In todays email:

• 😱 Syndication RED Flags

• 💸 Syndication Fees (mainly focusing on apartments)

Syndication Red Flags

In syndications there are a few red flag warning signs that you should investigate further. If you encounter one of these red flags in an offering document or researching an operator then I would head the other way. If you encounter these red flags, it is a dealbreaker.

1.  The sponsors not having a successful business background. At least one of the sponsors should have a background in running and operating a successful business. I want an operator/sponsor that can run of business even when times get tough like we saw in the COVID pandemic and what we are seeing now with the tough commercial real estate markets. Buying commercial real estate like an apartment is like buying a business even though it's attached to real estate.

2. No part time operators. A sound operator must work full-time in the business and I don’t want a person that I invested my hard earned money with to have a W-2 job and doing this business on the side. This business cannot be run like a hobby but must be full time in my opinion. I want someone full time watching over my investment.

3. It is best not to invest in a solo operator. You want there to be more than one partner. Ideally, you want to have two or three unrelated partners on the project each with their own responsibilities clearly defined.

4. No preferred return or preferred return with GP catch up. Every deal must have preferred return for the limited partners. The LP investors should get preferred distributions of cash flows. The return allows the investor to receive 100% of the cash flow up to a certain return. Make sure that the operator offers a true preferred return. This means that 100% of the initial cash flows goes to the LPs and there is no GP or general partner, catchup provision. The catch up provision benefits the operator and not the passive LP investor. It is better to allow the GP to have higher equity splits on the back end so that they are incentivized to do the best job for all.

5. Showing returns with a refinance. I will not invest in a deal with a projected refinance in the pro-forma since if a refinance is needed to have the deal make sense then probably too tight a deal. Modeling a refinance will set you up for failure. Typically, these are offers that are very fee heavy on the front end or they are trying to include GP catch up provision to allow them to pull off the excess cash from the deal prior to returning capital to investors. Always review the waterfall in the PPM to check for these issues.

6. Distributions as returns of capital and not return on capital. You need to understand how the sponsor classifies distributions by reading PPM. Distribution of capital will get you a reduction of your preferred return since your preferred return is based on the unreturned capital contribution. The preferred rate will not change but the amount you get each month will go down. Also possible tax implications. This typically happens with undercapitalized sponsors.

7. No skin in the game. I think 5-10% of the equity required to come from the operator/sponsor. This would be good but it does depends on other factors. You want the operator to have some risk in the deal.

8. No interest rate cap when there is floating interest rate. I have seen operators that did not plan ahead for the worst case scenarios and not buying a rate cap. These operators end up having the bank take the properties back. We have experienced this in a big way with the recent interest-rate increases in 2022-2023 and many operators getting into trouble and many are still in trouble.

Syndication Fees

In an apartment syndication, the structure of fees charged by the sponsor (also called the General Partner or GP or operator) to limited partners (LPs) may vary depending on the specific deal and partnership agreement. However, there are several common fees that LPs might pay:

1. Acquisition Fee:

   • This is a one-time fee charged by the sponsor for sourcing, evaluating, and closing on the property acquisition.

   • It is typically calculated as a percentage of the property's purchase price, often ranging from 1% to 3%.

2. Asset Management Fee:

   • This is an ongoing fee charged by the sponsor for overseeing the property’s operations and managing the asset on behalf of the LPs.

   • It is typically calculated as a percentage of the monthly gross revenue of the property, often around 1%.

3. Property Management Fee:

   • This fee is for managing the day-to-day operations of the property, such as tenant management, maintenance, and leasing.

   • If the sponsor or a third-party property manager handles property management, there is usually a fee of around 3% to 8% percentage of monthly gross rents.

4. Financing Fee:

   • This is a fee charged for arranging and securing financing for the property.

   • It can vary widely and may be calculated as a percentage of the loan amount.

5. Construction Management Fee:

   • If the syndication involves significant renovations or development work, the sponsor may charge a fee for overseeing the construction process.

   • This fee is typically a percentage of the total construction costs.

6. Disposition Fee:

   • This is a fee charged when the property is sold or otherwise disposed of.

   • It compensates the sponsor for the work involved in managing the sale and is typically a percentage of the sale price.

7. Refinance Fee:

   • If the property undergoes a refinance, the sponsor may charge a fee for arranging and executing the refinance process.

   • It is typically a percentage of the new loan amount.

8. Other Fees:

   • Other possible fees include accounting fees, legal fees, and reporting fees for administrative work, which may be charged to the partnership and indirectly affect LP returns.

9. Carried Interest. Also called “Promote”:

   • In addition to fees, the sponsor may receive a share of the profits (often called "promote" or carried interest).

   • This is typically a percentage of profits above a specified return threshold or preferred return to LPs.

As with any investment, the fees and terms should be clearly outlined in the Limited Partnership Agreement (LPA) and/or Private Placement Memorandum (PPM), and LPs should review these documents carefully before committing capital. The exact structure and magnitude of fees can vary based on the specific deal, market conditions, and the sponsor's experience and track record.

If you need help with any of the topics in these newsletters then email [email protected] to get more information about our advisory/consultation service.

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