April 28, 2022

JF2795: How to Analyze a Multifamily Syndication Deal in 5 Minutes


In this episode, Travis explains how to vet a syndication deal as a passive investor from beginning to end in five minutes or less. The process includes four simple steps:


Step #1: Start with Your Goals

Ask yourself what you’re trying to accomplish by investing in this deal, or simply by being an investor at all. Think beyond the numbers and focus on more emotion-based lifestyle goals like early retirement, owning a vacation home, or paying your children’s college tuition. These are the kinds of goals that will keep you motivated. 

Next, determine what kind of investments will best help you reach your goals. Will an equity and growth-focused investment vehicle work best for your situation, or would a cash flow and passive income-focused investment be a better bet? 


Step #2: Know Your Criteria

    • Market: What markets are you most interested in investing in, and why? Be as specific as possible. Look at growth, expansion, and job diversification within the market. 
    • Asset Class: You also need to pin down which asset class you want to invest in — multifamily, mobile home parks, self-storage, retail, hospitality, hotels, etc. Learn as much as you can through podcasts, mentorships, and books to help you with this decision. 
    • Property Class: Do you want to focus on brand-new Class A properties, or take on the high risk/high reward of investing in Class C or D properties? 
    • Business Strategy: Different strategies include value-add and new development under construction. Travis says the value-add strategy aligns best with his personal goals because it provides a margin of error in case of a slump or recession. 

Step #3: Know the Operator and Know Their Track Record

Make sure you know the operator well through phone calls, emails, Zoom calls, and face-to-face meetings whenever possible. You should trust them and agree with their philosophy. Travis prefers to work with operators who specialize in a particular niche — rather than those that do a little of everything — based on the philosophy that you can’t be an expert in everything you do. 

You can learn about an operator’s track record by asking how many times they’ve implemented their business strategy and what the results were. Have they ever lost investor capital? How have they handled deals that didn’t go well? 

Step #4: Understand the Deal

Make sure the deal is conservatively underwritten by looking at the cap rate the operator is buying at today vs. what they are projecting the exit cap rate to be upon sale. Also look at rent bump assumptions — are they realistic, or too aggressive? 

If reviews of the property exist online, read through them to get a feel for the current state of the property. Poor reviews regarding management are good, because improvements can be made after buying the property. However, complaints about structural issues or crime in the area are major red flags. 

Overall, make sure to look at the numbers, but remember that if you are working with an experienced operator, you’re satisfied with their track record, you’ve read through the deal, and you’ve asked all of your questions — leave the rest to the experts. In the words of Ronald Reagan, “Trust, but verify.” 


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Follow Up


Travis Watts: Welcome back, Best Ever listeners. I'm your host, Travis watts. This is another episode of The Actively Passive Investing Show, an episode you're not going to want to miss. Stay till the end, I promise it's going to be worth your time. What we're talking about is how to analyze, how to basically vet a syndication deal, beginning to end, in five minutes or less. You may have heard me in conferences I've spoken at, or other podcast episodes or webinars, cover some of this... But this in particular is going to be the most consolidated way that I personally vet deals in under five minutes, as a passive investor. So I'm here to make things easy and simple to understand, that's always top of mind. Without further ado, here we go.

The first step is to start with your goals. This is by far the most important step, you cannot skip over this. I see it all the time where people do, I think it's always a mistake. You've got to know, what are you trying to accomplish by investing in this deal, or by being an investor in general? I encourage you not to just set a number goal, a $10,000 a month cash flow, or a $2 million net worth, or whatever it is. Forget about the numbers. It's fine if you want to set that as a secondary, or just a checkbox kind of goal... But I encourage you to look at lifestyle goals.

What is the lifestyle you're trying to achieve? Is it retiring early? Is it having a vacation home in a primary residence? Is it about putting your kids through college? I don't know, you know you. I don't know you as well as you know you... But set goals that are emotional, set goals that really drive you. Are you really going to give up on your kids if we go through a recession? Likely not. I hope not. But you might give up on a goal that's just simply a number that has no meaning attached to it... Like "I wanted a $2 million net worth, now, it's one. I'll just settle there and call it good. It's good enough." I'm not going to jeopardize a goal that has to do with a child. If my goal was to put them through college, I will put them through college. I'm going to keep moving.

Once you've identified your goals, whether they're numbers, or lifestyle or a combination of the two, the next step is what kind of investments can get you to those goals? In other words, let's use that college example. There are really two ways you could put a kid through college, I suppose. There's saving up enough via net worth and just paying for it outright, or there's the cash flow process. I'm going to invest, I'm going to build up multiple passive income streams, and I'm going to pay the bills and the tuition as they pop up, using my investment income. You need to decide, do you want equity-focused deals, cash flow-focused deals, or a combination of the two? And this is hugely important. You'll see why here in just a couple of minutes.

If my goal was to build up multiple diversified passive income streams, well, I may not consider doing a new development deal that often won't have any cash flow, because it's under construction for a period of years. So that's not going to help me get to my goals. And if I did have a net worth goal like that $2 million net worth example, then putting my money in the bank in a CD, a certificate of deposit that pays me 1% annualized isn't going to build my net worth up very quickly. So that's not going to be an investment vehicle that makes sense. Come to think of it, when does a 1% annualized return really make sense for anyone? That's a great question, and I don't have an answer for you.

Alright, moving on to step number two, it's "Know your criteria." We're setting our goals aside now; we have an idea of what kind of investment vehicles might make sense, whether they're equity and growth-focused, or whether they're cash flow, or passive income-focused. But now we have to dive in a little bit deeper. What markets are we interested in? Assuming of course that we're talking about real estate. Do you want to invest in the state in which you live, in your own local backyard or community, because you see a lot of potential there, you have a lot of connections there? Or, do you want to invest as I do, in the Sunbelt markets because a lot of people and a lot of jobs are going to those areas?

Every city is different. I encourage you not to just generalize and say, "Well, I like Oklahoma, for example." Because Ada, Oklahoma or Roth, Oklahoma is certainly not Oklahoma City or Tulsa, Oklahoma. Those are vastly different markets, with completely different dynamics, and completely different tenant demographic. So you've got to be looking at growth expansion, job diversification. etc. This is the point in your criteria that you really pin down. Is it multifamily that makes the most sense to you? Is it mobile home parks? Is it self-storage? Is it commercial, retail, hospitality, or hotels?

This is where I would recommend that you listen to podcasts or you get a mentor or you pick up a book on learning the differences between the different assets that exist in the space, so that you can decide what works best for you. I've decided for me that value-add class B multifamily makes a lot of sense. I believe that it still does today. I've been doing it for over seven years. But that's just my criteria, and that doesn't make it right for you. That doesn't mean it should be your criteria.

Then we have to look at what class of property. An A-class property is newly built, it's got the most luxurious finishes and great amenities, it's usually centrally located within a major metropolitan area. B-class properties might be more in the submarket regions, built in the '80s, '90s, and early 2000s. C-class may lack some amenities, things like that, have more deferred maintenance. D-class properties are usually, in layman's terms, more in the ghetto, so to speak. The only thing below a D class property is really Section 8 government subsidies, mobile home parks, things like that. So that's your tenant demographic. Sometimes these can be very old properties, or have structural issues, or a lot of deferred maintenance.

In general, look at it like high-risk high-reward. I've seen groups come into the C and D space completely turn properties around and get a very large return on investment. At the same time, these properties are a headache and a hassle, and sometimes there's liability risk that's tied to doing that kind of business plan.

On the flip side, to look at A-class properties, these are usually institutional buyers, these are pension funds, insurance companies, and publicly-traded REITs... Sometimes syndication groups as well. Again, high-risk high-reward, but not taking a lot of risks, generally speaking, so the cash flow and the overall yield might be a lot lower, but it's a safer bet.

So with that in mind, know your risk tolerance. That's another bullet point here under number two; know what you're comfortable with. Are you an extreme risk-taker? Are you a younger individual with not a lot of capital, where you're willing to bet the house on a deal? Or are you looking at retiring and living on stabilized cash flow income? You may not want to look at C and D properties, you might want to be in the A and B space in that example. Not financial advice, always seek licensed financial advice. I'm just throwing out there some food for thought.

The last thing under "know your criteria" is knowing what kind of business strategy makes sense for you. There's value-add, there's new development and construction... Again, it ties back to your goals. What are you trying to accomplish? I've shared my criteria a lot throughout the episodes. I'm a fan of value-add; it makes sense to me to buy something at a slight discount to improve it and make it better and potentially sell it at a higher price. It gives you a little bit of margin of error in case we have a slump or a recession, that we have some margin of error.

Alright, step number three is to know the operator and know their track record. You should always know the operator; you should know them via phone call, email, Zoom call, face to face meeting. You need to know who the people are that you're investing with. Are they trustworthy? Do you like them? Do you agree with their philosophy? And I look at things like does the operator specialize in a particular niche? Do they just focus on B-class, value-add multifamily in particular markets? Or do they do a little bit of everything? Are they doing some new development, some value-add, and some self-storage? I tend to do less investing with those groups, just under the general philosophy that you cannot be an expert in everything you do. So they're probably going to be better in one area versus another. It makes it a little harder to know what deals are going to outperform or do better than others. So I like people who specialize, that's just a general sense of anything. Even outside of investing, I like to work with specialists.

Speaking to track record, I'm looking at things like how many times has this group implemented their business strategy and what were the results? I'm not looking for 100% accuracy, I'm not looking for 100% home runs; I just want a snapshot of how many deals they've done, that tells me their level of experience. How many were successful? How many underperformed? Have they ever lost investor capital? Have they ever had a capital call occur?

If a deal went south, I want to know what the story was, and what the circumstance was... Because I'm a realist. Things happen. Tornadoes, floods, fires, competition being built next door, a lot of things can happen out there in the space. That's why I'm such an advocate for diversification. But I'd always ask, "What happened? What was the outcome?" So notice, I have already covered all of this content before I've even looked at the deal. Because truly, these are the steps to me that are most important, before I even consider if I'm going to look at a deal from a particular operator.

Break: [00:12:36] - [00:14:23]

Travis Watts: I am the first to admit that when I started investing as a limited partner in syndications, about seven years ago, that I had all of this backwards. I wanted to see the deals, "Show me your deal." I want to see the numbers. "How much am I going to make?" That was the wrong approach. A lot of lessons were learned. I'm skipping over a lot of those stories and I'm getting right to the point of what I think is most important today, and the way that I do my process now.

What you've been waiting for - understand the deal. Let's talk about analyzing the deal itself. Once you've covered all the criteria that we just went over, does the deal meet your goals and your criteria? Is the operator trustworthy and known? Now I look at, is the deal conservatively underwritten? Of course, every operator in the space is going to say it's conservatively underwritten. But is it conservatively underwritten? I look at things like they're buying at what cap rate today, and what are they projecting the exit cap rate to be upon sale? Simply put, in my opinion, the exit cap rate needs to be higher than what they're buying at today. We don't want that to actually occur. In reality, that means the purchase price is likely to be lower in the future... But it's a form of being conservative in the underwriting. If they're making that assumption that we're going to have a softening market or rising interest rate environment, I look at the potential returns already factoring that in and I'm still good with the deal, that makes a lot of sense to me. If I'm looking at a nice, shiny number of say a 20% annualized return and I find out that they're buying at a four cap and saying we're going to sell it at a two cap, that's a huge red flag, because we just don't know if that's what's going to happen. If interest rates go up, like they are, then that's probably not going to happen, which means that a 20% return could easily turn into a 10% return, and now I may not be happy with the deal that I chose.

I also look heavily at rent bump assumptions. When you're doing value-add - again, I should throw that as a caveat. Assuming you're looking at a value-add deal and that they're going to buy the property with the intent of raising rents over time, I look at what those assumptions are. How much do they think they can reasonably raise these rates each year? If it's something conservative, like 1%, 2%, 3% a year, that's awesome. If they're saying 6%, 7%, 8%, 9%, 10% a year, I think that's way too aggressive. It's a definite red flag. Nobody can predict things like that. Even though we've seen inflation kick up and rents bump up, that doesn't mean it's going to be sustainable for the next 5 to 10 years.

Quick story on that. I was looking at a deal the other day that somebody sent me. It was a newer operator, and one of their assumptions was they were going to buy a deal today and in year number two, they were going to do a refinance and return 100% of the investor capital. Now, is that possible? Sure, anything's really possible. Is that probable or likely? No, it's not, in my experience. It's awfully hard to buy a large multifamily property in today's environment and interest rates rising, and to assume that you're going to give 100% of all of their capital back in only year number two.

I have partnered with different syndicate firms that never anticipate selling. This is more or less their model where they try to buy-and-hold forever, and do refinances when it makes sense, and then return investor capital. I have been in some of those deals for 5+ years, and still have not had 100% of my capital returned, even though that would be their goal and that would be the optimal thing to do.

The other thing I wasn't fond of on that deal, as I mentioned, is they're using a bridge loan, which is more or less a temporary loan. What I didn't like about it is it expired in two years. So if interest rates are 4% today and they're 6% in a couple of years, that's going to really hurt their assumptions on the deal if they were thinking that they're just going to go into a long-term debt play at 4% in the future.

The other thing I recommend doing is visiting the property if you can, if that's feasible and reasonable to you. If you can't, ask for any video footage. A lot of these groups will have video footage from their due diligence, or some aerial footage. Or hop on Google, Google Maps, Google Street View, and do a little drive-by virtually of the property. Just look at the surrounding areas, just know what you're investing in. Know if there's, for example, a mobile home park right next door to it. Know if you've got four competitors right next to you, multifamily properties. Know if the property is located right next to the city dump. These things matter, and I've seen a lot of things get conveniently removed from the overview and the photos, to where you really wouldn't know that information unless you really saw the property.

Another thing I recommend doing is reading the reviews on the property that exist right now online. I do want to throw a huge, huge disclaimer out on this, especially when it comes to value-add investing, where you're buying an underperforming property and trying to make it better. The probability that the reviews are going to be bad is quite high. There are two reasons for that. Obviously, number one, it's been a mismanaged property. There are probably complaints you're going to find about the property management, or people not taking care of maintenance, or having deferred maintenance that's not being addressed.

The second thing is just the reality check that if you or I walk into a restaurant we've never been to before and we have pretty good service, everything goes as planned, the food was good, and the pricing was good, we're probably not going to rush out the door and go leave a five out of five review. But if we walk into a restaurant and it's just a complete nightmare, and they mess our order up, they rip us off, and then the waiter is requesting a higher tip than what we left them, we're probably going to be very inclined to write a negative review. So what you tend to find on properties, multifamily specifically, is a lot of negative reviews, even when you might have a good property management company. Just keep that in mind.

What I do when I look at the reviews is I'm not looking at the star rating, like let's say it's two out of five stars. What I'm reading are the actual written reviews. If I find it's "Hey, the management, they never pick up the phone in the office." Or, "I've submitted a request to get this stain on my ceiling looked at over and over and nobody ever responds to it." These are positive in my view, because we're buying it and hopefully, we come in and we address all those issues and turn these residents around to being fans of the property, and not hating the management company.

Now, a red flag on a review would be a one out of five stars where they say, "Hey, we have structural issues. We have cracks running up and down our wall. I don't feel safe living here. My neighbor just got shot last month. There's always police all around the property. My car's been broken into multiple times." These are red flags. It's about the demographic and the area that you're in, and you want to be aware that these are issues that are likely going to come up when you are invested in this property.

Alright, let's talk about the numbers. All of you engineer-minded folks out there and analytical thinkers, definitely look at the numbers. Definitely look at the T12, that's the trailing 12 months of performance and expenses and income. Look at the T3, that's the trailing three months. Compare and contrast, but listen, here's my disclaimer. Please don't get caught up in the analysis by paralysis.

If you are working with an experienced operator, they know what they're doing, they have a track record, my advice is to leave it to the experts. I've already read through this, they've already interpreted the data, they already have a business plan in place to address that data. You or I being the passive investor that's not going to be hands-on or making the calls really should not be stressing over a lot of stuff on those statements.

It's looking at a cash flow statement of a publicly-traded company like Coca-Cola, and then forming the opinion that the CEO and their team don't know what they're doing or talking about. The assumption would be if I'm an investor in that stock, I'm going to leave it to the team to address those issues, I'm going to assume they know what's going on and they know how to address those best. And if I see any major red flags and a statement like that, hey, I'm not going to invest. That's always a choice of yours.

At the end of the day, the important part here is that you're looking for risks, you're asking questions. Please ask your questions before you invest in a deal, not after, or not the day before your wiring funds and you've already signed the commitments. Write down your questions, be organized, book a 15-minute call with the operator, and get through your questions.

I'll share another quick story with you. Early on, I invested in a deal that I was very excited about. It was a good deal, it was in a good market, it was with a good operator, but it was with a new operator that I hadn't partnered with, and I got so excited, I signed the docs, I did my quick due diligence, I asked some basic questions, and I got in the deal... And I realized I forgot to ask the distribution frequency, whether it was monthly distributions, or quarterly. It ended up being quarterly distributions, which I try my best not to do. That's part of my personal criteria, because I live on passive income. And more importantly, the distributions weren't set to even begin for about six months. I didn't realize that either. So it was really kind of a let-down, because, generally speaking, these are illiquid investments. I was in that deal for three, four, or five years, I can't remember, having that pain point that I had to revisit every single quarter. Please ask your questions up front.

At the end of the day, what I want to leave you with after all of this is just simply "Trust, but verify." Again, if you're working with a highly reputable firm, they've done this a lot, they're very experienced, I am going to have to put a pretty high level of trust in that operator to feel confident in doing a deal with them. However, when you're looking at overviews and pitch decks, everyone wants to make their deal sound amazing, everyone wants to have the competitive edge, they want to show you the best pictures, the best statistics, and the best of everything... So my advice here is to trust what you see, but also double-check it. Get on Apartments.com, look at the competition, read the reviews as I mentioned, and do the Google Street drive-by’s if you're not able to physically visit the property in person.

And you guys, this can be said with any kind of investing; whether you're a stock investor or a real estate investor, you're always having to trust but verify. It'd be nice to assume that everybody's telling the truth all the time and everything's perfect, but we all know that's not the case.

With that, I'm going to wrap up. That is how I vet a deal in under five minutes. I hope you found this episode helpful. Please like, subscribe, and leave a comment below. Let's connect on social media. LinkedIn seems to be everybody's favorite. Thank you, guys, so much for the support. I'm always happy to be a resource in the space when it comes to being a passive investor. If we haven't connected, let's do so and we'll see you next time on another episode of The Actively Passive Investing Show. Have a Best Ever week.

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