Month: January 2023

Have you ever looked up at a large apartment complex or a beautiful office building and wondered about what kind of people have enough money to own those?  You may be surprised to know that most of those properties are owned by people just like you and me!  These assets carry less risk than smaller properties and as a result, the largest institutions in the world love to lend on these properties.  While large firms issue the debt, most of the equity (down payment) comes from regular people. Leap Multifamily helps accredited investors just like you own a piece of those assets!

Let’s spend a few minutes talking about the basics of what a real estate syndication is and then we’ll get into the meat of it – how to choose the right deal to invest in.

 

What is a Real Estate Syndication?

In simple terms, a real estate syndication is a group of dozens, sometimes hundreds, of investors coming together to buy a much better piece of property than they could purchase on their own.  There are two groups of people in a syndication – the active sponsors and the passive investors.  The sponsors, also known as general partners (GP’s), do the hard work of locating and managing the property.  The passive investors, also known as limited partners (LP’s), contribute capital but don’t carry any financial or legal responsibility beyond the amount of money they choose to invest.  Passive investing at its finest!

GP’s can put together a syndication to purchase almost any type of asset, but this article will focus mostly on multifamily investments.

 

The 5 Major Benefits of Multifamily Syndications

There are some incredible benefits that come with investing in multifamily syndications and many real estate investors utilize these investments as a tax shelter and to build their wealth.  In fact, prior to the JOBS Act of 2013, syndications were available only for the wealthiest people. You had to “know” somebody to get in.

1.)  Passive Cash Flow: Most multifamily syndications throw off rental income each month.  Some deals will pay out distributions starting in the first month and others may require major rehab prior to having enough excess cash to pay out to investors.

2.)  Cash Flow: Most multifamily syndications throw off cash flow each month.  These passive investments will pay out distributions starting in the first month and others may require major rehab prior to having enough excess cash to pay out to investors.

3.) Equity Growth: One of the beautiful things about investing in commercial real estate is that the value of the property is based on how much cash the property generates. Unlike single-family houses, we may be able to force our properties to appreciate based on increasing the property’s income. This means that if we choose properties in cities where rents are rising, we may have significant equity growth that we can distribute to investors once the property sells.

4.) Less Risk: I’ve managed tens of thousands of single-family houses and I’ve seen every single type of issue you can imagine.  Tenants pushing concrete down pipes, wild animals breaking into houses, major foundation issues, flooded properties, roof replacements, etc.  You name it, I’ve seen it.  The problem with owning a few rental houses is that the sample size is very small and one bad event like a broken HVAC can cost you an entire year’s cash flow.

With 100+ unit apartments, there are always 1 or 2 evictions happening and HVAC’s break down every month, but the vast majority of the other tenants keep paying their rent.

5.) Major Tax Advantages: Real estate is perhaps the most tax advantaged investment you can make.  These investments throw off significant depreciation that you can use to offset other passive gains and when it comes time to sell, you can often parlay your equity into a new deal via a 1031 and defer your gains for many years. This allows your money to compound even faster!

 

The 4 Disadvantages of Real Estate Syndications

Many people believe that real estate syndications carry the best risk/reward profile of any investment out there.  However, this type of investment isn’t for everybody.  Here are the reasons why a multifamily syndication might not be a good fit.

1.)  Illiquidity:  Most syndications tie up your money for 3-5 years and withdrawing your money may not be an option.  Read the private placement memorandum for your investment carefully to see what the rules on an early exit are.  P.S., the illiquidity may actually be a benefit for all of you stock-market-timing-types out there.

2.)  High Minimum Investment: Many syndications require a minimum investment of $75,000 to $100,000.

3.)  Lack of Control:  Passive investors in multifamily syndications don’t have any control over how the property is operated.  Many people love this aspect because they can leave the hard work to the experts but if giving up control is difficult, this may not be the best option for you.

4.)  Must be an Accredited Investor:  Depending on the type of security offered, you may have to be an accredited investor to participate.

 

Ok, we’ve talked about what a multifamily syndication is and isn’t.  Now it’s time for the fun stuff – figuring out which syndication to invest your hard-earned money into.

 

Choosing the Right Multifamily Syndication

Asset Class

Almost any type of real estate can be “syndicated”.  Multifamily, self-storage, mobile home parks, office, retail, etc.  You will want to spend some time researching exactly which asset you want to invest into.  Each have their pros and cons.  Leap Multifamily has traiditionally focused on, you guessed it, multifamily syndications.  However, there are other great asset classes to choose from and we’ve expanded into industrial real estate and other asset classes with great growth potential.

Geography

After deciding on an asset class, investors will want to narrow down their focus to specific geographic areas.  Our advice is to invest in high growth states where people are moving to.  We have an interesting situation in the U.S. right now where domestic migration patterns are solidifying and there will be states that benefit from these patterns and states that lose.  These trends are unlikely to change anytime soon and this type of economic growth can be a nice tailwind for your investment. 

Leap Multifamily focuses on three states in particular – Arizona, Texas, and Florida.  Each of these states is likely to continue to benefit from strong population and economic growth for many years to come.  There are other great places to invest but developing a great base of operators and expertise in a market takes a lot of time and we want to invest with people and markets that we know very well.

The great thing about multifamily syndications is that if you live in a state where you don’t want to invest, you can still get money into other states where the odds of success are higher.

Great Operators

One of the most important pieces of the puzzle is picking the right operator.  There is a lot of expertise needed to identify, underwrite, close, and operate a $50,000,000 asset.  You should spend most of your research time on this piece of the puzzle. Your due diligence should include pointed questions about the operator’s track record, investment philosophy, underwriting guidelines, and operational expertise.

Which Deal to Invest in?

Ok, now you’ve identified an asset class, geographic market, and found several good operators to work with.  Most operators with solid track records will close on 3-10 deals per year.  The problem is that every operator is going to pitch each and every deal as the best one they’ve ever done.  Taking the time to sift through all these deals and find the gems is really important because not all deals are worthy of investing in.

 

Due Diligence Questions to Ask the Sponsor

Question:  What is the business plan for the property? 

1. 1. Is this a buy and hold? 
   2. A quick flip?
   3. Will there be minor/major renovations? 
   4. How long will the renovations take? 
   5. How will the operator manage the renovations? 

Question:  What does the debt look for this property?  It’s 2023 and the Fed has been raising interest rates for the last year.  The type of loan may be the most important thing to look at today. There will be some high-leverage adjustable-rate loans that will get operators into trouble and force a sale of their property.  You will want to ask specific questions about the type of debt the operator is putting on a property.

1. What is the loan-to-cost ratio?  All things equal, lower leverage equals lower risk.
2.  What is the debt service coverage ratio (DSCR).  Many lenders require at least a 1.25 DSCR. This means that after paying all of the property’s bills, there is excess money left over as a cushion.  The higher the DSCR is, the more cushion the property has if there are unexpected expenses.
3. Is the interest rate fixed?  Or adjustable?  If adjustable, is the operator purchasing a rate cap to limit how much the rate can rise?

Question:  What is the preferred return* and how does the GP/LP investor split work?

1. What kind of returns are you projecting for this investment?  Some investors don’t care about cash flow and are content with a big lump sum upon sale.  Others want consistent cash flow with less risk.
2. What are the fees that the operator is going to charge?  Do they sound fair?  Are the fees at “market” rates?
3. What does the cash flow waterfall look like?  Is there a preferred return?
4. How much of their own money is the operator putting in? Generally speaking, the more the better, as it shows their conviction in the deal.

Question:  How much future rent growth are you projecting?  This one is a biggie! Because commercial real estate is valued based on its net cash flows, if future rent increases come in at 2% instead of the 3-4% projection, that will make a large difference on the valuation in a few years.

Question:  What kind of expense growth are you projecting?  Same thing here.  Inflation is causing expenses to rise. How are operators accounting for this?

Question:  Cap rates – this one is huge because changing an exit cap rate by just .5% makes a big difference in the property’s value.  What’s the going-in cap rate?  What’s the exit (reversion) cap rate? 

Question:  How will the property be managed? Is the operator vertically integrated and runs their property management in-house?  Or do they use a 3^rd party property manager?  If so, who is the PM?  What kind of experience do they have with this type of property?

Question:  What is the average houshold Income in a 1-mile radius of the property?  This shows us how easily the average tenant can pay the rent and gives a good indication of how stable the tenant base will be in an economic downturn.  Most PM’s require tenants to have income of 3x the monthly rent.  If they are averaging 4x or 5x then that’s even better.

Crime Rates

High crime areas typically show higher returns on paper since prices are low.  But there is also higher risk with this type of area too.  Look up the crime stats for that zip code on google.

Rent Comps

Look closely at the rent comps that the operator has chosen.  Are the properties truly comparable?  Are the other properties superior in location, age, or amenities? Assuming they are comparable, are the projected rents at the top of the comp list? If so, that’s not as conservative as if the projected rents fall in the middle of the list.

Operating Reserves

Things go wrong sometimes. How much cash does the operator plan to raise for contingencies?

Sales Comps

Can the operator justify the price they paid for the property based on recent sales comps?
What about the exit price?

 

These are just a few of the questions that you should ask before investing in a multifamily syndication.  The operator should be able to answer these questions satisfactorily and you should feel comfortable and confident in your decision.  Never invest into a deal unless you are 100% confident.  Being able to sleep at night is worth a lot more than getting money into a so-so deal.  There will always be another deal to invest in!

 

If you are an accredited investor and would like to explore passively investing with Leap Multifamily on future deals, fill out our investor application here.

*Preferred returns are part of the deal structure and indicate the sequence of how distributions (from operations or a capital event) are disbursed. They are not guaranteed and should not be considered a financial projection. Actual cash flow projections and distributions from the sponsor may differ from the preferred return.

 

Sponsors can charge a variety of fees totaling north of $1,000,000 on each property they acquire.  It’s very important as an investor to know what these fees are, and if what the sponsor is charging is, “fair”. There is no set rule on which fees are charged and how much they are, but there are some general rules of thumb that you will see below. 

Below are the most commonly charged fees and my estimation of the market rates for each based on the many deals I review each month.

Acquisition Fee

What is it? 

This fee is collected upon closing the property. Syndication sponsors put in a lot of work to source, underwrite, close, and manage large, syndicated investments.  They must commit considerable money, sometimes north of $1,000,000 to put a property under contract.  Sometimes things out of their control happen (Covid-19, fast-rising rates, etc.) and they will fail to close on the property, losing their earnest money in the process.  The acquisition fee compensates them for their effort and the financial risk they take.

Market Rate

The typical acquisition fee is 1-3% of the purchase price with the deals I’m seeing averaging 2%.  Acquisition fees are seen on almost all deals.

Pro Tip

If a sponsor sources a deal off-market, eliminating some of the competition and hopefully getting the property at a lesser price, they may charge a higher acquisition fee. 

Asset Management Fee

What is it? 

Once the property is closed, the sponsor must execute on the business plan. This may take 2-5 years depending on the exit strategy.  Somebody on the sponsor’s team, or multiple people, will oversee the property manager, keep construction on target, and provide financial reporting to investors. 

Market Rate

This fee runs 1-3% of the gross revenue of the property and as of today, Q1 2023, the average is 1.5 – 2.5%.  Heavier value-add deals that require significant oversight may warrant a fee at the higher end of the range.  Asset management fees are seen on almost all deals.

Pro Tip

Most syndications offer a preferred return of 6-8%.  Since most properties don’t throw off that much money until the business plan is complete, the sponsor doesn’t make any money until a refinance or disposition.  Most of a sponsor’s money is made upon exit, assuming a profitable sale.

 

Loan Guarantor Fee

What is it? 

Multifamily lenders require that borrowers have a net worth equal to the loan amount and maintain post-closing liquidity equal to 10% of the loan amount.  Some of the loans are tens of millions of dollars and sometimes the sponsors’ net worth doesn’t qualify them for the loan.  They may need to “borrow” a balance sheet and pay that high net worth individual for that. 

Most loans for large multifamily syndication projects are non-recourse, meaning that if the property goes into default, the lender’s only recourse is to take the property back.  They can’t chase the borrowers for their personal assets.  However, there are bad boy carve outs for negligence and fraud.   

Market Rate

Typically 1% of the loan amount.  I see this fee on 20-40% of the deals I review.

Pro Tip

Lenders allow multiple borrowers to cumulatively qualify for the net worth requirement. Sometimes this fee is split between 2-4 different people.  If an investor is lending their balance sheet to the sponsor team they are typically referred to as a “Key Principle”, or KP.

 

Construction Fee

What is it? 

This fee may be paid to a member of the sponsor team or to a 3^rd party like the property manager.  This fee would be in play for development deals and for very heavy value-add deals.  These types of investments carry substantial risk and there needs to be 1-2 people who have construction expertise to manage the contractors and draw requests with the lender.

Market Rate

Varies widely but can range from 5-10% of the CapEx budget.  I see this type of fee on a good portion of the heavy value-add and development deals.

 

Refinance Fee

What is it? 

Taking out large loans is a LOT of work.  Lenders require an extreme amount of due diligence which is one of the reasons that I love this type of investment – experts are reviewing the deal and providing most of the capital for it.  Sponsors sometimes charge a refinance fee if they refinance before the hold period is up.

Market Rate

Typically 1% of the loan amount.  I see this fee on about half of the deals I review.

Pro Tip

Lenders allow multiple borrowers to cumulatively qualify for the net worth requirement. Sometimes this fee is split between 2-4 different people.  If an investor is lending their balance sheet to the sponsor team they are typically referred to as a “Key Principle”, or KP.

Disposition Fee

What is it? 

Marketing and selling a property is a lot of work, even when using a commercial real estate agent.  Syndicators may charge a fee upon exit to help compensate for some of that work.

Market Rate

Typically 1% of the sales price.  I see this fee on about half of the deals I review.

If you are an accredited investor and would like to explore passively investing with Leap Multifamily on future deals, fill out our investor application here.

 

The Ultimate List of Questions!

There are many questions to ask your sponsor before deciding to invest in a real estate syndication.  You’ll find many of them below, along with some color commentary on what you’re looking to accomplish in each section.  Rather than asking your sponsor all of these questions, try to find most of the answers in the offering memorandum and the underwriting model. It will save you both a lot of time and allow you to use the conversation to really hone in your most important questions.

 

Market / Sub-Market

Your goals for this set of questions are twofold.  First, you want to know everything there is to know about the market and sub-market.  A great market can bail out a bad investment and turbo charge a good one.  Secondly, you want to see how much the operator knows about market.  Market knowledge can be very informative when making underwriting assumptions. 

Why are you investing in this market?

What are the market’s prospects for population growth and job creation?

What kind of employment base is here? 

What does your lease audit tell you about the jobs your tenants have?

What is the crime rate in this sub-market?  Is it going up or down?

How many properties do you own in this market?

How many properties does your property manager manage here?

What is the average household income in a 1-mile radius?

 

 

Operator Expertise and Track Record

The goal for this set of questions is to find out the depth of operational expertise that the operator possesses.  Believe it or not, it’s not that hard to put together a $50M multifamily syndication and many self-proclaimed “gurus” teach people how to do exactly that.  You don’t want to invest in a deal that is run by several rookie operators banding together for the first time trying to “figure it out as they go”.   The person functioning as the asset manager is of special importance as that person must have experience in reading financial statements, managing the property manager, and construction oversight.

Are you using a 3^rd party property manager or doing property management in-house?

How many properties do you own?  What returns have passive investors seen so far?

Who is on the GP team?  What are their roles and responsibilities? 

Have you done real estate investing deals together as a team before?

What happens to the real estate investment if you get hit by a bus?

How much money is the GP team putting into the deal?  How about you personally?

Will you allow me to run a background check?  May I have your SSN please?

Will you provide references?

 

Business Plan / Deal Specifics

If you are comfortable with the answers to the preceding sets of questions, then you will want to dive deep into the current project.  Your goal for this section is to get to know the business plan and determine if you believe the sponsor can execute on it.   

What is the “story” on this property?  Why is the owner selling?

What do you like most about this investment? 

What is the biggest risk?  How will you mitigate that risk?

How does this deal compare in terms of risk/reward compared to other deals you have done?

How did you locate this property?  On-market or off-market?

What vintage is this asset?

Can you show me the sales comps to see how this price per unit compares?

How many total units?  What’s the unit mix?  Does this match the clientele in the area?

What is the rent-to-income ratio of the current tenant base?  What about after renovations are done?  Can the median household income in the area support those rents?

What’s the current occupancy at the property?  How about this sub-market?  What are you using for the stabilized occupancy?

What’s the business plan?  Renovations?  What is the renovation scope?  Do you have experience with that scope of work?  Capture loss-to-lease? Add washers/dryers? 

What are current rents?  What are pro forma rents?  (The more of an increase in pro forma rents

What is the projected hold period?  Have your other deals exited early?  (This has been common over the last 5 years.  Sponsors make most of their money upon exiting the deal). 

Are our interests aligned in terms of when to exit?

What do the first 90 days of operations look like? 

Will you re-brand the property?

 

Underwriting & Due Diligence

A huge piece of picking the right project to invest in is making sure that the projected returns in their underwriting model are based on realistic inputs.  Garbage in always equals garbage out.  A slight change in the exit cap rate or the amount of projected organic rent growth will have a drastic effect on the projected returns.  If you really want to get into the weeds then the sponsor can provide the Costar, Yardi, and Axios reports that they used for those projections.  This is what Leap Multifamily does and we also supplement that with economic research data to determine if the deal might have upside that isn’t showing up in the pro forma.  Comparing all of the deals we see against each other is what we use our Bluejay model for.  We can gauge the relative risk of all of the deals we see against each other.

What are your underwriting assumptions for future rent growth, exit cap rate, and future interest rates?

How did you choose your rent comps? 

Did you walk the competing properties for verification?

What kind of sensitivity analysis did you perform?  What is the breakeven occupancy rate? 

Did you walk every unit?  What did you find?

What did your lease audit find?  How many current evictions?  Average tenant income?  Where do the tenants work?

Are you underwriting a refinance or supplemental loan into the projected returns?  How much capital would be returned to investors?  What happens if we can’t achieve those capital events? 

What is the Yield on Cost? 

 

Fees & Cash Flow Waterfall

The questions and answers in this section are pretty straight forward and can usually be found in the investment Offering Memorandum (OM).  Your goal is mostly to make sure that the fees aren’t excessive, and the cash flow waterfall is fair.  The most common fees are acquisition fees (1-3% of the purchase price with 2% being the average), asset management fee of 1.5% to 2% of gross revenue, and then possibly one more fee related to a capital event like a loan guarantor fee, refinance fee, or disposition fee.  

Each deal will offer some sort of cash flow waterfall and generally a preferred return*.  Today, “market” is 7-8% preferred return and a 70/30 split thereafter.  There may also be a secondary hurdle where there is a 70/30 split up to a certain return, say 15%, and then a 50/50 split on profits after that.

Special Note:  It’s very easy to get hung up on the fee and waterfall structures to try and compare one deal to another based on those easy-to-research components.  Evaluating an investment needs to go much deeper than that!  Furthermore, understand that the sponsor’s profit-sharing structure should have a nice mix of fees and performance-based compensation.  If a deal is overloaded with too many fees, the sponsor is motivated to do deals regardless of the outcome.  If too much of the profits are tied to performance, then the sponsor will be motivated to take on too much risk.

What fees are you charging?  Common fees are acquisition fee of 1-3%, asset management fee of 1.5% to 2.5%, construction fees of 5-6%, refinance fee of 1%, disposition fee of 1-2%.  It is NOT common to charge all of these fees in the same deal so this conversation should revolve around what is “market” in this area and why that suite of fees was chosen versus another set of fees.

Is there a preferred return?  Common “prefs” are currently 7-8%.

What is the waterfall after the preferred return?  Are there multiple waterfall hurdles?

Are you doing a cost segregation study?  What is the estimated first year depreciation?

Where does my equity sit in the capital stack?  (Not all equity has equal priority). 

Are distributions and equity events counted as return of capital or return on capital?  (There’s a big difference in these 2 structures from an accounting standpoint). 

 

Debt

As of today, it’s Q2 2023 and the Fed has been raising rates consistently for almost a year now.  This has played havoc with the debt markets and changed the calculus for how to underwrite deals.  The debt being placed on the property is more important than ever.  There are many potential questions to ask but you should start with the LTV.  All things equal, a deal with a higher LTV will carry a higher risk/reward profile than one with a lower LTV.

What kind of debt?  Fixed rate agency?  Bridge debt?  Floating rate?  If floating, did you purchase a rate cap?  How long does the cap last?

Who is guaranteeing the loan?  (Lenders require net worth equal to the loan amount and post-closing liquidity of 10% of the loan amount. You want to know if the sponsors have this type of net worth or if they are “borrowing” the balance sheet of another high-net-worth investor) who is doing the guarantee.

What is the LTV?

Is the lender also loaning money for CapEx?  Or is this money being raised as cash?

What is the year 1 debt coverage ratio?  What about upon stabilization?

Lender 3^rd party reports.  Appraisal, property condition assessment, environmental.  Are these complete?  Any issues?

 

Subscription Specifics

Is this a 506(b) offering? 506(c)?  Depending on your accreditation status, you may or may not be eligible to invest in some offerings.

Is this offering open to non-accredited investors or accredited investors only?

How quickly do your deals oversubscribe?  When does the investor portal open? 

What is the date I need to wire my money in?

What types of funds are accepted?  Cash, SDIRA, etc.

 

Investor Management

Once you invest your hard-earned money into a multifamily syndication, you’ll want to be kept abreast of the project’s wins and losses.  In my experience, there is a high correlation between the quality of the investor experience and the sponsor’s operational expertise.

How often do you pay out passive investor distributions – monthly, or quarterly?

How are investors kept up with the progress?

Which investor portal do you use?

Syndications are illiquid.  What happens if I need my cash?

What happens in a capital call?  Have you ever had to do that before?

 

If you are an accredited investor and would like to explore passively investing with Leap Multifamily on future deals, fill out our investor application here.

*Preferred returns are part of the deal structure and indicate the sequence of how distributions (from operations or a capital event) are disbursed. They are not guaranteed and should not be considered a financial projection. Actual cash flow projections and distributions from the sponsor may differ from the preferred return.