessons Learned
This is the second property I have invested in that had a complete loss of investor capital. The other one was a syndication I owned directly rather than via a fund. It's actually not completely done yet (and when it is I'll write a post about it), but I'm pretty sure it will end up with a near-total loss of capital. That doesn't mean a return of -100%, but it's not that far from it. In addition, the single-family home REIT I've invested in is on the rocks as previously described in a blog post and on the podcast.
I think there are a few lessons that can and should be learned by syndication investors from situations like this.
#1 Diversification Matters
Imagine I had put all $100,000 into this property. I would be out $100,000. But I used a fund instead, so only around $5,000 of my money went into this property. This diversification limited my loss to $5,000, not $100,000. And in fact, the rest of the portfolio did sufficiently well to make up for that loss, still providing double-digit returns.
More information here:
A Private Real Estate Investment Update: My CityVest DLP Access Fund Goes Round Trip
#2 Past Performance Does Not Predict Future Performance
Just about every operator and fund manager I've ever seen has awesome past performances. But you can't buy that. Two prior funds from this manager provided equity multiples of well more than 2. That isn't going to happen with this fund, in part due to the performance of this property. Projected returns are just that. Past returns are just that. You can buy neither.
#3 These Are High-Risk Investments
Real estate syndications are high-risk investments. Not only is it possible to get returns upward of 10%, you can get returns in the 20%-30% range or even higher. But you can also lose your entire investment. There's a reason you have to be an accredited investor to invest in them. Accredited investors should theoretically be sophisticated enough to evaluate an investment on its own merits without the assistance of financial professionals. Perhaps most importantly, they should be able to lose their entire investment without it affecting their financial life in any significant way. The reason is because it really is possible to lose your entire investment. That's not going to happen with an index fund.
#4 Leverage Risk Is Real
The value of this office building did not go to zero. It is still worth something. This particular fund uses up to 70% leverage. So, it only takes a drop in value of 30%+ to wipe out your entire investment. Everybody loves to talk about “leverage” and “other people's money” and “borrowing at 4% to invest at 10%.” But leverage works both ways, and sometimes it takes a wipeout to remember that.
More information here:
How Our Portfolio Performed in 2023 (Including Real Estate!)
#5 Operator Matters More Than the Investment, but the Investment Still Matters
You have often heard me say that the operator (manager, syndicator, general partner, etc.) matters a lot more than the investment, because a bad operator can screw up a good investment and a good operator can make lemonade out of lemons. I still think that's true. I think this particular fund manager probably made the right decision not to throw good money after bad (I made a similar decision when given the opportunity to pour more capital into the syndication I had that went bad). However, even a good operator can't rescue every deal. I went back and read what this operator thought about office building investments back in 2016. Here's what they said:
“The emergence of Gen Y has created a younger workforce that continues to redefine the nature of demand for office assets. Our analysis has identified two trends in office space that will continue as Gen Y replaces Generation X as the majority of the U.S. workforce.
- Reduction in office square footage per employee. Tenants, particularly larger public firms, are downsizing their offices as they increasingly adopt policies for sharing non-dedicated offices and implement technology to support their employees' ability to work remotely.
- Changing preferences for workspace setup and features. Companies are increasingly seeking more collaborative work spaces for functional project teams, and there is growing demand for more on-site amenities at office locations.
We believe that the Company should also continue to benefit from the positive supply and demand dynamics of the office market due to increasing costs to build and a decrease in supply of office properties as current assets are being converted to other uses. We conduct specific submarket analyses in all of our Target Markets to understand the full picture of these supply and demand drivers. In Chicago, 4,122,124 square feet of office space have been taken off the market through conversions to hotel and multi-family properties since 2007.”
The operator clearly does not have a functional crystal ball. They did not know that in 2020 there would be a global pandemic that would dramatically accelerate the work-from-home trend and that office buildings would become worth dramatically less. Diversification protects you from what you do not know and what you cannot know. I still like this fund manager. I have invested in another of their funds, and I will probably invest with them again. But they're human, just like the rest of us.
Real estate syndications can and do go bad, even in relatively good markets. When the market turns against them, even more of them go bad. Invest carefully and go into these illiquid investments with your eyes wide open.
If you're interested in learning more about private real estate investments, consider signing up for our free real estate newsletter and check out our partners in the chart below.
Featured Real Estate Partners
What do you think? Have you had any syndications go bad? What happened and why?
Thanks for being transparent about a real estate investment gone bad. I imagine the loss of capital in this fund would initiate a review of all of your other real estate investments. Prompted by information about DLP capital on this website, I chose to invest after doing my own independent analysis. Probably other WCI readers have invested in other real estate partners mentioned on the blog or the podcaast. Has your opinion on DLP or other real estate investments changed?
The length of track record I demand before investing (or bringing on a partner) is probably now longer due to this and similar incidents. Not an issue with this particular company though.
Thank you so much for providing your thoughts. It is comforting to know that your opinion on this investment has not changed. Jim – reviewing the WCI site is part of my daily routine – excellent job, sir!
It seems like it’s best to ignore the narrative portions of the offering memo. They’re all able to tell a great story. All of them make it seem like the investment is a no-brainer and can’t lose. It’s easy to fall into the narrative fallacy. Probably best to just stick with the numbers, and how conservative their pro-forma assumptions are. The only narration I pay attention to is the explanation of their strategy. All the narration on the economics, demographics, consumer trends, etc. isn’t helpful. Also, sometimes you see an explanation of how it’s purchased below replacement cost, which makes it sound like there’s a large margin of safety. But I’ve seen a few bought below replacement who are now requiring capital calls.
Regarding Jim’s investments in real estate syndications/partnerships it would be helpful to know how much (if any) WCI receives from them in ad revenue, commissions, referral fees, etc. Even though it may not be prudent, some readers may think, “If it’s good enough for Jim to invest, it’s good enough for me”, without factoring in Jim’s adjusted ROI. If Jim invests $100k in VTI and it goes down 10%, then we know he loses 10%. But if Jim invests $100k in a real estate group that is paying him $100k, then the reader should know that Jim’s investing decision might be affected by the fact that he can’t lose money on the deal. There is nothing wrong with Jim being paid for promoting, as long as the reader is fully aware. I don’t think a blanket statement at the beginning of each year saying, “We might have conflicts of interest because companies advertise with us” is adequate. Yes, it does CYA, but transparency begets trust.
For sure it’s a conflict of interest mentioned in our annual state of the blog post. It’s also highly variable.
Of course the WCI revenue from promotion also goes toward WCI expenses, it’s not all going directly into my pocket. And of course we’re not going t publish the exact amount of revenue that comes in from each advertising partner. But it’s enough revenue that if you included it in my investment it would make a dramatic difference in the overall return from each of these investments. That said, the most valuable asset of WCI is the trust of its readers and obviously when an investment goes bad that readers learned about here, even though we’re very clear that these are introductions and not recommendations, we’re left with egg on our faces. So we’ve got MASSIVE incentive to try to minimize how frequently that happens. That’s a far bigger incentive than anything else associated with the whole process.
You should calculate your real estate investment returns since 2017 compared to the alternative of total world. You’d need to subtract the added complexity / cost of taxes with real estate from their returns.
However, you’d need to add back into the returns from the value of blog content and advertisers. There’s also the entertainment/ hobby value from researching those real estate investments for you. You accepted that you can’t pick individual stocks but can pick individual real estate deals (perhaps correctly, though).
That’s like comparing it to Bitcoin. Stocks aren’t real estate. Silly to compare the two. If I were going to compare it to something, VNQ seems a better alternative and I do regularly make that comparison. It’s not apples and oranges though. Less volatility on the private side but also less liquidity. More info here:
https://www.whitecoatinvestor.com/private-real-estate/
And a few of you are a bit fixated on the “additional component of return from the WCI revenue from partners.” Bear in mind, we have WCI partners who I don’t invest with. What am I supposed tod o with that revenue? And I have investments that aren’t WCI partners. What am I supposed to do with those returns? And how about the “promotional capital” that we could use with other product lines if we weren’t using it to promote real estate? It’s not as straightforward as a lot of you imagine.
On bogleheads they make a big point about the drop in REITs in 2008. Real estate is closer to stocks than bonds for sure.
Agreed. And it was 78% from peak to trough. I remember it well.
I’ve enjoyed reading about the different real estate syndication companies and your experiences investing with them. However, it seems like the shtick is to promise returns of 20-30 % and deliver returns closer to 10 % overall or even lose money. Of course it’s easy to pick on any asset class that’s underperformed the last few years. I’m curious if your experience has changed your view of real estate syndication as an asset class.
It seems like the hassle and illiquidity may not be worth the depreciation and fairly normal returns. My view is that in real estate investing, the best options are to stick with publicly traded REITs or shoot for real estate professional status. Being in the middle seems trying.
I agree there is a massive “hassle factor” with private syndications, equity funds, debt funds. You have to spend so much more time reading about them, dealing with the paperwork, understanding the lock ups, waterfalls, cash calls. Major PITA. Often times there are difficult tax issues. You lock your money up and its not instantly liquid like public markets. Paperwork. I agree though that you can get some very nice outsized returns in private equity real estate that feel like are easier than trading individual stocks or attempting options. I can’t explain why I think that. My stock trading or options just seems like gambling. And long term index stock investing is a long term game over many decades. Not like investing in a CRE equity deal and getting 18% annualized back in 3 yrs.
Stock returns are very random. You have no idea if the stock market is going to tank 50% next year. And the problem with REIT’s is they correlate with the stock market. If we have a stock market melt down, REIT’s will plummet too. VNQ recently traded lower than it did back in 2014. So that would be 10 yrs of little return. I do like private real estate debt funds. They are illiquid and you have more paperwork and wiring money hassle. But where in the stock market can you get a stable 8-9% return?
I talk about the returns I actually get here:
https://www.whitecoatinvestor.com/2023-portfolio-performance-real-estate/
I judge it to be worthwhile still. Don’t assume because one apartment building of dozens (hundreds?) I invest in went bad that it’s not going well overall.
I agree with you that everyone needs to choose their own place on the “real estate continuum” that makes sense for them. For us, publicly traded REITs (VNQ) and private funds is our spot. We’re pretty darn passive and pretty broadly diversified. But one can make a case for syndications, turnkey, short term rentals etc.
Very true for those that want to invest in real estate. My first real estate investment was in a syndication in CA that is still going but hasn’t given much return and are pretty leveraged so I’m not expecting much of a return given the higher rates. It was before I knew what to look for and thankfully was a very small investment. I’m invested in a couple funds that are doing pretty well but again, increasing rates will hurt the returns , although mostly it’s pushing back sell dates for a couple years. I mostly prefer to invest in my privately owned real estate now or syndications I’m involved in fund raising for. Mainly because I know and trust the syndicators and the fact they are more conservative in the deals they undertake. But most people don’t have that opportunity to personally know the syndicators. Unless you know the syndicators or know someone trustful who does, stick to funds from companies that have been around a while, ideally before 2008.
I am not too happy so far with real estate syndication. I’ve been having to file extensions on my taxes each year because of the delays with their K-1 forms. Some have gotten them out to me in a timely manner, but between that and not getting any quarterly payments is not a good sign. I will probably either purchase a property myself, or just put money into my IRA.
Delayed tax returns/K-1s are par for the course in this space. Don’t invest if that’s a big deal to you.
I’d like to see you maxing out retirement accounts before investing in these investments in a taxable account too.
I think retail investors kid themselves when they think they are doing “due dillgence” on a large commercial property. And “looking at the numbers of the deal before hand”. In the end you are investing in the sponsor. You are just trusting the sponsor & “hoping” it works out. And that is OK. It almost doesn’t matter if you waste time on webinars and reading though deal informantion. How will all that info mean anything to you anyway? When you have never owned a commerical property in your life and you are in a completely different business as your day job. Even a professional commercial real estate consultantcy firm or uber weathy private home office would struggle with running a large deals numbers, assumptions, projections though a model or whatever, and knowing if “its a good deal or not”. How is the average retail investor going to do this? And who has the time? You are not going to know the first thing about the particulars of that city, that asset class, how to sanity test the assumptions/projections, etc…
Good argument for using funds (hiring the manager) rather than individual syndications (where you vet both the manager and the deal).
This is a GREAT article and good reminder to be careful. I’m usually agitated when people say, “real estate investing is risky” and think, compared to what? (this stock market is infamously volatile and real estate has created the most wealth in this nation and used to be nearly 100% off-limits to non-accredited people). Funny enough, I came to this article as I’m sitting here editing a new website for my own development/syndication business and I wanted to put impressive numbers on the front page, but am hesitant and wanted to search for warnings on WHAT NOT TO ADVERTISE about past returns. We had ridiculous success on our last project and 150%IRR the past two years, so I thought, well maybe “22%+ Target IRR*” with the asterisk noting that our actuals were much higher…but this article makes me re-check myself (and remain honest) – and remember…I’m still part-owner on a large project I helped syndicate in 2020 that was projected to return 15% pref by 2023 and hasn’t returned ONE DIME yet. This is part of the reason my family is focused 100% on what we can control/manage from now on and ONLY doing business with VERY CONSERVATIVE syndicators and sponsors with proven track records AND MORE IMPORTANTLY, proven problem-solving capabilities. Everything takes longer and costs more that what people expect – staying local or with people you know you can trust makes the most sense – and not expecting too much like you’re at a casino looking to hit numbers. Thanks again for great transparent article!
Completely off topic but wanted to mention the CMS clinical quality measure survey on ED boarding times, for an ED personnel — comments until Feb 16:
https://yalesurvey.ca1.qualtrics.com/jfe/form/SV_bl9ZRmWhCuh4kse?utm_source=substack&utm_medium=email
Sounds like picking stocks to me. You are betting on a manager. You are paying for active management. You are betting on a specific business. Incentive payment back to WCI blinds the idea.
Remember that index funds only work (and can really only be used) in markets where there are index funds. There is no index fund for private real estate. Otherwise, it would probably work and I would probably use it. Yes, you’re paying an active manager. Yes, you’re investing (not sure betting is the right word) in a single business. Yes, there is a conflict of interest because these businesses pay advertising fees to WCI.
Exactly what I think every time I see these real estate pitches. The best real estate deal is the one that pays you to recommend it. Just like all the get rich books out there, the ones that ones that get rich are the ones selling the books.
It’s also easy to be cynical. It sounds smart to be pessimistic, but the optimists usually carry the day. This post was about a bad experience with real estate. But I could have easily written about something like my debt real estate returns the last seven years:
6.71%
9.13%
15.84%
7.61%
7.67%
9.47%
9.10%
7-16% with no negative years (not 2020, not 2022). Lots of investors find that sort of thing to be pretty attractive.
You wouldn’t own any syndications if they weren’t paying you 😂
And if you are going to list returns please provide your audited results, until then you are just lying.
Whatever anonymous internet troll. I’m not going to pay someone to audit my personal investing spreadsheet so I can appease you on a blog for crying out loud.