6 Things to Watch Out for in Analyzing a Real Estate Syndication Offering

by | Apr 13, 2023 | Syndication Basics

Now that we have evaluated the Sponsor, it’s time to dive into the actual deal presented to us. In this article, we will focus on the actual Asset. For Market evaluation, please see our article “Analyzing Markets for Real Estate Syndications“. We do not want you to get scared of the long list we have below, just realize that with everything else with time you will gain more experience and this will become a second nature to you. The list below is a bit more focused on a Multifamily asset type, but the basics apply to almost every asset class. 

Before we dive in, we recommend that you go through these articles:

Sponsor Experience with Asset Type and Market

We learned that the Sponsor is the most important part of the investment. The Sponsor’s experience with a particular Asset class and Market is very important and can affect their ability to make an investment work. Each time a Sponsor goes into a new asset class or market they need to learn from the start the nuances of working with that class or the details of the market. Because this is a team sport, often Sponsors will try to mitigate the risk of being “new” by partnering with other experienced sponsors. So when you are evaluating the experience, be sure to ask about not only the real estate expertise but that particular asset class. 

You also want to ensure that the Sponsor has a “boots on the ground” person. Especially when you are looking at larger deals or deals with a lot of Value-add, it is really not reasonable to expect that the sponsor does not have a presence close to the asset to ensure ongoing monitoring of progress.

Return Projections

We are investing for returns, so we should ensure that the targeted returns are what we are looking for. Depending on your investment goals, your return targets will differ. If you are investing for growth, then you will likely be looking for higher returns and riskier assets. If you are investing for capital preservation, you will likely be looking for less risk, which might mean lower returns. All this said, at the top level, you are looking to ensure that your expectations align with these top metrics:

  • Preferred return – you should expect at least 7-8%
  • IRR/AAR/Equity multiple – we are grouping these together, as they are trying to convey the same information slightly differently. You should expect to at least double your money in 5  years for a value add deal, lower if a more stabilized asset type. For details about each of these metrics read our article IRR, AAR, Equity multiple, oh my!
  • Hold Period – for Value Add, you should expect 5-7 years; for new construction, 2-3 years
  • Cash on cash projections – you should look for these to be broken down by each year, as often you might see “Average Cash on Cash.” If you are looking for cash flow yearly, you want to ensure that you know when to expect distributions. 
  • Waterfall splits – we dive deep into waterfalls in our article Real Estate Syndication Waterfalls Explained. You should expect 70/30 or 80/20. 

Sponsor Fees

Outside of profit splits, the sponsor makes money through fees. This is only fair, as they are actively working to manage the asset. What is not fair is outrageous fees. So evaluate these with caution! Here are the most common ones you might see

  • Acquisition fee – expect 1-3%
  • Asset Management fee – expect 1-2%. Ensure that you are aware on what is the basis of this percentage.
  • Refinance fee – expect 1-2%
  • Disposition fee – expect 1-2%
  • Construction Management Fee – 5-15% of the construction budget

Asset Location & Amenities

We discussed Market analysis, but every market has sub-markets and pockets, which can be good or bad. The market as a whole is important, but the actual Asset surroundings and amenities are equally, if not more, important for the investment. Things that can impact the asset are:

  • Proximity to employers – the shorter the commute for people, the more attractive the property will be
  • Infrastructure – access to major roads, grocery and retail shopping, hospitals, schools, parks, etc. All of these are important for a good tenant experience. The convenience of access can often bring a premium on rent.
  • School District – if the target tenants are families, this is an important consideration
  • Crime rate – the higher the crime rate, the worse tenants the property will attract
  • Amenities – pool, dog park, common areas, BBQ. Depending on the comparable properties, some might be more of a “luxury” than a necessity.

Financials

We will dive in deeper in a future article about this, but here are the top-level items you need to consider as part of the evaluation.

Purchase and Exit CAP rate

What are the purchase and exit (reversion/sale) cap rates? If the exit CAP rate is lower than the purchase one, ensure that you understand the sponsor’s reasoning. For conservative underwriting, the exit CAP rate is often higher than the purchase one.

Comparables

How do we know that the Sponsor can actually raise rents? We usually look at the comparables to ensure that there is room for growth. Things to consider:

  • Location and similarity – age, unit size, and amenities should all be considered to ensure the like-to-like comparison
  • Rent per square foot – this is an easy way to compare with the target property quickly
  • Upgraded vs. Classic units – rents for renovated units are usually higher
  • Occupancy rates

Rent Growth Assumptions

Rent growth is one of the reasons Real Estate is an amazing investment. With rent growth, usually, NOI (Net Operating Income) grows, which means our investment’s value grows. However, you want to ensure that the sponsor is conservative on rent growth and does not get too optimistic. In the last few years, we have seen really high rent growth along with high inflation. Realistically, however, the historic rent growth has been 3-4%. Ideally, you want to see the Sponsor underwriting and projecting performance based on a conservative estimate rather than the last couple of years’ performance.

Expanse Ratio

You should expect to see Income and Expenses per year outlined in the offering. For a quick sanity check, verify that the expanse ratio is between 50% and 60%. If the expense ratio is below this, the Sponsor might not be planning for expenses correctly, and if the expenses are higher, there might not be much room for returns. 

Speed of renovations

If you are looking at a value add deal, inquire about the speed of renovations. If the Asset is 200 units and the expectation is to renovate 80% of that in one year, chances are this will not happen. Two factors will impact this:

  1. Occupants –  there are people still occupying the units, and you have to wait for a lease renewal or an incentive for them to allow renovation
  2. Renovation time – it takes time to renovate a unit, and the more units you have to renovate, the larger the number of crews you need to have.

While not impossible for the above to be accomplished, you would want to ask the sponsor for a track record from past projects demonstrating their ability to complete such a massive project so quickly.

Debt Details

We have all heard about interest rates going up, right? Well, a big part of a Real Estate Syndication success relies on debt. Debt is what makes the returns of Real Estate so lucrative. From a Debt perspective, you want to look at the following:

  • Debt share – with the recent rate increases, this has fallen to 50-65% of the purchase price 
  • Fixed vs. Floating Debt – if fixed, what is the loan maturity? If floating – can the property sustain raising interest rates? Was there a rate cap purchased?
  • Interest rate – what interest rate is obtained. Note that you might see some lower rates as more properties are making loan assumptions. With this, it is important to check the loan maturity again to ensure that it will align with the hold period and, ideally, go beyond. 

With the new uncertain state of interest rates, this might be one of the most important items to understand. A lot of syndications are getting into trouble as interest rates increase and rate caps expire.

Conclusion

We know it is a lot to learn, but ensuring that not only the Sponsor gets vetted, but each deal is paramount for a successful Real Estate Syndication investment. In future articles, we will dive in deeper into each of these factors. For now, check out these additional articles to continue your learning:

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About Prolet Miteva
For over 20 years Prolet Miteva helped some of the leading tech companies design, build and analyze their products. Now she is focused on designing, building and helping people analyze smarter their passive real estate investments.Prolet started her real estate investment journey 13+ years ago with a single-family rental. Shortly after, she realized that the real power of investing is in syndications. Now she is focusing on her investments and building up Wealth Syndy to the tool the passive investors deserve.