The Capital Stack
Comparing Funds and Syndication
Real estate deals are funded in a multitude of ways. Companies like ours will typically operate with a fund or raise capital on a deal-by-deal basis (syndication). Last week’s newsletter reviewed the pros and cons of the fund model. Now let’s take a look at our go-to approach thus far, the Syndication model.
Syndication (Deal-by-Deal): Syndication refers to the process of raising capital on a deal-by-deal basis. In this structure, a sponsor (also known as the syndicator or lead investor) identifies a specific multifamily property opportunity and raises funds from individual investors for that particular deal. Each deal is treated as a separate investment entity. Syndication allows for more flexibility in choosing specific properties and gives investors the opportunity to select the deals they want to participate in based on their preferences.
- Single asset risk isolation
- The equity is raised for a single asset allowing investors to evaluate each property and determine if it fits their criteria. This allows for a seamless risk evaluation process.
- The sponsor has the flexibility to customize the structure of each deal individually. This allows the sponsor to tailor the terms of each deal to accommodate to the specific preferences and requirements of potential investors involved in that particular investment opportunity.
- No pressure to do a deal
- Without having funds raised in advance, the sponsor is not under pressure to meet preferred return hurdles until they close on the deal. This can lead to a more disciplined investment approach.
- Single asset risk isolation
- In a deal scenario, if an investment performs poorly, investors face the risk of losing their entire investment. In contrast, in a fund structure, the blended average of all the deals can help offset losses and potentially ease the impact of underperforming investments. This diversified approach allows the strong-performing assets to potentially uplift the overall portfolio performance and provide some level of protection against individual investment setbacks.
- No proof of funds
- When the sponsor is in the process of acquiring a deal, they may not have proof of funds to demonstrate their ability to make the purchase. This hurts their credibility when dealing with sellers, lenders, and brokers. The sponsor must show that they have the capability to raise the necessary funds during the due diligence period.
- Fee income
- Fees in multifamily real estate are primarily generated through acquisitions, which can sometimes lead sponsors to adjust their investment criteria in order to generate more fees, rather than focusing on maximizing investment returns.
- Lack of economy of scale
- Typical legal fees for single asset syndication will be $7-$15k. This cost is incurred with every property acquired, rather than one-and-done like the fund model.
The pros and cons of different funding approaches in real estate investing can create a “grass is always greener” scenario for many general partners (GPs). Fund guys want to be deal-by-deal guys and deal-by-deal guys want to be fund guys. It is crucial for GPs to consider whether their deal pipeline can support their investment targets. On the other side, limited partners (LPs) should prioritize evaluating the experience and track record of the GP. A skilled GP can turn a seemingly bad deal into a successful one, while an inexperienced GP can negatively impact even a promising deal. Once the LP has trust in the GP, they should evaluate the investment scenario to be sure it meets their goals. Every deal, every fund, and every individual investor is different, and that goes the same for LP expectations. Pension funds want 6% and they’re happy. Debt funds want 8% and they’re happy. Preferred equity wants 8-12%. Common equity wants 10-20% or sometimes more. It’s a very big “it depends” on which investment strategy and structure is the “best” way to finance a real estate deal.
Major Market News
ReSeed is a startup GP accelerator company designed to provide emerging GPs with mentorship and funds to start or grow their investment platform. TheRealDeal (April 5, 2023) wrote an article on the start-up and says ” ReSeed will raise LP capital on a “deal-by-deal basis” to invest in any deals brought forward by its operators. It will start with multifamily deals in the $5 million to $20 million range.” The goal of ReSeed is to be what YCombinator is for the tech/venture capital world. By partnering with ReSeed, GPs gain access to the expertise of seasoned professionals with over 20 years of experience in the industry. This mentorship extends to assisting with securing both debt and equity for their investment deals as well as GP co-invest & EMD funds. Obtaining these funds is one of the primary hurdles that often prevent new GPs from being successful. It’s not uncommon for deals to require $50-$100k of earnest money and 5-10% of the total equity to be provided by the GP, ReSeed will provide the financial support for a new GP who doesn’t have access to these funds.
On the investment side, ReSeed will raise institutional funds and provide them with allocation to the sub-institutional world. Many investment opportunities in the sub-institutional world are too small for institutional investors to dedicate their time and resources to individually. However, by partnering with ReSeed, these institutional investors can gain access to a diverse range of deals through ReSeed’s network of GPs. The article quotes Moses Kagan, a Co-Founder of Reseed saying “There are disproportionate returns available in the sub-institutional market, because you are dealing with owners who are often worse operators, hire worse property managers, hire brokers who are lower quality and don’t know how to run a real sale process.” ReSeed enables institutional investors to participate in a broader spectrum of deals that would otherwise be impractical for them to pursue individually.
Source: TheRealDeal. Startup hopes to formalize real estate apprenticeship. https://therealdeal.com/chicago/2023/04/05/michael-silberberg-sued-over-civic-opera-building-loan/
Tips and Tricks
General Partner (this is us,Sheffer Capital): (GPs) are the key decision-makers and active participants in real estate investment deals. They are typically responsible for sourcing investment opportunities, conducting due diligence, structuring deals, and managing the day-to-day operations of the investments. They take on a more hands-on role, utilizing their skills and knowledge to increase the performance of the investments. GPs also bear a higher level of risk and are rewarded through various mechanisms such as management fees, carried interest, and the promote, based on the success of the investments.
LP limited Partners: (LPs), on the other hand, are passive investors who provide capital for real estate projects without being directly involved in their management. LPs include individuals, institutions, or other investment funds seeking exposure to real estate but with a desire for a more passive role. LPs typically rely on the expertise and track record of the GPs when making investment decisions. They contribute capital to the investment and, in return, receive a share of the profits based on the terms outlined in the partnership agreement. LPs generally have a more limited role in the decision-making process and rely on the GP’s ability to generate attractive returns and protect their investment.