I am constantly building relationships with and educating individuals who have some degree of interest in investing in our deals. Over my many conversations, I have kept track of every question that these individuals have asked. Now, I’ve decided to narrow down my list of questions to the top 20 most asked, sorted by (1) about the sponsor / structure, (2) financial metrics / associated risks, (3) process / timeline and (4) general.
About the Sponsor / Structure
Q1: What is the Sponsors track record?
A1: The answer to this question will vary by Sponsor; each has their own history and business structure, and thus a different track record. To speak to our Sponsors specifically, we only partner with what we firmly believe to be the most top notch Sponsors in their niche who hold high values, place focus first and foremost on Limited Partners (LPs) (i.e. capital preservation and downside protection), and have a strong history of performance. If you would like to see a more specific break down of each of our five Sponsors, I will gladly send you a one pager if you request it via email.
Q2: Does the Sponsor invest in their own deals / why are they investing such a small amount?
A2: The most common answer to that question is yes. Sponsors will invest alongside LPs in their own deals to show alignment, not to mention they are also interested in the strong returns they are projecting. As to small investment amounts; some of our Sponsors annual deal flow is very strong, they’re not only doing one or two deals a year like most individual investors are, they might be doing 5 or 10! $50K in 5 or 10 different deals in a year equates to $250-$500K over the year! That’s not exactly a small amount. Another aspect to consider is that many Sponsors are the guarantor on the secured loan for the property, thus facilitating the need for a liquid personal balance sheet.
Q3: How is the deal structured and are they allowing non-accredited investors in?
A3: The answer to this question varies. But, more often than not, syndicated deals are structured as 506(b) under SEC Regulation D with no spots for non-accredited/sophisticated investors. See my blog on the topic here for a more in depth look.
Q4: What is the hold strategy and how long can I expect to be in this investment?
A4: Typical hold strategy is 3-7 year hold with an average of 5 years. Most Sponsors have a clause in the legal docs that allow for a longer hold period (say 100 years). The reason that this is so exaggerated is so that we are at no point forced to sell by outside factors. Our goal is to optimize value and this allows us to hold through a down market and wait until the market has recovered.
I advise that an investment in our deals should be considered an illiquid investment. That being said, we operate in good faith and will work with LPs to try to find a solution if they need to get out of the investment due to a particular life event. However, there are no guarantees.
Q5: How is the deal structured in terms of profit sharing with the LP & GP?
A5: All of our Sponsors structure their deals as a waterfall. The first “hurdle” in the waterfall is the 8% preferred return (pref), where LPs receive 100% of profits until they reach an 8% return. After this hurdle, most of our deals are structured at a 70/30 split (you may see different splits with other Sponsors), where all profits after the 8% pref are split at 70% to the LPs and 30% to the General Partner (GP). You will sometimes see a second IRR hurdle, where after XX% IRR (typically 15-18%) the split goes to 60/40 or 50/50. If this information adds a degree of confusion, I recommend to concentrate on the projected returns (see A7), as they are more easily understood and by nature have the waterfall structure built in.
This information will be laid out in detail and readily available in the investment summary.
Q6: What are the common fees and how does the Sponsor make their money?
A6: First and foremost, all fees are separate from return projections. What that means is that fees will have no impact on the return projects you will see in any of our deal decks; the LPs are not paying any fees “out of pocket.” That being said, Sponsors most often make their money in three ways. (1) The acquisition fee (1-3% of purchase price) which is paid at close and covers all costs associated with finding and putting the property under contract. (2) The asset management fee (1-3% of monthly revenues) which covers costs associated with executing the business plan; overseeing the property management company and construction management company, identifying and implementing value-add strategies, improving operational efficiencies, etc. (3) The equity split of profits after the pref; most common here is 70/30 (70% to the LPs and 30% to the GP), but you may also see 60/40, 80/20, etc.
Financial Metrics / Associated Risks
Q7: What are the projected returns?
A7: Typical projected returns metrics are as follows:
Preferred return (pref): 8% (LPs take 100% of profit until they reach an 8% CoC)
Internal rate of return (IRR): 16-22% (a time sensitive rate at which your money grows, annually, over the life of the project)
Cash-on-cash (CoC): 8-12% (a rate of return that determines the cash income on, or in proportion to, the cash invested, measured annually)
Equity multiple: 1.7-2.3x (on a $100K investment, LPs earn $170-$230K, including return of initial investment)
That said, all of our Sponsors consistently exceed projected returns, made possible by our conservative underwriting.
Q8: What is the minimum investment?
A8: $50,000 with increments of $5,000.
Q9: Should I invest all of the capital I’m looking to put to work in to one deal or spread it across multiple?
A9: Spread your capital across a number of deals. The key to a strong investment portfolio is diversification. The beauty of our strategic partnerships is that we are able to offer opportunities for diversification across markets as well as multiple asset classes (multi-family, self-storage and mobile home parks).
The amount of capital you should put to work in each deal will depend heavily on the amount of capital you are looking to deploy in total. If you are looking to deploy $1MM, for example, you can benefit from diversification by investing $100K in 10 deals. On the other hand, if you only have $100K to invest, consider placing $50K in 2 deals. Each investor’s financial situation is unique to that person, so there is no steadfast rule to follow here.
Q10: Are there any tax benefits from a passive investment in commercial real estate?
A10: There are many. Depreciated and accelerated depreciation can result in a paper loss on an LPs K-1 statement (pass through tax doc), which can also be used to offset other gains in your investment portfolio. Possible 1031s in to new deals can help you grow your earnings tax deferred. A supplemental loan or a refinance can return a significant amount of initial invested equity, which the IRS considers a non-taxable event. As stated in the answer to Q19, you can invest using a SD IRA, which would allow you to return your profits to your IRA account, tax free. For a longer, more detailed answer to this question, see my blog on the topic here.
Q11: What are the risks associated with this investment?
A11: Let’s get the brutal truth out of the way first. Because there are outside factors not in our control (namely, market conditions), there is a risk that you can lose your entire investment, just like you could in the stock market, single family homes (SFHs), a small business/start-up, etc. On a more positive note, we view this as a very highly unlikely possibility for several reasons. First, our conservative approach to underwriting leaves room to bear a market downturn, whereas this is less likely the case with more aggressive underwriting (see A11). Second, we buy proven assets. That is, assets that provide a return day one as opposed to appreciation plays or buying very poorly managed assets. Lastly, a couple of key metrics: delinquency rates at the bottom of the financial crisis in 2009 were 1% on MF properties as compared to 5% on SFHs; we buy assets where our sensitivity analysis supports returns at or even below historically low market vacancy and rent rates. For example, it’s not uncommon to see a projected single digit returns on a property 10% below projected rents with at occupancy rate of 81%, even in a market with a historically low occupancy rate of 84%. If you would like to analyze a sensitivity analysis, I will gladly provide you one if you request so via email.
All risks associated with an investment will be laid out in great detail in the private placement memorandum (PPM).
Q12: What would happen/what is the Sponsors strategy in the event of a down market? What’s to stop the Sponsor from selling in a down market and wiping their hands clean of the asset?
A12: All of our partners’ number one value is capital preservation and downside protection. That being said, the goal during a down turn would be to hold until the market recovers, while still providing the 8% pref to investors. If things get really bad and we do not meet the 8% pref in a given year, we have a catch up that entitles investors to the 8% pref the next year PLUS the difference from the previous year. I.e. if we only return 4% in year one, LPs are owed 12% in year two. Additionally, we underwrite conservatively to ensure that, even in tough times, we are still able to provide a return to investors.
The answer to part two of this question is twofold. The obvious part being that the Sponsor also makes more money in a strong market and thus benefits from holding through a down turn, just as our LPs do. The second, and far more important, part is a matter of relationships, reputation and brand. Our Sponsors are all, by no mistake, top notch Operators and are in this game for the long haul; putting our investors interest firsts and foremost, even if that means bearing some of the negative implications, helps to maintain that already strong relationship, reputation and trust/faith among our current and prospective partners.
Process / Timeline
Q13: How frequently are distributions made?
A13: We do quarterly and monthly distributions. Quarterly is the most common, with monthly being a bit more aggressive/work intensive on behalf of the Sponsors, but investors love this for obvious reasons. I’ve also heard of, but never seen, annual distributions.
Q14: How often will communications/updates be sent out?
A14: Again, this varies by Sponsor. But most often you will see this in line with distribution frequency; monthly or quarterly. Updates will outline a number of items including, but not limited to; value-add implementation progress updates, property pictures and financial statements.
While Sponsor updates will come monthly or quarterly, I remain available, at all times, to my investors as a resource for specific questions or general discussion throughout the life of the project.
Q15: Will I be able to 1031 from one deal in to the next?
A15: You cannot 1031 in to our deals since you are purchasing units of our Limited Partnership and not actually the property itself. However, although not guaranteed, there is potential to 1031 from one of our deals in to the next, given the right timing, thus providing the extremely powerful benefit of tax deferred growth.
Q16: How involved can I be as a limited partner?
A16: Typically, not involved at all. Most people think that the primary reason behind this is that the Sponsor knows what they are doing and wants full control in order to implement the most sound and effective business plan. While this is true to a certain degree, it is by no means the most important factor. As stated a number of times throughout this article, our main concern is capital preservation and downside protection. By limiting LPs roles/voting rights, we eliminate their liability beyond their initial investment in the event of a law suit, loan default, or some other misfortune.
Q17: What is syndication?
A17: Syndication, in its broadest sense, is a pooling of resources (time, money, knowledge, man power, etc.) in order to achieve a larger goal than one would not be able to achieve alone. More specifically, in terms of commercial real estate value-add syndication, it is a structure in which a GP pools money from investors/LPs. The GP implements the business plan and provides a return to LPs who have a limited/passive role in the project. I offer a more in depth explanation in my blog on the topic which can be found here.
Q18: What is an accredited investor?
A18: An accredited investor is an individual who meets one or more of the following requirements: $200K+ annual income for the past two years with the expectation to make the same the following year; a combined spousal annual income of $300K for the past two years with the expectation to make the same the following year; $1MM net worth, excluding primary residence.
To quickly determine if you meet the criteria to be considered an accredited investor, visit the quiz at the bottom of the home page on my website.
Q19: Can I invest with my LLC or SD IRA?
A19: From our side the short answer is yes. It would simply entail a slight difference in how you sign the subscription agreement and fund the deal, with no added degree of difficulty. In fact, I have a contact at STRATA Trust Company that can help you set up an SD IRA and be your single point of contact along the way and your SD IRA liaison for any investment with us. I’m happy to share that contact with you if you send me an email request.
There are some things to consider, however, such as the UBIT (unrelated business income tax), which is why I recommend seeking the counsel of your CPA, financial planner, etc.
Q20: What is a supplemental loan?
A20: Due to the nature of a value-add syndication, it is very common (and the ultimate goal) to create significant value in a property through renovations, tightening operational efficiency, etc. In the case that this is in fact achieved, the Sponsor may consider going back to the bank with a now higher assessed property value (since property value = NOI/CAP) and either refinance the property or obtain a second/supplemental loan, depending on market conditions and what interest rate you can obtain vs current interest rate. This allows the Sponsor to pull out equity and return it to investors, tax free.
While there is dilution (8% pref now based on remaining equity in the deal as opposed to initial invested equity) typically associated with an equity even, the event also increases the cash-on-cash (CoC) & IRR on the project. A win-win.