As we slowly emerge from the global pandemic, investors seeking high risk-adjusted returns are finally waking up to the undeniable strength of apartment or multifamily real estate investing. Many real estate sectors such as office space, hotels and retail got decimated during the past 18 months. Apartments, however, have seen demand surge. Multifamily construction has not kept up with the growing population and the precipitous rate of household formation. Some people hit hard during the pandemic have sold their homes and moved into apartments. As the mortgage payment forbearance period ends in the fourth quarter of 2021, many more homeowners are expected to put their homes on the market. As vaccination rates across the country rise, and employers resume hiring, recent college graduates and young adults looking to start living independently are finally leaving their parents’ basements and their friends’ couches to strive out on their own. All of these cohorts turn to apartment living.
Many commercial real estate investments happen through a syndication. A syndication is simply the pooling of resources to accomplish a common goal. If you have been on a commercial airplane then you have been part of a syndication. Chances are you were not interested in paying for all the costs of operating that flight so you and all the passengers put your money together or “syndicated” the flight.
Real estate syndications involve a team of active real estate professionals called syndicators, operators or deal sponsors. This team brings together passive investors who do not want to learn the details of real estate investing. Many investors enjoy their current careers or love to spend their time doing other things. They understand that real estate offers diversification, strong returns, and a less volatile risk profile from traditional stock investments. It is the job of the operator to research the market, find the deal, close the transaction, implement the business plan, and operate the asset until it is sold.
We caught up with David Kamara, Founder and CEO of Cape Sierra Capital, a real estate investment company, to discuss what questions investors should ask a syndicator before joining their real estate investment offering. Kamara shares his thoughts based on almost 2 decades of investing in single family and multifamily real estate.
Do You Trust The Operator?
This is the most important question that you need to ask yourself. Do you feel that the operator will do the right thing for you when faced with a really difficult decision? Experienced professionals such as secret service agents and court judges get moral character wrong all the time. Do your research. Ask the operator to tell you about those investments that did not go as planned. It is easy to do the right thing when everything is going well or when the market is in an up cycle. Experience in down markets matters. “Ask whether they were invested in the 2008 downturn and how they weathered that period. Ask what lessons were learned then that they apply today,” advises Kamara.
How Aligned Is The Operator With The Investor?
The most obvious means by which an operator is aligned with the investor is the fact that if they do not deliver results or act immorally then they will cease attracting investors for subsequent deals. Look for operators that have been in business for many years. It takes a long time to build a reputation and only a few poor decisions to destroy it. Understand that just because a syndicator invests their own money in a deal does not mean that they are 100% aligned with you. It is certainly good that they invest their own cash but this does not guarantee a positive outcome.
Who Is Providing The Loan Guarantees?
Most syndicated real estate loans use non-recourse debt. This means that even if things do not work out, passive investors are not liable and their personal assets cannot be used to fulfill the loan obligation. What you may not know is that banks still do require guarantees that the investment will be managed in a conscientious manner, without fraud, misappropriation or environmental degradation. The operator has to make these guarantees typically backed by net worth greater than the loan amount. Should there be any illegal acts the principals who provide the above guarantee are indeed personally liable. It is important to understand who provides these guarantees. You do not want that outsourced to a third party.
Who Is Paying The Up Front Costs?
Before a deal gets presented to investors a lot of money has to change hands. Earnest money deposits, often to the tune of hundreds of thousands of dollars, have to be put in escrow. Lenders often require that their application fees and third party diligence costs be paid up front. Significant legal fees are often paid up front. Many fees are not recoverable should the deal not close. It is helpful to understand who pays for these costs and whether you may lose your capital should the deal not close.
What Is The Investment Legal Structure?
The majority of syndications are organized as a limited liability company (LLC) or a limited partnership. These structures enable easy distribution of profits to investors as income is not taxed at the entity level but flows through to the investors’ individual returns. The biggest disadvantage of real estate investments is that they are illiquid. Your capital will be tied up for a long time and you cannot readily exit the investment. Your rights as a limited partner will be spelled out in the offering legal agreements. Make sure you understand the constraints of what you are allowed to do before you invest to avoid surprises and uncomfortable conversations later. Do not skim through legal documents.
What Are The Projected Returns To You After All The Fees Are Paid?
It is important to be clear about the percentage of the profits that you are entitled to on an annual basis as well as when the property is refinanced or sold. What are the various fees that the operator is charging? Typical syndications often involve some or all of the following fees: Asset Management Fee, Acquisition Fee, Disposition Fee, Construction Management Fee. Are the property returns being projected calculated before fees or after fees? Make sure you understand how the cash waterfall flows and when it fills your buckets.
What Are The Assumptions Used To Arrive At The Projected Returns?
Every multifamily investment will have two key components of the return: i) the cash on cash return which gets paid out annually, and ii) the split of profits when the property is refinanced or sold. It is important to understand the assumptions associated with each of these components. Where the majority of the return comes from is a range that defines the personality of the deal. Kamara emphasizes, “Any model can be manipulated with lofty assumptions. Ask for justification of the following key assumptions: cap rate at exit vs current, each year’s rent growth projections, capital expense projects during the hold period and vacancy projections. These are some of the most important metrics to pay attention to.”
Why Is This Deal Unique And Why Does It Make Money?
Each investment opportunity has a story. Try to understand why the operator is particularly thrilled about this opportunity. What is the deal thesis and business plan? What needs to be true for the operator to be able to execute the plan? Think through the possible range of outcomes if things do not go exactly according to plan.
What Is The Market Doing And Does It Support Your Potential Investment?
In real estate the market is very local. As a result there are many real estate markets. It is often a mistake to equate national headlines to what is going on in the town where your operator is about to tie up millions of dollars. Kamara further elaborates, “the key is to investigate further, examine the facts carefully about the big picture and your specific location, and then make your own conclusions. Also understand that markets are cyclical. They do not always go up. They do not go down forever either. The difficulty is understanding where in the market cycle you are. Nobody can predict the top or the bottom. Good operators plan for numerous market outcomes.”
As outlined above there are many questions that you need to answer before you e-sign those legal documents, wire your money in, and join the ranks of passive real estate investors. You need to understand and be confident in the operator, the deal and the market. Kamara strongly recommends you vet them in that order. Find a trusted operator and they will bring you good deals in markets that make sense. The operator or syndicator is the key to the puzzle.
Cape Sierra Capital focuses on providing investors with passive cash flow by investing in multifamily real estate. To learn more about how cash flow works and how you can gain back control of your time download a free copy of their e-book The Personal Cash Flow Formula.
To hear about upcoming investment opportunities join Cape Sierra Capital’s Exclusive Investor Network.