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Syndicating a small or very large piece of real estate - be it a JV on a small scale or pooling of your money with others to buy larger commercial real estate projects is a great idea - if executed well. It is a proven path for wealth creation - if bought at the right price and managed well. Not all real estate classes are created equal - and not all operators are equal either - and this recent recession is a case in point. There are 10 typical mistakes in real estate syndication projects / JVs that you must avoid ! What are they ?
1. Inexperienced Operator with NO OPERATING TRACK RECORD.
Operating a business is hard work and takes years of experience .. through the peaks and the valleys of the economic cycles. Many a syndicator has had some success raising funds, sometimes for flow-through tax deals or for other parties. They make a commission only. Hey, let's open up a syndication firm they say. Buy an asset and manage it and take commission and an operating profit. Big mistake in many cases as it takes years to understand how to buy, even more years how to buy well and not overpay .. and even more years to manage an asset well .. especially in a more normal less heated economy !
Thus: check the operator`s and the sales person`s track record ! Scrutinize the depth of knowledge in the asset space they operate .. and not just before the boom that ended in 2008 .. but through it ! Don`t confuse slick marketing for a great investment !
Also ask: Has the sales person selling you the product actually delivered real results on previous products sold ?
Talk is cheap .. and sexy marketing with beautiful charts and fancy pictures is only a bit harder but still very easy ! Delivering hard returns in the harsh cold reality is very hard .. and has been done by surprisingly few !
2. Unrealistic ROIs using unrealistic assumptions or paying you from your own money
`Double your money` .. by gambling in Las Vegas ! Place your money on `red` on the roulette table, and you too could make a 100% ROI in 2 minutes ! But on average, you`ll lose ! Hence: look at the risk adjusted return: look first at the chance of a return OF your money .. then look at a return ON your money !
A common trick is to use unachievable future values of condos or land prices as a high ROI is easily achievable on a spreadsheet or in an ad. However this is now a lower demand world caused by more cautious and financially less wealthy baby boomers.
Although housing has shown feeble signs of recovery, this economy has been a wake-up call to investors who thought they could ride a never-ending real-estate bubble for condo projects, land sub-divisions or international real estate in hot markets like Costa Rica, Mexico or Belize. Then there's commercial and office real estate, where many institutional investors have recently taken enormous losses.
Additionally, often the promised returns are paid from your own investment $s ! It is easy to produce a 20% return over 5 years .. by paying you your money back. Thus: look at the underlying vehicle that produces this return. Thus: are these future values achievable in the timelines advertised ?
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3. False sense of security - syndications using terms such as "asset backed" or " up to 18%+ interest on our mortgages" or "secured by a mortgage" .. since in many cases these mortgages are in 2nd or 3rd position and exceed by far the value of the underlying real estate. In construction or land development projects the investors money is often in 2nd or sometimes in 3rd position behind an expensive first position .. hardly security but a sham ! Don't call it a mortgage if it is indeed equity or investment dollars.
Thus: security not in 1st position or exceeding going in prices, based on future speculative possible prices is not security .. it is false advertising !
Related post on "guaranteed" returns: http://myreinspace.com/public_forums1/f/62/t/20207.aspx
4. Overpriced Assets sold to innocent investors at a huge premium.
Often an asset is purchased by the syndicator, and then sold to the "innocent" public for a lift up from a low of 20% to several 100% on some land deals. This used to be OK in a very strong market. Thus: check the true asset value if you intend to invest .. and do not accept their excuses for uplifting the building or land value because there isn't any ! Then hopefully you can co-invest with one of the many ethical syndicators out there !
5. Excessive Fees - usually upfront - independent of project success !
Some syndicators charge in excess of 10% sales commission which seems to be the norm but is still very high. Some operators charge an acquisition fee, like a realtor, of up to 3 or 4%. While this sounds low, on a 25/75 mortgaged asset a 3% acquisition fee is actually 12% on the invested cash. Also an annual asset management should probably not exceed 0.5% on the asset value or 2% of the cash invested ... otherwise it is too rigged towards the syndicator and not the investor.
It has to be win/win ! Lower is better !
6. Improper Legal Structure .. There are 5 exemptions a real estate operator can use to do a syndication in the so called exempt market. They are called exempt, because the issuer is exempt from having to file a prospectus with the security commission. The units purchased are often also referred to as securities. What is a security ? It is an interest in land or a piece of real estate, an undivided interest, voting shares, non-voting shares, REIT units, mutual fund trust units, limited partnership units, a syndicated bond or a share of a mortgage .. all with an unknown outcome. These security exemptions are:
a) friends and family
b) close business associates
c) over $150,000 (so called "aggregate acquisition cost")
d) accredited investors, those that have over $1M in investable assets or an income over $200,000 for the last 2 years
e) an offering memorandum, with certain restrictions (differs slightly by province) such as an investment under $10,000 or for eligible investors (investable assets of $400,000 or $75,000 in income .. a lot lower hurdle than accredited)
Therefore, if you are not a friend or family member of the operator nor his close business associate nor are you accredited nor do you want to invest over $150,000 you should have an OM. This is different if your buddy from high school with whom you golf twice a month is opening his second restaurant, and he asks you and 4 other friends to pony up some money. An OM is not required, just a simple agreement. The line between a JV between 2 or a small number of people (say 12) and a security is not defined .. in a small group scenario a USA (unanimous shareholder agreement) is signed by all parties, which nevertheless should allow for the first 3 exemptions as even a USA could be deemed a security by the various security commissions.
7. Executives that were charged .. by the Alberta or BC Security Commissions or are embroiled in lawsuits with their current or previous investors.
Thus: check out the project and the people and sales people behind the project. What did they do before they did this venture ?
8. Big ads promising huge returns. The advertised return initially are usually paid for with your own money. Big ads are an expense to the business. These marketing fees often approach 12% to sometimes 20% of the funds raised .. plus sales commissions .. plus acquisition fees .. a very high hurdle as it has to be made up through asset performance which takes a few years. A 30% initial cost hurdle (incl. sales commission) assumes a return of well over 40% on the remaining 70% productive cash just to break even ! A 35% cost hurdle needs a return of 50% on the productive cash to break even ! A 40% cost hurdle needs a return of over 66% to break even !
Thus: look for soft costs or marketing costs besides (huge) commissions (and acquisitions fees) too .. 3 % - 5 % of money raised is reasonable .. more is not !
9. Not taking ownership of the asset although promised by their marketing. Ensure that the investors actually own the asset ! Frequently the asset is not held by the investment group but by a privately held company and the money is lent to them. It is now almost impossible to trace the money trail .. especially if this company also co-owns many other assets with many mortgages. Thus, one collapsed and unrelated project can derail your project too !
10. Proper Disclosure .. All relevant facts should be disclosed upfront by the operator: the fees, the intended venture, any uplifts, the legal location, the price, intended timelines etc. ... Therefore if the syndcator buys piece of real estate for $250,000 and syndicates it to 3 investors at $100,000 each, each for 25% of profit and 25% for the operator after he takes a $50,000 fee or "uplift" that is not illegal. It may be a bad venture (or it may not). The security commissions do not care if the commercial nature of the venture is bad. They care about disclosure, filings and forms. It is your job to check all relevant facts, and if the fees or prices are appropriate and if the advertised numbers, usually outside the legal documents, are actually achievable in the real world !
In summary: it has to be win/win Are the operator`s profits aligned with yours, the investors i.e. usually at the end on exit? Or are they lining their pockets upfront regardless of asset performance ?
There are quite a few scams out there .. and many were in the news lately .. but even more exist that just exploit the legal loopholes .. but there are many honest folks too. Use these 10 guidelines to distinguish between the honest and the dishonest operators .. and you too can successfully and profitably co-own a small or larger piece of real estate or a pool of hard assets with others !
Share your positive and especially negative experience here if you wish .. possibly with other related websites.
State facts only to avoid defamation claims or cease-and-desist letters !
no "XYZ are crooks" or "ABC stole my money" .. as this is too vague and potentially libelous ! State "I invested XX $s in ABC firm and now they are in receivership" or "I invested XYZ $s and the firm doesn't answer my emails or phone calls" .. or just state "XYZ firm charges X fee and Y fee and Z fee and ABC equity" or as I have seen in a hotel development project in Calgary: no disclosure whatsoever how profits between A shares (owned by investors) and B shares (by the syndicator) are shared. Nothing whatsoever !
Just because some auditors are crooks doesn't mean all are. Some because some lawyers go to jail doesn't mean many are dishonest. Just because some merchants cheat you not all are dishonest. Same in the real estate syndication business ! Many honest folks trying to make a living and offering a credible product. Some not so honest folks .. and some that operate a ponzi scheme or an outright fraud using legal tricks.