A diversified mix of investments is often promoted by financial advisors and gurus as a way to reduce risk and volatility. While this strategy is tried and true, the more diversified you are, the more your portfolio’s returns will resemble the overall performance of the market. You’re not going to be the next Bitcoin millionaire or see your brokerage account go up by 8,000% because you discovered the next short squeeze opportunity. Hello GameStop!
When it comes to real estate syndications, diversification is inherently difficult. Unless you already have millions, high investment minimums can leave you with only a few deals to invest in before your capital runs dry. You have to ask yourself a few questions prior to hunting for the right sponsor or deal. What’s more important to you as an investor? Diversification or a concentrated, calculated risk on a single asset? How about the track record of the operator versus your personal experience investing beside them? What percentage of your total net worth should be invested passively versus actively?
When you’re considering passively investing in a syndication, you have a few choices in the types of offerings you’ll come across. The aforementioned questions are paramount to keep top of mind, so you can identify deals that match your investment goals and risk tolerance.
When I began investing as a limited partner in these deals, I looked at my portfolio holistically and asked myself questions about why I was considering this type of investment in the first place. Step one was simply identifying the type of deals that made sense to complement the other investments in my portfolio. That is a question only you can answer. This post is intended to give you a look at the different types of structures you may come across so you can assess what makes sense for you. As with anything in life, there are always trade-offs.
The single-asset model is the most common type of deal in the space. The sponsor has spoken to you in the past, and you’ve indicated that you’re interested in hearing about the deals they get under contract. Soon after the purchase agreement is signed, you’ll be hearing from them by way of an offering memorandum introducing you to the property and the opportunity. There will likely be a webinar to dive deeper into the business plan and to answer any questions the group may have about the property and the plan.
The advantage of these types of deals is you can personally underwrite the asset being promoted. You can decide if the numbers make sense, if the exit strategy is solid, and if you’re comfortable with the leverage being utilized.
The multi-asset model is very similar to the single-asset syndication. It simply includes more than one property. The sponsor may have uncovered a seller that has multiple apartment communities and is looking to retire from the business. By selling them all to one buyer, they can eliminate a lot of hassle for themselves. The sponsor potentially can get a better deal than they would have otherwise by providing this convenience to the seller. The passive investor gains some diversification with more than one property in the offering.
It is likely that the assets are similar in size and property type, but might not be. If you have a strip mall being sold with an apartment building, ask yourself whether the sponsor has a solid track record in both asset types.
These types of structures require a different level of comfort with the sponsor. In essence, blind pool funds ask the investor to commit capital to the sponsor prior to them identifying one or more assets to purchase. It could be a single-asset blind pool fund that will close to other investments after the acquisition of a single property. Or it could be left open for the purchase of additional assets.
In the case of the latter, you pick up some diversification by having more than one property. What you lose is the ability to underwrite the deal yourself. All you can fall back on is trust that the sponsor is going to make the right decision and invest your money wisely. Ask yourself to carefully consider how comfortable you are with the sponsor and their track record. It may be a great deal, but you won’t know until after your funds are committed.
Semi-Blind Pool Funds
These types of funds are similar to blind pool funds but give specifics in the operating agreement about the characteristics of a property that the fund can purchase. For example, XYZ Fund is seeking 150-250 unit apartment complexes in the Atlanta, Georgia MSA, built between 1995 and 2010, located in B-class neighborhoods, and have light value-add potential. With this type of structure, you are assured that your money won’t be used to purchase anything outside of these parameters.
Blind and semi-blind pool funds are becoming more prevalent in a competitive marketplace, particularly with multifamily. Brokers and lenders want to know that a buyer is going to be able to close. With funds raised ahead of time for the down payment and operational budget, the sponsor has a leg-up on other potential buyers.
I’m invested in both single-asset syndications as well as one semi-blind pool fund. I prefer the identified asset type of investment because, generally, I want to know what I’m buying. I certainly want to be comfortable with the sponsor because a bad sponsor can run a good deal into the ground. However, just like a lender puts more weight on the asset than the borrower in a commercial transaction, I, as the investor, like to underwrite the property.
The fund I’m invested in is with a sponsor who has a decorated track record and team of leaders that have been in the business for decades. They’ve seen multiple market corrections and have had success operating in various stages of the economic cycle. The property type the fund was seeking was exactly the exposure I was looking for and in a market I couldn’t access otherwise with that type of concentration. Generally, I would prefer a REIT over a syndication fund, as a REIT has the advantage of liquidity.
What type of structure are you considering or have already invested in? What do you see as the advantages and disadvantages?
Paul Shannon is a full-time active real estate investor, as well as a limited partner in a number of syndications. Prior to leaving the corporate world, Paul worked for a medical device company, selling capital equipment to surgeons in the operating room. After completing a few rehabs employing the “BRRRR method”, he saw scalability and more control over how he spent his time, and left to pursue real estate in 2019. Since then, Paul has completed over a dozen rehabs on both single-family and multifamily properties. He currently owns over 50 units in Indianapolis and Evansville, IN and is a limited partner in larger apartments and industrial properties across the US. You can connect with him at www.redhawkinvesting.com.
Nothing on this website should be considered financial advice. Investing involves risks which you assume. It is your duty to do your own due diligence. Read all documents and agreements before signing or investing in anything. It is your duty to consult with your own legal, financial and tax advisors regarding any investment.