For the first time investor and even for repeat investors, the syndication of multifamily deals can seem to be an opaque and complex process. However, the process is quite straightforward despite the complexity of specific steps in this process. We hope that the answers to these Frequently Asked Questions will help clarify the process. We suggest you watch the explainer video under the “What is deal syndication and how does it work?” FAQ which will provide a broad overview of the whole process before delving in to the other sections. And, as always, please don’t hesitate to reach out to us for any clarification or further detail.
Investor Frequently Asked Questions
This brief video explains the deal syndication process:
Identifying the "right" deal in which to invest can be a long process typically involving reviewing and analyzing many, many deals before finding one that meets our criteria for investments. In general, our process has the following broad steps:
- A macro analysis of the market and of the submarket. The market analysis includes population, job, and income growth trends (and associated forecasts) as well as crime trends and fundamentals of housing supply and demand in that market. We then repeat that analysis for the sub-market in which the property is located. In addition, for the sub-market, we look for proximity of retail, schools, places of worship, access to employment centers etc. for that property as well as whether or not the property is in a flood zone or other factors which may pose a risk to the property. Once we feel comfortable with the location of the property, we proceed with the next step
- Underwriting the deal is a critical next step where we place a value on the property by forecasting income growth (and/or expense reduction) at the property. This involves a thorough dissection of the most recent T12 and Rent-Roll (using our analyzer) and identifying opportunities for revenue optimization. In addition, we review the rents and amenities of comparables in the area to get a sense of how the property compares to its competition and to assess opportunities for revenue growth. We also tie this back to the sub-market analysis to help determine if revenue growth is supported by incomes and home prices in the area
- If the initial financial analysis provides sufficient comfort for us to move ahead, we engage with property managers, tax consultants, mortgage lenders, and insurance brokers to fine tune our underwriting and arrange a visit to the property. This most likely results in multiple rounds of fine-tuning of our underwriting. Throughout, we use conservative underwriting principles to help ensure that we have sufficient "safety margin" in the deal to help us navigate unexpected events in the life of the deal
- If after all of this analysis, the property still appeals to us, we submit an offer. Typically, in markets that we operate, there can be multiple rounds of bidding and we only stay in the process up to a price that we are comfortable with: if the prices reach a level which will preclude us hitting investor returns, we bow out of the process. It is not sufficient for a property to be merely profitable: it needs to hit return metrics that we set based on the market in which the property is located and of the type of the property. We do let the broker and seller know of our interest in the property at our price - sometimes a deal can fall through with the initial bid winner and the deal may then be available to us at our price
- Once our offer is accepted, we do a thorough due diligence of the property itself including a full audit of leases and financials. The due diligence also includes engaging structural engineers and designers to identify any deferred maintenance items as well as to fine tune our rehab plans. Any significant discrepancies found that deviate from initial seller representations may require a renegotiation of contract terms and, unusually, termination of the contract
- Once this due diligence has been completed, we finalize our financing and close on the property before commencing on our business plan for the property
Given all of this, it should be unsurprising that deals that we like are far and few in between
Finding deals that work from a returns perspective is a key challenge: we simply cannot cover the number of markets that would be required to scale this in an efficient manner. In addition, others may have seller and broker relationships that allow them to source deals that we simply may not see even in the markets in which we operate. For these reasons, we are constantly in contact with a number of trusted partners who may have access to deals that we like. When presented which such a deal, we do our own due diligence on the market and financials of the deal before deciding to partner on a specific deal. In addition, the size of certain deals may make require multiple partners to invest in and close on the deal. Real estate truly is a team sport and it is one of the reasons that we love being involved in this market!
The cap rate (or capitalization rate) for a property is the returns that are achieved from an all-cash purchase of a property: it is a measure of the unleveraged (i.e. without any debt) returns from a property investment.
Mathematically, the property cap rate is simply the Net Operating Income (NOI) divided by the purchase price of the property. The NOI is the revenues less operating expenses at the property.
The property cap rate should not be confused with the market cap rate which is an aggregate measure of the returns of equivalent properties in that market. The market cap rate is used in the determination of the value of a property based on its NOI. Thus, the key objective for the general partners in a deal is to increase the property's NOI by either reducing expenses or increasing revenues. Increases in NOI manifest themselves in increased valuations for the property via the market cap rate.
As a specific example, consider a property with an NOI of $720K per annum at the time of purchase of the deal for $12mm. The property is purchased at a cap rate of ($720,000/$12,000,000) = 6%. Note that this is not the market cap rate which may be above or below 6%. Why would a buyer purchase a property at a cap rate different from the market cap rate? There could be few reasons for this: the market cap rate is an aggregate measure for properties of that type in that market; however the property may have characteristics that may justify a lower or higher purchase cap rate. Another reason may be that the property has significant opportunities for value creation which may justify the buyer paying a higher prices than the market cap rate may suggest.
Through a combination of increased revenues (e.g. via higher rents through rehab’d units, increased other income etc.) and reduced expenses (e.g. via implementation of water conservation measures at the property), the property’s NOI increases to $960K per annum after 3 years. If the market cap rate at this time is 6.25%, the property will be valued at $960000/6.25% = $15.36mm, an increase of $3.36mm from the purchase price.
Publicly traded securities (such as stocks that are bought and sold on exchanges) have prospectuses that provide details on the security offering. A Private Placement Memorandum or PPM is the analog of a prospectus but for private placements such as multifamily syndications. Each time an investor invests in a real estate syndication, she will receive a PPM which should be read and understood. Relevant portions of the PPM are then filled out by the investor and the General Partner in order to document the transaction. We typically distribute PPMs via DocuSign for review and execution which makes the process fully electronic, fast, and convenient for all parties.
The purpose of the PPM is to create a legally compliant framework for raising capital from investors. It is primarily a disclosure document that is descriptive in its style and allows the investor to decide on the merits of the investment. It is designed to provide full disclosure on all aspects of the offering: the description of the property, the business plan, the terms of the offering, any commissions and fees, and any risks associated with the investment. It is not a marketing document although certain elements of the PPM can be used to serve a marketing purpose. As such, a robust PPM can be seen as an indication of an experienced and disciplined sponsorship team.
The components of a PPM are:
- Introduction: This section summarizes the company, its principals, its core business, and information on the property and a summary of the high level terms of the deal.
- Offering Terms: The economic terms of the offering are summarized in this section including the offering period, the minimum required investment, the capitalization of the company, along with estimated costs of the business plan. This section also covers the provisions to protect the investors including liquidation, conversion, and voting rights
- Risk Factors: Any relevant risk factors to the specific syndication as well as general risks in similar investments are spelled out in this section. Risks may include competition or market risks, tenant risks, regulatory risks, liquidity risks, and legal or tax issues
- Other Documents usually bundled with the PPM include:
- Operating Agreement
While the PPM defines the characteristics of the deal and associated risks, the operating agreement defines the rules, regulations, and provisions that govern the internal operations of the entity. This includes, in detail, how the company will operate, how meetings and votes will be held, how distributions will be made and when, where to access project books and records etc. The general partners must adhere to these components of the Operating Agreement. It also spells out the rights and responsibilities of the limited partners to which they must also adhere. Essentially the Operating Agreement takes over when the deal is closed and is being operated.
- The Subscription Agreement is the application for the investor to join as a Limited Partner. The agreement is with the company and specifies the number of shares that the company is agreeing to sell to the investor which the investor in turns agrees to buy at the specified price
- Investor Suitability Questionnaire: This Questionnaire is used to obtain certain information from the investor which is then used to determine whether the investor is an Accredited or Sophisticated Investor as defined under applicable state and federal securities laws
- Operating Agreement
While not all deals will have all of these fees and some deals may have other fees, the typical deals that we sponsor have the following fees:
- Acquisition fee: this is typically a percentage of the purchase price of the property and compensates the General Partners for all of the work and some of the costs involved in identifying and acquiring a property. It takes analyzing many, many deals in varying levels of detail before closing on one. This fee is typically between 1-2% of the purchase price for the property
- Asset management fee: this is the fee paid to the asset manager for overseeing and executing on the overall business plan of the property and is typically 2% of collected revenues
- Property management: while this is typically represented as a fee, it is an ongoing operational expense item paid to the property management firm for ongoing operation of the property. This typically averages between 3 and 4% of revenues
- Splits: see the FAQ on splits for more details
In addition, there can be other costs in the deal including broker fees, lender fees, and other closing costs. It should be noted that the pro forma returns communicated to investors are all net of these fees.
The preferred return is the threshold return that must be paid to the Limited Partner (LP) or passive investor before the General Partners (GP)are compensated. For example, if the preferred return is 8%, the total equity in the deal is $1mm, and the available cash for distribution in a given year is $120,000, $80,000 is paid to the LPs and remaining $40,000 is distributed to LPs and GPs according to the specifics of the deal (see the FAQ on split).
Preferred returns are typically carried over to the following year if not met in a given year. For example, in the example above, if there was only $70,000 available for distribution in that year, all $70,000 is paid to the LPs and the remaining $10,000 is rolled over to the following year when the LPs are owed $90,000 before the GPs receive any compensation.
After the preferred return is paid to the LPs, the remaining cash is distributed amongst the LPs and GPs according to the split documented in the PPM. If the split is 70% to LPs and 30% to GPs, then the remaining cash is distributed accordingly: 70% of the cash in excess of the preferred return is paid to the LPs and the remaining 30% is paid to the GPs
The typical minimum is $50K although certain deals have a $75K or even $100K minimums
Distributions are typically made quarterly and usually start after 6 to 9 months after acquisition. Any return of capital and any gains from sale are typically made within 30 days after sale. Similarly, any return of capital on refinancing events are also made within 30 days of the refinancing event.
For each deal, monthly updates on the status of the business plan and associated operating metrics will be sent out. In addition, quarterly distributions will be made approximately 15 days after each quarter. At the end of each year, a K1 statement will usually be sent out before March 31st barring any unexpected circumstances.