There is a saying that real estate investing means tenants, termites, and toilets. If you are acting as the landlord yourself, yes the income generated might not be as passive as advertised. Fortunately, there are ways to off load the work and still hit great cash flow and multifamily syndication is one of them. I personally have invest in some deals with friends of mine back in Texas and Atlanta area with good results. It was nerve wrecking though, writing that first check and handing your hard earn money over to someone but I was glad I did because they’ve all generated significant returns for me.

On our panel for the Meetup in August was Boris Liubovitch, Principal at Wealth Growth Investments and Brian Burke, President/CEO of Praxis Capital. Between the two of them they have over 2,000 doors under management. It’s safe to say they know a thing or two about this space. I want to thank them for the experience and wisdom they shared with the group and recaptured here in this post.

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Identifying Markets

There are many factors and data sources to gauge what market to be in, some free and some are paid services. You can find data from Census Bureau, Bureau of Labor Statistics, Costar, or even the top performing cities index from Milken Institute. There’s not one magic number or indicator to look for, ultimately you want to look for population and job growth and preferably in a state that’s landlord friendly.

Analyzing Deals

Both panelists mentioned they get most of their deals from brokers. Once they’re in a market their reputation and track record as closers get around and deal makers will approach them.

For pre-deal due diligence, one should tour the property, perform physical assessment on what might need fixing to come up with your capital expenditure budget such as siding, roof, etc. As for market assessment you can go as far as to apply to rent a unit in a neighboring property to get a sense of the market rent, competition, and type of amenities you might need to provide. Once the deal is under contract in the due diligence contingency period the sponsor will walk every unit, audit the lease to the rent roll, check up on maintenance tickets, and inspect the big expensive items like roof, mechanical units, and HVAC.

Be on the look out if the CAPEX is reasonable or not. The number one mistake sponsors make is not raising enough capital. If it’s not enough or the deal is not going according to plan such as drop in occupancy etc then the sponsor might have to do a capital call to make up the difference.

As for property management, some sponsors are at a scale big enough to do that in house. Regardless, most cases the deal should incorporate about 5% to it. If it’s too high or too low it should prompt more questions from the investor’s end.

It’s important to consider the sponsor’s track record as well. You are betting on the jockey (the sponsor) just as much as the horse (the deal). A bad sponsor can totally screw up a good deal just as a good sponsor can pivot their way out of adverse conditions. Ask for reference from past investors.

The criteria for what’s a good investment or not varies depending on the sponsor. Typically 8% and above cash on cash return is good, some only look for over 10% CoC. If you are using IRR, maybe look for something with 14% if it’s a long term 10 or more year hold, and adjust up the returns for shorter hold periods. I personally see a lot of deals now around 18% for a 3 year hold, occasionally I’ll see one > 20%.

It’s almost an impossibility to pick top and bottoms in market timing. Boris and Brian advised getting longer term loans or look in the investment package if you are on the investor side to avoid an untimely large balloon payment. There’s always a market in something, so be patient, conservative, and consistent. That’s not to say there might be a good time to go play golf for a year or two.

Raising Funds

Every deal or sponsor might vary a bit. In general 75% of the acquisition price comes from debt financing, the other 25% plus the CAPEX comes from investors. Sponsors can or choose not to invest along side with equity investors. It’s good if the sponsors have skin in the game, but for giant deals it becomes challenging for the sponsor to have so much equity tied up and still keep scaling so not necessarily something that should scare investors off.

Typically the sponsor will form an LLC to hold the title in and participate as General Partner (GP), and they will create the following legal documents for the investors, limited partners (LP) to review and participate:

  • Operating Agreement – spells out the rules, regulations, and responsibilities of the GP and LP’s.
  • Private Placement Memorandum – states the objective, risks, and terms of the investment
  • Subscription Agreement – indicates what percentage of ownership the investor has

Along with that you will likely receive an offering package from the sponsor that summarizes the deal, business plan, comp analysis, and expected returns etc. Through all these documents you should have a good idea on how the capital stack is structured and how returns will waterfall down to the investors via preferred return and the profit split.

Keep an eye out for fees. There should be some, it’s just the cost of doing business and help the sponsors to keep the lights on. If there are no fees that should raise some eyebrows. Investors can expect to see 1 – 2.5% acquisition fee or tiered as the deal size gets bigger, 1% or so for loan fees, 1% for asset management. One gotcha worthy of attention is what is that 1% of… is it income, equity, debt plus equity, purchase price, or cap rate value? It can be dramatically different depends on how it’s spelled out.

You don’t necessarily need to be an accredited investor (net worth of $1M or more excluding primary residence or > $200k income for the past two years, $300k jointly for married couples) to invest in a private placement. Per SEC regulation each offering can have up to 35 unaccredited investors if they have a prior existing relationship with the sponsor.

Lately there’s been quite a few real estate crowdfunding sites (PeerStreet, RealtyMogul, Fundrise, etc). While they provide access to more deal flows for investors, it can be hard to vet the end sponsors. These platforms act as the middleman and inherently create extra transaction friction. Investors also have to ask themselves that if the end sponsors are experienced why would they need to go to crowdfunding sites and subject themselves to additional fees. Chances are they’re new and lack the investor base, warrant more attention by the investors.

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