You’ve just heard about syndications and you are pumped up and ready to invest. What’s the next steps? As an active investor and passive investor, you will find out that before you can break into the syndication investment space there are a few barriers to overcome. In this article we break down the 5 hurdles you will need to clear before making your first investment.
Finding the deal/investment opportunity
If you are an active investor you will need to develop broker relationships or relationships with sellers to help create a pipeline of deals for you to review. The reality is that not every investment opportunity you look at will be a good one. If you have a developed investment philosophy and goal you will likely reject more deals than the quantity of which you make an offer on.
Passive investors are not constantly on the hunt for the next deal to purchase but rather are looking for deal providers (i.e. syndication deal sponsors) that will provide investment opportunities. Like the active investors not every investment opportunity that is put in front of you will be an opportunity that fits your investment goals. Having a clear understanding of your investment goals will help create a guiding compass so you can appropriately filter what opportunities you want to invest in and which you should reject.
Building trust with the broker/seller
This hurdle primarily applies to active investors. As an active investor you need to secure deals to bring to your passive investor network. Finding the deal is not the end of the road, however. Once you find a deal that you are interested in purchasing you must present yourself in such a way that the broker/seller takes your offer. The highest price does not always get the deal done. Sellers will look at track record, financial standing and deal terms amongst other metrics to help identify which offer they should select.
For example, if you offer $5M on an apartment complex however someone else offers $4.5Mn with a $1Mn nonrefundable deposit the seller may see the offer with the nonrefundable deposit as a better offer. As the buyer is so confident that they are going to close they are willing to make a $1Mn non-refundable deposit. Brokers and Sellers are interested in certainty of closing so you should put your best foot forward in displaying that you are a serious candidate.
If you are an advanced passive investor or someone that straddles the line between active and passive investments, then having a relationship with brokers and sellers may be helpful as a source of investment opportunities. This is not necessary however so you can prioritize your time building relationships with deal sponsors.
Securing the money to make the investment
Money for investing in real estate syndications can come from multiple places. As a passive investor you may have more options to choose from than you realize. As an active investor you will be focused on filling out your capital stack. Money for the investment will come from two main sources – debt and equity. To get equity you will need to build relationships with passive investors and to get debt you will need to build relationships with lenders and meet their qualifying requirements.
Building trust with the investors/deal sponsors
No one will invest with you if they don’t trust you. It is that simple. Real estate investing is not cheap, and investors need to part with thousands of dollars to complete an investment transaction. How would someone take such a leap of faith this if trust is not part of the equation?
Real estate investing is a relationship driven business. Active investors (deal sponsors) need to build relationships with passive investors so that whenever there is an investment opportunity the active investor already has passive investors ready to invest. The passive investor as well needs to do some work up front in trying to find active investors that are investing in the type of deals that the passive investor likes. Passive investors should have several deal sponsors in their networks. This will provide a source of more deal flow and diversification in their investment portfolio.
It takes time to build relationships and find out if the deal sponsor and passive investor relationship is a good fit. Like brokers/sellers not always choosing the highest offer, a passive investor should not just look for the person making the promise of the highest return.
Neither should the active investor jump at the first person ready to give them money. There needs to be an evaluation process to ensure alignment of interest and investment goals/philosophy. Real estate investing in multifamily syndication is a long term investment – taking the time upfront to build this deal sponsor and passive investor relationship will save a lot of headaches in the long run.
Qualifying for the loan
Qualifying for a loan on a commercial real estate asset is a bit different than qualifying for a residential home loan. If you are going to take out a mortgage to purchase a primary residence the bank is going to look at your credit score, your debt-to-income ratio, they may ask for all your taxes and pay stubs amongst a list of other items.
When it comes to commercial real estate however, the bank looks at this property as more of a business. You are buying a business that happens to be based in real estate, so it is evaluated like a business. Instead of qualifying you, the bank will make sure that the building meets their requirement. The bank will underwrite the investment property and verify that the projected income will be sufficient to cover the expected expenses in addition to pay back the debt. This is a relief as not everyone that invest in a syndication has enough cash flow from their earned income to show that they can (worst case scenario) pay the debt on a multimillion-dollar property. The bank doesn’t expect you to. The property should pay for itself. Also, an added benefit is that the loan will likely be a non-recourse loan.
There is an underwriting of the deal sponsorship team as part of the loan process. This looks a bit different than the underwriting of a personal home purchase. The lender will want to see that the sponsorship team has some experience and a net-worth that matches the value of the property. Further they will want that the sponsors have a certain level of liquidity (i.e. net-worth that is cash or readily convertible to cash) compared to the overall deal value. In cases where sponsorship teams do not meet these criteria, they can pay individuals a percentage of the deal returns to be a “balance sheet” guarantor. This means the person is being paid so that the sponsorship team can use the guarantors net-worth to qualify for the loan. Another option is also using key principals.
This step only applies to passive investors that have mixed roles between passive and active. If you act as a key principal or loan guarantor you may fill the role of both a passive and active investor. This is valuable (and profitable) especially if you like to invest with newer syndicators.
All these hurdles must be overcome to get into your first deal. Once you have made your first investment then there are other considerations that you will have during the deal and ultimately upon exiting the deal.
The 5 hurdles to overcome before making your first real estate syndication investment are:
1. Finding the deal/investment opportunity
2. Building trust with the broker/seller
3. Securing the money to make the investment
4. Building trust with the investors/deal sponsors
5. Qualifying for the loan