How To Analyze A Real Estate Syndication Like An Underwriter
Real estate syndications essentially need two types of funding: debt funding usually obtained from a lender and equity funding which is derived from passive investors and the general partnership. Equity capital provides for such critical components as the down payment and the capital expenditures that are earmarked for improvements to the commercial real estate asset.
It goes without saying that passive investors who are the individuals who contribute most of the equity capital should always conduct their own due diligence before investing in any real estate deals. Oftentimes, however, potential investors don’t know exactly where to start in their due diligence of a real estate syndication.
One of the key factors that potential investors should review is the business plan that the general partner has put forward. The investment strategy is one of the first things to look at to help you decide if this is a sound investment or not.
Also, you want to review the deal sponsor’s track record. Have they been syndicators for a long time or are they newer? Do they have a strong background in business and do they have extensive experience in multifamily syndication acquisition, rehabilitation, and management? Do they have a solid reputation? What will the sponsor’s role be with this particular multifamily property? What is the amount of their investment into the real estate syndication deal?
Become Your Own Underwriter
As a limited partner who is a passive real estate investor in the deal, you will want to learn how to quickly evaluate deals for potential risk.
You may not have a professional underwriting model that would be typically used for underwriting multifamily acquisitions, but you can create your own model by developing different ways to assess commercial properties.
So, what are the key fundamentals people like investors and underwriters look for in determining if a real estate syndication is a good deal?
This means understanding how an underwriter deciphers if a real estate syndication has the potential to be profitable. In this article, you’ll learn what questions to ask to better evaluate the sponsor’s business plan, the property manager and the property management company, the local real estate market, and the operating agreement.
The Occupancy Rate and Cash Flow Relationship
The best way to start when you’re evaluating a commercial real estate property is to review the financials and every line item. Start with the cash flow. Is the project profitable?
The occupancy rate is directly tied to the rent roll and the rent roll is tied directly to the cash flow or rental income. Occupancy doesn’t necessarily mean people are paying. There is the physical occupancy rate, which is the number of units being occupied. Then there is the economic occupancy rate, which is the number of units that are actually paying, so that is an important distinction that you should be aware of when conducting your due diligence.
Commercial properties that have a high occupancy rate are usually in desirable areas or the asset class is in high demand. If the prospective and current tenants find this type of asset appealing because of the renovations, amenities, or location then the property will likely, in turn, have a high occupancy rate.
On the other hand, if the property is in a rough area of town, with little amenities and in poor conditions, the property likely have a low occupancy rate, which will make it a much more risky investment proposition.
We, at PCRP Group, like to see an occupancy rate of 90% or better unless there is a really compelling story for a lower occupancy rate.
In either of these situations, it is an important role of the sponsor to detail in the business plan how they are going to manage the property, make improvements and increase occupancy or maintain a strong occupancy rate.
Operating Expenses of the Investment
Operating expenses are important to review in the pro forma. What are the costs currently and what are they projected to be? Operating costs encompass a lot of expenditures – it’s the maintenance of the property, the landscaping, the day-to-day management costs, the taxes, the common area utilities, the insurance, etc.
The first step is determining the age and the condition of the property. Did the sponsor supply good pictures or drone videos? Is it well maintained or is it a value-add property that will need a lot of improvements done to get it competitive with other properties in the area?
For example, if it is an apartment complex that needs to be updated, there will be additional equity that the sponsor will need to raise (beyond the down payment) so that the general partnership can conduct those renovations. The business plan should detail what they plan on doing for the renovations and the amount they plan on spending for these renovations. This is called capital expenditures or “Capex”.
Research Other Properties in the Area
Once you’re satisfied with the occupancy rate and the operating expenditures, you’ll want to review rental rates for units that are comparable to this property to make sure that the projected rent increases aren’t inflated and unreasonable. Determine how much the per-square-foot rental rate is for similar apartment buildings in the vicinity.
If the asset is showing below market rents, and the general partners have a plan to raise rents because of newer amenities, increased efficiencies, or plans to update units, just determine if that makes sense for the area given the rental comps that you have found in the area.
If the operating expenses remain low and the revenues increase through rent increases and other strategies to increase revenues, then investors should see a healthy return on their investment.
One of the most important aspects of the general partnership’s role that will have the most profound implication is its ability to keep expenses down and to find ways to increase revenues and ultimately increase the net operating income (NOI).
We, at PCRP Group, will rely on professional underwriters who are extremely experienced and knowledgeable and who can field our relentless requests for more clarity on data. With our team of experts to decipher what is a great deal and what is not, we reject the majority of the projects that are presented to us, roughly 95%. We’re conservative on our underwriting, but we like it that way.
Is the Risk Worth the Projected Returns
You became interested in commercial real estate investing because you want to develop ways that your money can work for you so that you can generate steady passive income. Your responsibility as a passive investor is to research each real estate investment to the best of your ability.
To determine if these investment opportunities align with your financial goals, the limited partners must thoroughly understand what is being presented in the Offering Memorandum (OM), the business plan objectives, the Private Placement Memorandum (PPM), any other legal documents, and the terms of the real estate deal. If you don’t understand fully, you should reach out for guidance and get your questions answered.
You know that there is no such thing as a risk-free investment. An important role of a sponsor is to be totally transparent and provide you and the rest of the investors with all of the information that is available, but at the end of the day, you have to decide if this investment is one you will pursue.
Other questions you might want to ask before investing:
- Are they offering a preferred return?
- Are your distributions paid out on a monthly basis or on a quarterly basis?
- What is the annual rate of return?
- What is the internal rate of return?
- Who is the property management company on the project and what are their credentials?
- Do the financials make sense and do the projections seem reasonable?
- Based on the deal sponsor’s track record, do you feel comfortable investing with this syndication company?
- What is the going-in capitalization rate and how does it compare to similar properties in the area?
- What is their projected exit cap rate, and does that make sense?
Time Is Money! Successful Investing Requires Thorough Research Beforehand
The intricacies of commercial real estate investing can be a bit more involved than investing in the stock market or bonds, but there is an enormous amount of advantages with real estate investing that stock investing can’t provide. Also, real estate has an intrinsic value whereas a stock’s value can be reduced to zero.
So now you have some pointers on how to better evaluate a real estate syndication and a series of questions you will want to explore the answers to. Although it may appear complicated, the entire process of analyzing real estate syndication deals does not take a lot of time. It does, however, take an effort on your part to fully understand the scope of the investment so that you can safely mitigate risk.
Scrutinizing the deal is worth the effort. So, to help you tackle that process with more ease, we’ve put together a list of questions HERE that you may want to ask a deal sponsor before you invest in a commercial real estate syndication.
Remember, investing is designed to help you build wealth, so finding the right investments that will help you meet your financial goals is a worthy use of your time for both you and your family’s future security.
Until next time, Earn Passively & Live Abundantly!
Note: We are not financial advisors nor are we tax specialists. We always advise that you seek advice from your advisors before making any investment or financial decision.
Ready to Learn More?
The best way for you to learn more about commercial real estate syndications is to join the PCRP Passive Investor Club.
Through the PCRP Passive Investor Club, you’ll get a priority review of all the deals we offer. We’ll work with you to determine your investing goals and then present you with the best deals to meet those goals. We’ll then guide you every step of the way as you invest in those deals.
So if you’re ready to start investing passively in institutional-grade, commercial real estate in fast-growing, climate-resilient markets in the U.S., join the PCRP Passive Investor Club – IT’S FREE! – and get started on your path to EARN PASSIVELY and LIVE ABUNDANTLY!
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