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Analyzing a Real Estate Syndication like a Professional Underwriter

Real estate syndication funding starts with limited, passive investments that cover, at minimum, the down payment on the purchase of a commercial real estate asset, such as a multifamily investment property.

Before committing to a deal, passive investors must conduct their own investigations and find a lucrative deal in which to invest their money.

Soon-to-be investors perform due diligence by looking into the business plan's details and investigating the general partners' performance history. For example, as you consider your next syndication deal, find out if the sponsor generally has profitable or negatively cash-flowing deals in their past.

Do they have a plan if the market goes south?

What are the potential returns compared to the risk?

As a limited partner evaluating deals at your own risk, you have to know how to assess real estate syndication investment possibilities. What does "conservative underwriting" from the fund's sponsor imply? What are some ways to become an expert deal analyzer?

The best way to evaluate real estate investment like a professional is by doing the same steps as an expert underwriter. This means understanding how an underwriter deciphers if a real estate syndication has the potential to be profitable. In this article, you’ll learn how to evaluate their business plan, the real estate market, and operating agreement.

Keep reading to discover three expert underwriters' tips for looking at a real estate syndication arrangement from a conservative viewpoint. Then, after you've finished reading, you'll feel more confident performing due diligence on the next potential real estate syndication that comes along.

Take Your Time Reading the Investments' Business Plan

A well-formed business plan is crucial before dealing with property owners. Acquisition fees, the management team, renovation expenses, asset management costs, and who can invest in the company should all be included in the business plan. The following sections will walk you through net operating income, annual income, and expense projections.

The Occupancy and Cash Flow Relationship

As a passive investor, you’re likely interested in generating cash flow from your investment capital. If you’re examining a potential investment’s financials, consistent cash flow and high occupancy will paint the investment opportunity in a positive light. A commercial real estate syndication opportunity reflecting positive cash flow upon acquisition is more likely to allow the general partners and management team to execute strategic business plans for renovations, updates, or greener-living choices.

Occupancy is the number one indicator of how much cash flow a property generates. Therefore, cash flow should be high if a property has high occupancy. So the question you should ask is: why does this property have such high occupancy?

Usually, properties with high occupancy are well-kept. This means that the landscaping is attractive, there aren't mounds of trash anywhere on the premises, and the pool and amenities are in working order. These details lead prospective renters to look favorably upon the property, which keeps current tenants wanting to stay put.

In contrast, let's explore what contributes to low occupancy rates. One possibility is the property's physical appearance; if it appears run-down or needs TLC, that could be a turn-off for potential tenants. Another possibility is that the property is new; sometimes, these places just haven't had enough time to reach maximum occupancy.

In either case, a strong business plan will detail how the management team plans to market the property to reach desired occupancy levels.

Operating Expenses of the Investment

While passive investors aren’t in charge of managing operating expenses, it’s a useful and informative exercise to walk through what the syndication and management team(s) consider as they’re vetting a commercial real estate property.

First, the syndication team ensures the operating expenses of the property don’t exceed a set percentage of revenue. They ask themselves, “What will it cost to keep this property running and in good working order?”

Begin analyzing the potential costs the management team might face by browsing the offering documents. Sometimes it’s possible or even necessary to pay the property a quick visit. Consider the property's condition, maintenance and upkeep, personnel costs, taxes, assessments, and other charges that can vary depending on the property type or location.

If it has been well-maintained or is a new build, renovation expenses should be low, resulting in increased projected returns. However, if the property needs some renovations (value-add), part of the capital raised upfront will likely be used to cover these costs. This will attract more tenants and allow for higher rental rates in the future.

A real estate syndication's operating expenses should also consider tax implications from the property's purchase price, interest costs, and--very importantly--the property management team's costs and asset management fees.

Attend investor calls, scour the documents provided, and don’t be afraid to ask the operator about their track record and whether they’ve successfully implemented business plans like that outlined in the offering. Then, do further vetting on the syndication team to uncover which prior projects were most similar to this one and how those turned out.

Research Other Properties in the Area

Once you understand occupancy and operating costs, as well as a general understanding of the company's real estate investment plan for this piece of real estate property, you'll consider the rental rates. Forming your impression of comparable homes' condition and rental rates is part of the due diligence procedures. In other words, look at how much rent per square foot is the "market norm" for comparable properties in the area.

It's common practice, particularly on new builds, for the developers to provide below-market rents and perks such as "first month free" to attract renters. However, when searching for yield-play or value-add investment opportunities, the current property manager may be offering low rent rates with the understanding that comparable assets elsewhere provide superior amenities, more up-to-date interiors, or are in a better location.

The operator develops a strategy for incorporating gradual and constant rental rises over the next few years of ownership until market value rent rates are reached. Rental increases are usually related to new facilities, unit upgrades, greater efficiency, and a better property management firm being put in place at acquisition. In addition, if operating costs are kept low, investors should see their return on investment rise as rents climb.

The two primary duties of general partners that will have the most impact on net operating income (and, as a result, ROI for all investors) are raising rents to market rates and keeping operating expenses low.

Of course, the operator team relies on the opinions and projections of reliable, experienced professionals in the tax, legal, and property management field when determining whether or not to invest in a syndication real estate deal. However, as you explore the possibility of investing your own financial capital into a commercial real estate syndication, you must use your own common sense and research to analyze the information presented.

In short, do you agree with the cost of owning and managing the property throughout the investment period? Do you understand how the numbers for estimated ownership costs, rental rates, or other metrics were calculated?

If not, ask! A reliable, honest GP team should be happy to answer your questions and break down the calculations to help you.

Is the Risk Worth the Projected Returns

You got into real estate to make your money work for you and generate dependable, prolonged returns. However, as a passive investor, the number one thing you are responsible for is researching each real estate deal thoroughly before using your savings as investment capital. This process may appear to be more complicated if you're new to real estate syndications and trying to make your first investment.

To determine if the real estate syndication deal aligns with your objectives, each investor must thoroughly study the business plan and private placement memorandum.

While there's no such thing as a risk-free investment, you can evaluate a real estate syndication's strategy to see how it minimizes risk and offers cash distributions to passive investors on a dependable schedule.

Consider the tax benefits of depreciation in conjunction with the expected cash flow returns, as well as any profit shares you may receive upon the sale of the property. Finally, compare all of these to your surveys of rental rates, tenants' demands, and the property's track record for management and sponsor team.

Questions you should consider before investing:

  • Do you think the projections given are correct and based on data?

  • What could make the deal fall apart, and how might your investment be saved within the deal?

  • Is the general partner’s financial data reasonable, and are there more potential upsides or downsides than what's being stated?

  • Based on the sponsor team's past performance, can you trust this real estate syndication opportunity?

A competent real estate syndicator understands that all (sophisticated or accredited) investors feel safer and more confident when risks are reduced and will work to provide you with evidence of successful markets.

Time Is Money! Successful Investing Requires Thorough Research Beforehand

It is crucial to attain adequate knowledge about real estate investing before impulsively jumping into it. Investing in a real estate syndication is not the same as investing in the stock market or purchasing a rental property.

Now that you've heard it from a conservative underwriter’s perspective, you know how to do your homework and assess offers before putting your signature on a private placement memorandum (PPM).

Although it may appear complex, analyzing real estate syndication deals is crucial to mitigating the risks of investing in a property. While you can't change economic conditions or know how much your assets will be worth, you can take charge of risk management by scrutinizing the real estate syndication deal.

If you learn to think like a conservative underwriter, you'll see the markets differently and assess risks better. In addition, this skill set will help you use real estate to finance your long-term goals and grow your wealth.

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