Ultimate Guide to Syndications: Going from “Active-Passive” Investor to an LP in Syndications and Private Placements

Video version of this article with extra commentary:

In 2016, I paid over $30,000 to get the mentorship to be an apartment operator/investor. What I learned in the process was that I did not need to be a General Partner and that I had enough income and net worth to invest as a Passive investor (LP).

Technically I paid $40,000 on this fiasco too.

Webinar – What are Syndications/Private Placements? – https://youtu.be/n_qsZHBOCS4

 

 

For me, it was simple math. The assumption was that my money would grow at 15-20% a year in part cashflow and equity & forced appreciation.

I was on the flight path to Financial Independence. And this is why I have shifted my focus to non-investing activities and enjoying the journey.

I made the jump to MFH/Syndications after more than 7 years in the SFH mindset. Read more here.

Every investor is at different stages of the game. This article aims to offer guidance on when to make the jump to more scaleable syndications.

Like ‘Rome’ I believe all most paths lead to investing in Syndications (as long as you are not a jerk and can halfway network with people).

Should I invest in syndications or private placements with investment experience?

Most investors start by investing in single-family home rentals. The natural progression is to move into larger more scalable assets such as being an operator/general partner (GP) or passive investor/limited partner (LP) in a syndication. Most novice investors do their research and come to the conclusion after evaluating the scalability, economies of scale, and diversification that bigger deals are the better route, but is that what you should really do?

Wait, what is a syndication or private placement?

I use an airplane analogy when I explain these syndications. In an airplane, the General Partners in the cockpit fly the airplane (find deal, negotiate, find investors, line up lending, manage the 3rd party property management, operate the investment). They are typically signing on the debt and their net worth needs to be greater than the loan size. In coach, you have the passive investors or Limited Partners who come on the plane and go to sleep. We look for both because its all about putting more people together and leveraging each other’s strengths.

Bigger is better

Theoretically, it does make sense. Larger investment deals, such as syndications or apartments, would likely bring in larger cash flow and better deals due to better teams. If you do the math, you will likely net at least $100-300/month per property with a single-family turnkey rental. Assuming you earn a decent wage as W2 employee, you will probably need 20-40 of these single-family rentals to replace your income.

Cost segregations that typically cost around $5,000 create bonus depreciation. Bonus depreciation creates more upfront depreciation – often front loading in the first year of ownership. This is only practical in larger assets or scale.

Cost Segregation & Bonus Depreciation – http://simplepassivecashflow.com/costseg/

I personally had 11 single-family homes, but experienced one or two evictions per year. On top of that, there could (and have) been other big maintenance and capital expenditure events that happen (3-4 a year with the same sample size of 11 homes). In other words, single-family homes can only get you so far and you will need to invest in more to truly generate more cash flow.

Thus, investing in syndications can be an attractive way to achieve true financial freedom because it is even more passive than SFH’s.

The caveat

But before you jump the gun, let us assess the full picture. From 2016-2018, I have had over 1000 strategy calls with real estate investors and coaching clients. (Today Calls are only available to Hui Deal Pipeline Club members) Many new real estate investors want to skip investing in single-family homes and jump into the deep side of the pool and invest in large syndications as a private placement. Who knows if they can swim? Some individuals can make this jump into syndications. Great for them! Keep in mind that this transition is a big step that requires more capital, a larger barrier-to-entry, skills, network, and unequivocally more risk. It might make sense to get a mentor to point you in the right direction.

If you are planning on being an operator or a general partner (GP) with no prior experience then I think you are smoking crack and I wish you luck. Jay Papasan, author of The ONE Thing, agrees here. You will always make a mistake and I would rather see you make it with a small deal first. Entrepreneurship is often about survival. Stay alive until you get lucky. I am one for going after a bunch of singles first then going for home runs. Plus, if you like real estate investing and want to become an operator, you will benefit by building valuable experience as you mold your track record and brand from starting with small rentals. I think that is why SimplePassiveCashflow.com has become so popular because it started small and progressed organically. Its funny that most of my coaching clients who have phenomenal W2 salaries want to start with the small stuff as if they are gluttons for punishment (I think it speaks to their character and how they achieved so much) and the folks with no track record of any success and are broke always want to swing for the fences.

If you are planning on being a passive investor or limited partner (LP) with no prior experience then there is room for some debate.

More often than not, some investors just try it on their own. They network with some lead investors/syndicators and believe in every executive summary they read. Do not be a sucker. This is not a good approach and often leads to investors getting taken by the glossy PDF and profile pictures.

A discussion of risk and severity

The biggest problem with being a LP on a syndication is the potential of working with a shyster who takes your money. This is a very small chance of happening and can be mitigated by due diligence and creating a network that verifies characters. The risk and severity are modeled below.

Being a single family home operator has its own headaches and dangers which I have documented on past articles. It is “extremely remote” to have a $10,000-20,000 move out disaster and a lawsuit. Being a direct operator has higher returns coupled with more risk.

In my analysis of risk, a syndication (with the right people) decreases the variability of the investment performance as shown below. For example, a deal may not perform up to pro forma so instead of a 100% return in 5 years, you get 70% return in 5 years.

One Investor’s Story

In terms of my investment ideas/activity, here’s what is spinning around in my head (Note: The ideas listed below are going to conflict with one another because each path is a different approach):

1. Duplex, Triplex, Fourplex or small apartment complexes – This was the path I was going towards before we got into contact. I’ve been looking at Columbus and Cleveland, Ohio. I liked Columbus more because of population/economic growth. Got in contact with a couple agents from BP that service Columbus and I haven’t found anything that cashflows at a reasonable rate. A lot of deals cashflow at like $50-$150 per door and that’s going to be eliminated as soon as someone moves out. So while I’ve been looking for a bit, nothing yet.

2. Syndications – After coming across your stuff, I thought being a LP may be the preferred route. I get that I wouldn’t get the experience of knowing the ins and outs of RE if I did it myself, but what do I really want out of life? Do I want to spend so much time finding deals, buying, building the portfolio, or should I just be a LP and use my time for other life goals? Not quite sure, but the idea of being LP sounds like a solid approach. In any case, I won’t have accredited status for 2+ years, so I can’t even go full blast into this path unless I get in on similar deals like the ATL one you had.

3. BRRR – Open to doing any BRRR activities. I thought about this path for single-family homes, but I felt like it may be too hard to jump into BRRRing something out of state. That’s why I’ve been focusing on 1. above because Im trying to find stuff that doesn’t need a ton of work. If it needs relatively minor stuff that a PM can fix, that would be preferred before I jump into BRRRing things.

You could pursue a hybrid approach of investing in all of the above (although 2 of 3 would be more practical to not spread yourself too thin).  Again, it totally comes down to how much money and time you have. More specifically if you have a lot of liquidity then you can do more than one track. All these things are totally correct and shows that you have the big picture. Just a matter of choosing which path you want to go on. Congrats!

My recommendations

I recommend for investors to get their feet wet with investing in single-family properties first. Yes, I previously noted issues with single-family homes, which you will experience at some point. But there is no better way to learn and build up the war chest as a prerequisite for more scalable investments and private placement syndications. I believe that once an investor understands this and can 1) build some sort of liquidity and cash flow and 2) be able to call BS when a syndicator starts to use bogus proformas and assumptions.

Keep in mind that entering larger syndications requires serious capital. As guidance (not a rule or SEC law), let’s say you have $100,000 liquidity as a non-accredited investor and are ready to invest in syndications. You will likely only be able to do a couple $50,000 investment deals, which sounds great. But without adequate cash flow coming in from other investments you are a sitting duck for a year or two – the education process stops. So, if you encompass some experience investing or renting out single-family home rentals, are employed saving at least $30,000/year, and/or have some substantial liquidity (over $200,000), the transition would be smoother in terms of liquidity management and education progression.

If you are a tables and graphs person check this out to see a loose rule on when to make the jump to syndications.

In terms of returns, being the direct operator normally produces higher gains. Generally, 25-35% a year on paper if purchased correctly. However with my track record I consistently lost money on 3 out of ever 10 rentals, but overall I hit my anticipated $200-$300 per month cashflow per property. Throw in the chance of a disaster tenant in there like my $30,000 repair bill and a few months of vacancy and you can see how you can quickly go into the red. The only way you can protect from this volatility is to… get more properties! Something to think about in a correction if you are buying turnkey/retail properties is that you will likely be in the red with equity as unlike being a passive in a syndication you are not buying with forced appreciation.

Returns from syndications usually run in the range of 80-100% return in 5 years or 17-20% a year. This is less than being your own operator on a small rental. In terms of risk you are putting a lot of risk that the General Partners will uphold their fiduciary roles. Assuming you mitigate this as best you can by checking backgrounds and only working with those you know, like, and trust with one degree of separation, the volatility of returns is much less than the smaller rental variety. What I like about syndications is that a deal is not done unless there is a lot of meat on the bone which helps protect your equity position in a downturn – just beware of the loan terms and if it is a recourse or nonrecourse loan.

I would say 80-95% of LP investors don’t know what is truly a good deal and invest off what other LPs say (who don’t know either) and pretty pictures. How do I know well I talk to a lot of LPs so that’s why. And a lot of people only invest off the executive summary which does not include the T12 P&L (Trailing 12 month Profit and Loss statement) and rent rolls. Crazy huh?!?

Here is a shotgun spreadsheet that will get you 10% of the way there but in order to truly vet a deal you need to build your network to vet the person via conferences, masterminds, paid coaching from me which I could walk you through a deal.

Another example of trick and games being played:

What is “Cap Rate Gate?”

It’s when a syndicator manipulates the reversion cap rate to greatly influence the total returns, so they can attract investors to a deal. 

Cap rate is the market determination of how much you should pay per NOI. It is what it is and Class A is lower than Class B and Class C. An increasing Cap Rate means it’s a softer market and you are not going to be paid as much for you NOI. To be a conservative underwriter you like to see the Reversion (exit) Cap rate +1.0% higher than the starting cap rate. For example if your starting Cap Rate is 6.25% then you want to use 7.25% as your reversion cap rate.

The Reversion is a “wild-ass guess” to begin with. That is why you want to be conservative as assume you will sell in a softer market. By using anything less than +0.75% is simply “kicking the can” down the road. Likely what the syndicator will do is just blame the missed targets on the economy where it was just screwed from the get go.

See below how much it impacts the total return. This is why you need to look under the hood and stop taking the “sticker price” for face value.

Four ways Sophisticated investors diversify in syndications:

1) Different leads/operators

2) Asset classes such as MFH, self-storage, mobile home parks, assisted living

3) Geographical markets

4) Business plans (5-year exits vs legacy holds)

Whatever you do, try to stay as close to the investment as possible. Knowing your syndications’ operating team is the most important part of the deal. Do not invest with random people. Even if the operators are good, there is the chance that good operators do bad deals and you need to be able to be on the lookout for the “money-grab.” You want to have the experience to understand their offering at the surface level as opposed to blindly jumping on board because of the promised return on investment. And to do this you need to analyze the Profit and Loss statements for the last 12 months, rent rolls, and pull your own rental comps. These items are typically never disclosed to investors. As you can see it’s a game of smoke and mirrors. The less data they give you the less questions and the less question the more likelihood of you investing.

Crowdfunding sites are great in theory but sort of like online dating websites for syndicators who can’t find funding. Do you really want to work with these people?

Well online dating really isn’t too bad and in some ways become the normal from 2010 on but Crowdfunding sites are still in their infancy.

In the end, do not forget your end-goal. About 80% of investors who stumble on Simple Passive Cashflow want passive income. Folks start drinking the Kool-Aid, and will be financially free in 4-7 years pending taking action. Always keep your end in mind by taking a more passive approach and start designing your ideal lifestyle today.

See chart here for further visualization

Beware of going the Mom and Pop route

Thinking about flipping houses? Do so for the fun of it but for most high paid professionals when you factor in your hourly rate and the risk of market volatility you are better off staying at your day job..

You’re competing with the pros.. People who spend all their conscious and subconscious time trying to source the best properties and managing people correctly. You may kick butt at work but often managing white collar subordinates does not translate to leading blue collar personnel.Many deal hunters I know spend off hours taking brokers out to lunch or a Dallas Mavericks game frequently to get to the top of the list for the next deal.. Your competition also has overseas virtual assistants combing seller lists for the next deal. Not saying you cannot find a deal on your own but who are you kidding?

Lets assume at one in one-thousand deal falls into your inbox.. This is at best because I personally get over 20 deals in my inbox a day and a few syndication deals that has met their minimal deal standards (however they may be).
Where do you live?
I put great emphasis on having a deal sponsor be local to the property where they can passive birddog the property and respond to an issue.. Some investors I know say its a total deal killer not to have the person live there their whole life.
You cannot have a property management company be your eyes and ears.. Maybe this strategy has worked with 1-8 units in the past but those properties are very forgiving.. In the end ask yourself the question…. are you ok letting a $12-15 an hour person (who is constantly looking for a better gig) manage your $3M asset? No, there needs to be a general partner local or making routine trips to oversee progress.. Especially when there is other peoples money at stake!

Mom and pops – you have to love them! They go into single-family homes and scale up to duplexes, triplexes, quads, and to 8 units, 16, 20…

They read something like this and they think they get some property management ($12-$15 an hour employees) and think they are good. #BiggerPocketsBro

Here are more reasons why this path is flawed:

  1. Lending terms over 4 units and under 1 million dollar loan size is no man’s land for lending. Banks know this because amateurs do these types of loans and the failure rate is so high. Worse rates, terms, and resource debt.
  2. Mom and pops have all their money (100-400k) in one deal. This is not diversification.
  3. A few years ago me and my partner had the idea that we would just pull our money together and go into one of these under 50 unit apartments since at the time we were a still wary about trusting another person. But as we started looking for deals and running the numbers we realized that the pricing was worse than the over than 60 unit deals due to the competition of unsophisticated mom and pop investors.
  4. Mom and pop investors usually suffer from trust issues. They have severe blind spots and it is rare that they are a sophisticated well connected investor. Yes they take painstakingly care of the property and pick up trash when ever they are there but that only takes you so far.

What I like about mom and pop investors is that they eventually screw up and sell to us sophisticated investors at a discount.

I know that’s not nice :/

Commentary from other Hui Deal Pipeline Club Members:

“My near term goal (2 to 3 years) is to invest $500k to make $4k to $5k per month of low risk, real estate passive income (if still possible), I was thinking that deploying this as a limited partner over a few geographically diversified multi-family investments was a good way to get started, and to start learning.  One of your first podcasts I listened to (SPC080) was one about when you decided to move to Multi-family from Single family.  I agreed with most of your arguments in that podcast: 1) I don’t want to buy another job 2) SFH’s only scale so far 3) the return on SFH’s may not be big enough to justify the time put in (most of the turnkeys I’m looking at now have pretty low cashflow), however, it is a good small investment to learn the business. The 1st rule, or course is to not lose money…  So, therefore, following your path and taking it step by step is more prudent.”

“Many of the points you hit on are the same pain points that I am currently working through myself in regards to real estate investing. 1)  I’ve invested in SFH rentals currently and in the past, and the cash flow from these deals are great. However, the time commitment to my W-2 career prevent me from scaling this investment model. 2) Syndications are the way to go, and that’s why I’ve sought out a trusted mentor like yourself to teach me the ropes, and to bounce ideas off of to try and mitigate risk as much as possible.  It’s tough giving someone your money in hopes that they will maintain and deliver on their fiduciary responsibilities. If the opportunity is good enough for you to place your hard earned money, based on the trust I’ve developed in you, it’s good enough for me. Right now I’m building my war chest so I can go to battle on financial freedom.”

Other resources:

Here is info in Turnkey rentals or Turkey rentals.

Here is a webinar I did explaining what a syndication is: https://youtu.be/n_qsZHBOCS4

Our latest 253-unit acquisition in San Antonio (Mystery Shopping): (March 2018) – https://youtu.be/vj8ZMteppfg

Post-purchase mid-rehab walk-through (March 2018) – https://youtu.be/-5h2GKZ3I58

Here is another 52-Unit deal in Iowa: https://youtu.be/rzLARk-x0JY

Post-purchase early rehab walk-through (April 2018) –

https://www.youtube.com/watch?v=bgxEV68CWpE&feature=youtu.be

More videos and webinars provided to Hui Deal Pipeline Club Members. Join here!

For actual FAQs from past deals please email Lane@SimplePassiveCashflow.com for the password.

This why we invest in B and C Class deals and stay away from Class A (typically unless its a good risk-adjusted return).

The “Bread and Butter” investments (Living Guides):

Being your own Bank
Leveraged stock investing
Non-Preforming Notes
High-level snapshot of the current cap rates

Other Investments a little out there…

Crypto
Hotel investments
Oil & Gas
Website/Online Business repositioning
Life Settlements
Conservation Easements
Diamonds (Just joking)
Go Bigger! Diversify your money! Invest alongside the pros!

Four ways Sophisticated investors diversify in syndications:
1) Different leads/operators
2) Asset classes such as MFH, self-storage, mobile home parks, assisted living
3) Geographical markets
4) Business plans (5-year exits vs legacy holds). And take advantage of the overall scalability and Cost Segregation & Bonus Depreciation

*Usually I see investors place no more than 5% of their net worth into anyone deal

Join us on the Quest for the Uncorrelated Assets!

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