Don’t choose the wrong syndicator! Avoid these red flags!

Operator level:

Part-time. Proficiently managing a large multi-family property, self-storage complex, car wash or any other business is not for the faint of heart or part-timers. If someone is going to manage an asset that I have invested in, then I want their full attention on that asset and business.
New to the industry. There is nothing wrong with changing careers and getting started creating wealth through real estate, but if someone was a barista yesterday and a syndicator today, then I am not investing. I have been a licensed real estate broker and investor since 1999 and a licensed general contractor since 2017. If someone is new to the industry, then they need to have a seasoned and experienced partner on their team as an operator.
Single-party operator. There must be more than one operator (NOT related). I prefer multiple partners for the sake of accountability and to prevent any temptations to abandon an asset if times get rough.
Group 1031 like-kind exchange-minded. Some operators strive to sell one deal and rather than pay the capital gains and depreciation recapture, they strive to move all investors forward to the next opportunity. This whole process is about preserving capital and building generational wealth. Some operators will pay the attorneys and CPAs to do all the paperwork necessary to buy out those limited partners that need their capital returned at sale so that the remainder of investors can move forward as a collective entity if they choose to do so in order to defer capital gains and execute a 1031 like-kind exchange as a group.

Deal level:

Rate caps. This is top of mind recently as rates have jumped at their fastest pace in history. It is normal to purchase a value-add multi-family deal on a bridge loan (similar to a construction or rehab loan) in order to improve the property and add value. Sometimes these loans can be floating rate debt instead of fixed or a set term like 2 or 3 years with a rate adjustment at time of renewal. If it is a floating rate, then a rate cap must be purchased and in place and should be modeled in the pro-forma at its max rate to ensure project viability and invest ability.

I am personally in a deal where the operator did a bridge loan of 2 years with 3 additional extensions. Because the rates moved so quickly, they have caught this 30+ year operator by surprise. Fortunately, this 30+ year operator did purchase a rate cap; however, the speed of rate increases has caused problems. For example, cash flows that were coming in the form of distributions to limited partners had to be suspended and shifted to pay the new interest payments as the interest rate on the note moved up and beyond the rate cap in place. In this case, the rate cap that was purchased actually paid back the operator the spread beyond the cap. The next consequence is that now the operator must purchase an extension of the bridge loan or choose a long-term product at today’s rates; either scenario comes with a heavy financial burden (in the millions) to buy another rate cap or buy down an interest rate. This particular operator has the bandwidth and long-term investors internally to deal with the situation without making a capital call to limited partners. My capital will be preserved by a quality asset, a savvy and skilled operator that has the experience, skin in the game, and is in this business for the long game the same as me.

No skin in the game. While an argument must be made for operators to have the bandwidth to inject or salvage a deal personally before going to limited partners, there is still a need to know that the operator also has personal funds at risk so that values are aligned.
Distributions as Return OF Capital. This one is sneaky. By making distributions as a return OF capital rather than a return ON capital, it reduces the amount going forward that your distributions are based on and leaves the operator with more cash flows faster instead of you.

I am learning this one personally as we invested in 632 units with one of the largest names in the industry and then started receiving distributions as a return OF capital. This particular icon investor has plenty of capital and boasts over 10,000 units. The point being is that I should NOT have made any assumptions because of legendary status before dropping $200k. Read the PPM carefully.

Preferred returns. Most operators will make an acquisition fee to pay their staff for all the hours of underwriting, sourcing deals, due diligence, etc. and that is normal, however; limited partners should see the first fruits from the cash flow from the investment thereafter before the operator begins to collect any further proceeds. Managing the income stream so that limited partners receive the first fruits of cash flows incentivizes the operator to manage the business and operations to hit their projections or better yet, exceed their projections so that they can also reap rewards along the way rather than waiting for or forcing a sale or a refinance so they can get paid.

NOTE** Beware as some operators are simply in the business of collecting acquisition, management, refinance, etc. fees!

Refinance modeled in underwriting. While it is typical that a value-add project will force value on a project in anticipation of a refinance to pull cash out (similar to the single-family BRRRR – buy, rehab, rent, refi, repeat method), I do not want to see this modeled in a proforma as a requirement to hit projected returns or to produce a catchup or refinance fee for the general partner.

I am personally in a deal in the Carolinas with an operator that just concluded a refinance, returning 40% of our initial investment, after two and half years of heavy lift regarding capital expenditures in addition to completely turning the property around and we are now ready to re-deploy capital again with the stage set to continue to reap cash flows from the asset over the next several years.