While apartment syndication can reward investors with long-term passive income streams, it also comes with some risk. So, as a passive investor you should be sure to ask General Partners the right questions to ensure they are putting you and your capital in a secure position for success.
These should include questions about the experience and capabilities of the general partner’s team, the portfolio strategy they will execute on, what sets them apart from other apartment syndicators, and how they plan to mitigate risks and uncertainties in today’s volatile real estate market.
What should I avoid when looking at a General Partnership team?
In the 28 apartment syndications we have invested in, we have worked with both brand new and highly experienced syndicators with over a decade of experience and a staff of 16 employees. Both have advantages and disadvantages. The main takeaway is to feel comfortable investing with the General Partner you know.
Avoid the used car salesman.
Some General Partners use high-pressure tactics to convince us to invest, which we decline. For us, the used car salesman approach doesn’t work. When we invest passively, we look for smart, creative, articulate, and down-to-earth individuals.
Do their words speak louder than their results?
We also avoid empty suits—or those people who know all the latest buzzwords. They will tell you they are working with a family office that represents $100 million, and then beg you to invest $50,000. Then, they will even reduce it to $5,000. The worst deals we have seen are from this type of person, and we run away!
Is a celebrity partner really better?
You also need to watch out for the “celebrities.” I bet, if you can find somebody who has invested in a celebrity’s deal, and you ask how it went and what the final returns were, the outcome will have been dismal.
What is the General Partners experience?
The reality is it is essential to work with an experienced sponsorship team. That said, we have invested with inexperienced General Partners. However, they were directed and led by General Partners with 10+ years of experience. New syndicators need the resources and expertise of highly experienced investors, and this is a great way for them to learn about the business.
When inexperienced General Partners team up with highly experienced General Partners, you, as the passive investor can benefit. The deal will typically be more stable. The Deal Sponsor can give tasks to the inexperienced GPs to gain knowledge and become more valuable in future deals.
So, what qualities should an expert-level General Partner have?
Knowledge in
- The market
- Property management
- Insurance
- Cost segregation
- Accounting
- Underwriting
- Risk mitigation
- FEMA flood zones
- Financial expertise
- Legal documents
Contacts with
- Lenders
- Commercial Brokers
- Insurance Agents
- Cost Segregation Experts
- Accountants
- Lawyers
- Contractors in every submarket
- Subcontractors-
- Electricians
- Plumbers
- Sewer repair
- Roofers
- Subcontractors-
Their finances
- Net Worth
- Liquidity
- Fannie Mae “Experience”
- Local Bankers
- Regional Bankers
- National Bankers
- Loan Brokers
For a new GP on your first deal, your limited partners will feel more comfortable investing their hard-earned money into the deal, knowing there is a very experienced team standing behind you. As a passive investor, it allows you to work with an expert-level team, even if there is an inexperienced GP involved.
How long will the property be held?
As a passive investor, consider both long- and short-term options when looking at the holding period of an apartment syndication. What should you look for when considering each option?
Long-term holds
An example of a long-term syndication hold would be 10 years. The plan with a longer-term hold is to rehab all the units, and then refinance during year two or three. After the property is refinanced the lion’s share of the investment is returned to the Limited Partners. Since it is debt, it is not a taxable event. Also, the cash flow should increase to around 15% to 20% during the third or fourth year. These are the properties we prefer because we love the stable and steady cash flow, and we love receiving the bulk of our investment back which we can re-deploy in another deal to create infinite wealth.
Short-term holds
Some syndications are held 3 to 5 years, are considered short-term. In this case, ideally about half of the units would be remodeled. Once the property is stable after the remodel, it is then sold. The goal is to double the investors investment. But it is a taxable event. So, in many cases the investors need to pay taxes on their massive gain. We do not enjoy giving up a 37% of the profit in the form of taxes, so we strive for longer term holds.
Many investors do like the short-term model, but we personally, enjoy the “Steady Eddie” cash flow of the long-term holds! But, since we know investors who enjoy both, when we are General Partners, we try to have a mixture of short term and long term holds every year.
What legal regulations will be followed, and documents provided?
It is always important to understand what legal regulations will be followed and what legal documents will be provided.
As a passive investor, you should always confirm that any syndication deals are well structured in accordance with SEC Reg D 506(b) or 506(c) offering guidelines.
It is always important to review any legal documents associated with the syndication deal. This includes the Operating Agreement and other applicable documents that outline the roles and responsibilities of the General Partner.
In all the deals we have invested in there have been three legal documents to sign:
- LLC Agreement
The apartment will be owned by an LLC with an LLC Agreement, which should give you, the limited partner or member of the LLC, certain rights. Conversely, it will control the General Partners, or Managers, and not allow them too much leeway.
- Private Placement Memorandum
The Private Placement Memorandum (PPM) is a document that breaks down the business plan for the investment. It isn’t required for a 506(c) offering, which is only for accredited investors. But in every deal, we have invested in the PPM is included.
- Syndication Agreement
The Syndication Agreement breaks down how many shares you are purchasing and the method you are choosing to invest through. For example:
- A Self-Directed IRA. (read “The Dirty Little Secret” about SDIRA investing here.)
- A Solo 401k.
- Investing with your spouse, and you both sign.
- Investing with your spouse, but the spousal consent is NOT required. (For Elena and I it is just easier to quickly fill out the paperwork.)
- Investing via an LLC.
- As a foreign national via a domestic LLC.
- As a Tenant-in-Common, TIC (Pronounced “Tick”).
When combined, the three documents can total 150 pages or more.
By taking the time to review the legal documents thoroughly, you can protect yourself and maximize your returns when investing in apartment syndication deals. There should always be verbiage in the LLC Agreement stating what your options are in certain situations. God forbid you get divorced, pass away, or the Deal Sponsors commit fraud. A scroll through the documents can bring up any red flags and save you major headaches in the future.
You might think it odd for me to give you tips to ensure you are investing in a legitimate syndication. However, we have seen some strange deals lately. In one proposal, we received a three-page contract drafted by the sole General Partner. Please run from deals like that!
Ask about tax reporting
When investing in an apartment syndication, passive investors should also be aware of K-1 forms and the associated reporting requirements.
Investors file K-1s with their taxes each year, which report their portion of the income, deductions, credits, and more from a specific property. It is the Deal Sponsor’s responsibility to ensure these documents are completed accurately and sent in a timely manner.
There are circumstances when the K-1’s will be delayed, and you will need to file an extension with the IRS. This year, we are in the middle of gathering 21 K-1’s. We know some will be late and have already filed our extension, as we have done every year since investing in apartments. It’s not a big deal or a red flag with the IRS, rather a common occurrence sophisticated investors have. The IRS understands this.
When acting as a General Partner or Deal Sponsor, we strive to provide K-1s promptly so that investors can complete their taxes without delay or disruption.
How reliable will the distributions be?
Another important thing for a passive investor to be aware of is the distribution schedule and anticipate cash flows from their apartment syndication investments.
In some cases, there won’t be a distribution for the first six months. During this time, if units are being remodeled, the vacancy rates will be high. Cash reserves are being added to the apartment specific LLC bank account for rainy days or emergency repairs.
In many deals, the estimated cash flow is broken down annually. Typically, it will be around 4% to 5% the first year, 6% the second year, 8% the third, ramping up as the rents are raised over time. Generally, on average over 5 years we expect to see 8%. We’ve invested in a few with cash flow around 4%, but we sold within 3 years and nearly doubled our investment.
Plan on quarterly distributions that ramp up over time. Plan on years of recession with lower to zero distributions. Plan on years with more distributions. In other words, be prepared for anything!
Investing with second mortgage or HELOC funds
You might be tempted to take out a second mortgage on your house. We generally don’t recommend this in investing in apartment syndications because cash distributions can be sporadic.
A recession can happen, you could lose your W-2 job (and therefore your income), while at the same time cash distributions become non-existent. And you’re left having to pay your second mortgage on top of your first mortgage. Which puts your home at risk.
By taking a more conservative approach, you can protect yourself from potential losses while still reaping the rewards of apartment syndication.
We are risk averse, which is why we love apartments. There is no need to make it a risky investment!
If you do not learn to invest passively, you will work until you die.
Without a form of passive income to cover your expenses you will ALWAYS need a job with a salary or hourly wages to pay for your expenses. By learning how to invest passively, however, you can build up a reliable income stream that will provide financial security and allow you to enjoy retirement sooner.
As you grow as an investor, you can create diversity in your investments for even more financial security. We invest passively in many deals to create diversity. We also reinvest most of the cash flow into future deals creating infinite wealth. It is great to see our investments double every 5 years, ensuring our financial stability for years to come.
At Andover Holdings we have decades of successful investing experience, and we want to share that knowledge with you. If you want to learn more about creating a lifetime of wealth, we invite you to check out our course in passive investing for apartments where you will learn the warning signs and risks associated with apartment investments and how to spot lucrative deals. By providing you the necessary knowledge, we want to help you feel empowered to make decisions about apartment investing!