Real estate syndication offers a fantastic opportunity to invest in properties beyond what you could do on your own. However, it’s not without its share of challenges. One of the most critical decisions you’ll make in this type of investment is selecting the right operator. In this blog post, we’re going to delve deep into the art of choosing the right operator for your syndicated real estate investment. We’ll also explore the potential consequences when an investor skips due diligence on their operator through a hypothetical case study.
The Players in the Game
Before we delve deeper into the roles of General Partners (GPs) and Limited Partners (LPs), it’s essential to grasp the unique dynamics at play in the world of real estate syndication. This partnership is akin to a well-orchestrated symphony, where each participant plays their specific role, contributing to the harmony of the investment. The GP takes the lead as the conductor, while LPs blend their financial prowess seamlessly into the composition. Together, they create a powerful ensemble that can reap substantial financial rewards. Now, let’s take a closer look at these roles and how they interplay to produce successful investments.
The General Partner (GP) — The GP is the heart and soul of the operation. They’re the ones actively managing the investment. Their responsibilities include finding and conducting due diligence, purchasing assets, daily management, refinancing, and sales decisions. In return, they expect to see cashflow and equity returns.
The Limited Partner (LP) — On the other hand, LPs (Limited Partner) are the passive investors who receive passive profits. They conduct their due diligence on the presented GP information, provide the necessary funds, and respond to the GP’s requests. In exchange for their capital, they get to relax and enjoy a share of the profits without actively managing the deal.
Why This Partnership Arrangement Works
In real estate syndication, success is often a team effort, and the synergy between General Partners (GPs) and Limited Partners (LPs) is the driving force behind it all. The GP is like the captain of a ship, steering it through the tumultuous seas of property acquisition, management, and profitability. They bring the deal flow, management skills, and a desire to make the deal a reality — and often need capital to turn those opportunities into reality.
However, even the most skilled captains need resources to sail their ships, and this is where the LPs come into play. The LP is financially equipped to invest but may lack the deal flow, expertise and/or the drive to actively manage the investment. Therefore, they provide the essential financial backing that enables the GP to turn opportunities into reality, creating a formidable partnership that fuels the engine of real estate syndication. With their distinct roles, GPs and LPs are like two pieces of a jigsaw puzzle, perfectly fitting together to create a complete and successful investment strategy.
Vetting Your Operator
At the core of any successful partnership is trust. When venturing into a syndicated real estate investment, the first step in vetting your operator is to conduct a personal gut check. Do you genuinely like them? Are they authentic, transparent, and honest in their dealings? Trust is the foundation of any successful partnership, and these qualities serve as the bedrock upon which fruitful collaborations are built. Now, let’s dive into other details of vetting your operator and ensuring a successful investment.
Professional Background: Experience matters. How many syndications have they completed, and how many deals have they taken full cycle? An operator with a proven track record, one who has navigated the intricacies of multiple successful syndication ventures, is a valuable ally. Their experience inspires confidence, assuring you that they have the ability to manage the investment and mitigate potential risks.
Track Record: Investigate whether your operator has had an asset go sideways in the past and how they handled such situations. An operator’s ability to adapt, problem-solve, and recover from setbacks is a testament to their resilience and expertise. Learning from their past experiences can provide valuable insights into how they manage adversity and mitigate risks.
Investment Strategy: Understanding your operator’s typical investment strategy is crucial. Are they focused on cash flow, forced equity, or buy and hold? This insight helps you align your expectations with their approach and ensures your investment goals are in harmony with their strategy. Additionally, scrutinize the major risks associated with their chosen strategy, particularly concerning lending. Awareness of potential pitfalls allows you to be prepared and make informed decisions.
Team Composition: The strength of the team is crucial. Who’s on board, and what’s each person’s role? A well-rounded team can skillfully navigate challenges that may arise during the investment process. A diverse set of skills and expertise among team members can be a reassuring sign that your operator is prepared for all contingencies.
Asset Management: The person responsible for managing the assets plays a pivotal role in the success of your investment. Their experience and dedication are crucial, as they will be the ones overseeing the day-to-day operations and ensuring that the investment stays on course. The individual tasked with asset management should be well-versed in property management and have a track record that shows their ability to handle the responsibilities effectively.
Communication Plan: Clear and consistent communication is the compass that keeps a syndication investment on the right path. Your operator should have a well-defined communication plan in place. Inquire about how they intend to keep you informed about the investment’s progress. This could include the distribution of financial documents such as K-1s and regular updates on property performance. An operator who communicates transparently helps build trust and ensures you’re well-informed throughout the investment journey.
Waterfall Structure and Fees: Lastly, gaining a comprehensive understanding of your operator’s profit-sharing structure, fees, and any catch-up provisions is crucial. Clarity in financial matters prevents future disputes and allows you to make informed decisions about your investment. Understanding how profits are distributed and what fees are associated with the investment ensures you’re well-prepared for the financial aspects of the venture.
Watch for These Red Flags
In the world of real estate syndication, it’s not all sunshine and rainbows. As an investor, you need to be vigilant and keep a keen eye out for potential red flags that might indicate a risky partnership (check out all 8 Red Flags here). Here are some warning signs you should never ignore:
Only One Managing Partner: A lone operator might seem like they can handle it all, but this could be a risk. Real estate syndication is a complex and multifaceted business. Having multiple partners on board brings diverse skills and perspectives to the table, which can be invaluable when facing unexpected challenges. The strength of a team often outweighs the abilities of a solitary operator.
Operator not Fully Committed: If your operator isn’t fully devoted to their real estate business, it could spell trouble for your investment. Success in syndication requires dedication and full-time engagement. Part-time operators might not have the bandwidth to give the investment the attention it needs. A lack of commitment can lead to poor decision-making and neglect of critical aspects of the investment.
Lack of a Track Record: Inexperienced operators may lack the skills and knowledge needed to navigate the intricate waters of real estate syndication. A lack of a track record means they haven’t encountered and solved the myriad challenges that arise in these ventures. When it comes to your hard-earned money, it’s safer to entrust it to operators with a proven history of success.
Operator not Actively Participating: An operator should lead from the front, actively participating in the deal. Their presence and involvement are essential for the investment’s success. An operator who is passive or distant from the investment can hinder the decision-making process and hinder the property’s performance. An engaged operator provides leadership and guidance when it’s needed most.
No Co-Investment by the Operator: Co-investment by the operator is a powerful signal of their commitment. When operators have their own capital invested in the deal, they have a personal stake in its success. This aligns their interests with those of the investors, motivating them to make the investment flourish. A lack of co-investment could be a signal that the operator lacks confidence in the deal or isn’t fully committed to its success.
Illustrating the Impact of Due Diligence
Consider two scenarios that underscore the transformative impact of due diligence on an operator in real estate syndication.
In the first scenario, Jane, an enthusiastic but inexperienced investor, entrusted her funds to Sam, an operator who offered promises of high returns with minimal risk but lacked the necessary experience and preparation for effective management. Within a year, Jane’s investment turned into a stressful ordeal. Chaotic property management, unpaid bills, and disgruntled tenants revealed Sam’s inadequacies as a capable operator. Moreover, erratic communication added to Jane’s woes, culminating in financial losses and disillusionment.
Contrast this with Alex, an investor who rigorously vetted Sarah, a seasoned operator with an impressive track record. His meticulous due diligence encompassed assessing Sarah’s character, professional background, team, and past performance. Alex’s decision to invest was well-founded. Sarah’s transparent communication, adept management skills, and robust team guaranteed a successful investment. Property management was efficient, bills were paid on time, tenants were content, and returns exceeded expectations.
This juxtaposition highlights the power of due diligence. In the case of Alex, it led to financial gains, peace of mind, and a thriving partnership, emphasizing the critical role of selecting the right operator for a prosperous real estate syndication journey.
Choosing the right operator for your syndicated real estate investment is not just a matter of chance; it’s a calculated process. By conducting due diligence, assessing an operator’s character, experience, team, and track record, you can significantly reduce the risks associated with your investment. In the world of real estate syndication, a strong operator-investor partnership is the key to unlocking success and ensuring a prosperous future. So, go out there, make informed decisions, and build a thriving real estate portfolio! Your financial future is in your hands.
Whitney Elkins-Hutten is the co-author of the international #1 bestseller Resilient Women in Life and Business, host of the Passive Investing Made Simple and Multifamily Investor Nation YouTube shows and podcasts, and the Director of Investor Education at PassiveInvesting.com, a private equity firm with $1.4 billion in assets under management, including 3500 multifamily units, 6600 self-storage units, and 30 car washes. To date, PassiveInvesting.com has achieved an LP ARR of 29%, an LP IRR of over 26%, and a 56%+ increase in asset valuation in three years or less.
Whitney will be joining us as an educator at Quest Con Live: Women in Alternative Investing on Nov. 17, 2023. To learn more about this event go to QCL Registration.