Why Alignment of Interest is Crucial When You Invest with a Syndicator and How To Ensure It Exists
There are numerous advantages to investing alongside a syndicator, such as having access to more investment opportunities, diversification, enjoying high returns at a lower risk, etc. But as a passive investor, you need to make sure that the syndicator’s interests align with yours.
Alignment of interest is crucial, since syndicators receive fees or managing the deal and managing investors’ money part of their compensation. The most common fees are:
~ acquisitions fee (paid to syndicators once the deal closes)
~ asset management fee (paid yearly/quarterly from property’s net income)
~ disposition fee (paid once the property is sold)
This fee structure can bring a conflict of interest between the syndicator and you, the passive investor. You want to make sure that the syndicator purchased the property because it was a great deal, or sold it at the right time to maximize investor’s returns, and not because the fee was tempting. Sometimes it’s not black and white; I’m not saying that syndicators buy or sell properties just to get fees, but they will be more careful if they had some skin in the game. The question is…how do you make sure of that?
In one of my previous blogs I wrote about syndication and how it works, but before you get to that, there are a few things you must pay attention to. When you are looking to take the leap into a new investment venture and invest passively, choosing the right syndicator is key.
Here are just a few ways you can make sure the syndicator’s interests are in line with yours.
1. The Syndicator Invests His/Her Own Money in the Deal
Always ask the syndicator if he/she is investing in the deal. When a syndicator invests his/her money in the deal — you know their interests are aligned with yours; after all, they put money from their own pockets in the deal and have the same risks as you. This is how REITs are different than some syndicators — they only take fees and never invest their own money in the deals. Their interests are to maximize their fees and that has a potential for a conflict of interests.
2. Make Sure You Have a Preferred Returns Mechanism
Not all syndicators give preferred returns, but as a passive investor, having such a mechanism is in your best interest. The preferred return is a return on investment that the syndicator offers to investors with the purpose of mitigating the risk associated with investing capital in the deal. Typically, you, as a passive investor, will be promised to get first dibs on profit at a rate of X%, as long as the partnership generates enough cash flow to pay it. Preferred returns are usually 6%-8%. The preferred returns is paid BEFORE the Syndicator receives any fees associated with the investment. Hence, the syndicator is extremely motivated to work hard to make the investment as profitable as possible.
3. The Syndicator Signs on the Loan as A KP (Key Principal) and Becomes a Loan Guarantor
By doing this, the syndicator is putting their balance sheet on the line, since even though most commercial real estate loans are non-recourse, they will become recourse if the syndicator commits a fraud. In that case, the lender is able to collect 100% of the loan balance from the syndicator’s personal wealth. As such, signing onto the loan is a way for the syndicator to vouch for their character. They have a lot to lose, and their interests are aligned.
To conclude, I cannot stress the importance of making sure you end up with the right syndicator and looking at these three ways will guide you in the process. Once you do choose the right syndicator, it is up to you to oversee the investment. For more excellent tips and advice on making sure the syndicator’s interests align with yours, listen to my podcast interview with Joe Fairless!
To get your FREE copy of The Ultimate Guide for the Passive Investor, visit www.ellieperlman.com
About the author
Ellie is the founder of Blue Lake Capital, a real estate company specializes in multifamily investing throughout the United States. She is also the host of a weekly podcast called “That REllie Happened?! Unbelievable Real Estate Stories with Ellie,” a podcast that brings the true stories behind the deals, from the most successful real estate investors around the globe. Ellie started her career as a commercial real estate lawyer, leading real estate transactions for one of Israel’s leading development companies. Later, as a property manager for Israel’s largest energy company, she oversaw properties worth over $100,000,000. Additionally, Ellie is an experienced entrepreneur who helped build and scale companies by improving their business operations. She holds a Masters in Law from Bar-Ilan University in Israel and an MBA from MIT Sloan School of Management.