Today, I want to explain to friends, family, and in general everybody that is not familiar with multifamily syndication, what my partners and I do when we put a deal together.
In real estate, as well as just about any industry a syndication is when a group of people or companies put their resources together – whether it be time, money or expertise to achieve a goal that would be difficult for each person to do on their own. For investors, this is a very effective way to pool their financial and intellectual resources to invest in projects much bigger than they could buy and run by themselves.
As it relates to buying into a multifamily deal, when you invest with a syndicator, you own a percentage of the property along with the other investors in the deal. This means all the great benefits, such as accelerated depreciation and preservation of capital, are enjoyed by all the investors in the deal.
There are many types of real estate syndication deals. You can join a syndication putting up a new building that is to be constructed, cashflow deals when wants to make an exit, or value-add deal, which is what my partners and I specialize in. This mainly consists of forcing the appreciation of the property by driving net operating income.
In these scenarios, there are typically properties that have either fallen prey to mismanagement, have deferred maintenance, or have some big upside play where the property can be repositioned. In any case, the value-add properties we target are all cashflow deals. We are not buying deals for appreciation only.
Now, you may be wondering, how does a syndication work. To get to that, let me first talk about the three main participants of a syndication deal. The people putting the deal together are called the Deal Sponsor. They are also referred to as the General Partner, Syndicator or Operator. Then you have the passive investors, known as the Limited Partners. The final part if the Property Management team. Aside from the structure, there are many supporting functions that go to work to put the entire structure together, like the lender, the SEC attorney, the real estate broker, the accountant, the title company and others.
While there are many players and moving parts, the Deal Sponsor is the one that keeps it all together. They need to identify the market, work with the lender to get the financing locked in, execute the business plan, make sure the renovations are getting done, staying in constant contact with the property management company, and keeping the investors up to date.
The Limited Partners, or the investors, provide the equity in the deal. They are bringing the cash to get the deal done. These people are typically accredited investors and do not have day-to-day operational responsibility. Rather, they rely on the Deal Sponsor to make sure they are doing what they said they would do for the return they targeted at the time they funded the deal. With that said, they usually have very limited decision making in the operation of the property, which reduces their personal liability if a lawsuit crops up. Additionally, they are not on the banknote so if things go very bad for the property, their exposure is what they originally invested and not the entire amount of the property itself.
The Property Management group is of vital importance to the overall success of the deal. A strong management group knows the local area, knows the market’s strength and weaknesses, and has the know how to fill the units with quality tenants. They are also great at running teams of renovators and making sure the tenants are kept happy where they live. This group works closely with the Deal Sponsor in not only running deals, but also identifying opportunities, assisting with underwriting, and working on due diligence and new property on-boarding.
So, let’s recap. So far you’ve learned what a syndication deal is and its benefits, you learned a few types of multifamily deals and the participants of these deals, who are deal sponsors or syndicators, limited partners or investors, and property managers.
When it comes to the overall deal strategy, there are 4 main parts: Market, Asset, Business Plan and Deal Exit Strategy.
The first part of any value-add strategy is the definition of the market. Typical target markets are in high growth metropolitan statistical areas, or MSAs with above-average job growth, a growing population, and employer diversification. The sponsor will also look at how the market rents are growing without any major renovations as well as the number of new units coming online and their absorption by the marketplace. All these things are indicative of a good market.
Once the market has been identified, the search is on to look for the right asset in that market. For many, they are looking for stabilized properties with conservative underwriting with room left for a value-add play. Perhaps the deal is operating at 82% occupancy and the expenses are very high, but the roof, mechanics, and foundations of the property are still in very good shape. These sorts of deals provide the least amount of risk. The best deal is a property that is not very old and does not require so much work that it would kill the budget and exceed the cost per unit it could sell it for.
Once the property is selected, the due diligence is performed. This includes a deep review of the physical property that usually covers everything from the roof to the individual units down to the boilers and electrical systems. You want to make sure that all are in top shape and there are no items that could throw the deal off, like Federal Pacific breakers and aluminum wiring. Aside from the physical, get the accountant to review the financials and verify that the rent income lines up to what is being reported in the statements provided by the bank and the management company. Usually, the deal is cash flowing and there is enough actual income from the deal to support the note and the expenses. This is what any good sponsor will underwrite the deal on. They will base the numbers off what they are today and not base it off of what MAY happen in the future. Sure, you can create a model of possibility, but this is not what you submit to the bank. Rather, this model of possibility becomes part of the business plan, which will be discussed next.
After the Letter of Intent, the LOI, purchase agreement and close, now is the time to execute the business plan. In this case, the business plan is created by what you not only found during the due diligence process but also what is seen on the competitive landscape. The ultimate goal is to increase the net operating income (NOI) by increasing income or reducing expenses. This will include interior renovations, rebranding the property, adding amenities such as reserved parking, coin-operated laundry, and vending. Other considerations will also be to improve the overall tenant experience like giving new tenants a small gift basket when they move in and 24-hour building support. Reducing expenses is the other lever used to boost NOI. This can be done by hiring new property management, getting new property insurance, or installing technology to improve boiler efficiency if heat is paid by the landlord. The deal sponsor tracks all the improvements for not only the accountant but also to inform the investors on how the property is progressing.
As the business plan is executed and the property is stabilized, the deal is held for as long as defined to the investors before the Deal Exit Strategy. Typically there is a 10-year hold with a 3 to 5-year refinance to return at least 60% of the investors’ initial contribution while still holding equity in the deal. The return really depends on where the current market cycle is – whether in growth or recession – and if it makes sense to refinance and/or sell.
Once the business plan is executed, this is where the Deal Sponsor and the Limited Partners cash out and everybody wins – if the property and the Sponsor performed to make the deal a success.
Now, how do syndicators make money with these deals? The Deal Sponsor makes income from the pre-defined split with the Limited Partners. This split varies on a deal and the Deal Sponsor’s background. There is also an acquisition and asset management fee the Deal Sponsor received for landing and launching the deal as well as the ongoing management of the property.
The sponsor’s main component of income from a syndication deal is the split with the limited partners. Depending on the operator, you may see a straight split or a waterfall structure. Some Deal Sponsors have a 70/30 split in favor for the Limited Partners plus a 9% preferred cash-on-cash return. Both the Deal Sponsors and the Limited Partners have equity in the deal for the life of the syndication.
A second form of revenue for the sponsor comes in two common fees; an acquisition fee, and an asset management fee. The Deal Sponsor will receive an acquisition fee which is a percentage of the property price paid to the sponsor at the time of close, while the asset management fee is the ongoing fee that the sponsor collects for their daily activities in overseeing and managing the asset. It is common to see a 2% rate for the acquisition and the asset management fee. All these splits and rates vary by Deal Sponsor. It depends on the sponsor, the market, and the opportunity itself.
Anyway, this is meant to be a high-level view of a syndication setup, the groups involved and how money is made in this deal. Are you syndicating deals now? How does your breakdown look? Let me know in the comments. I’d love to hear from you.