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Many passive investors turn to real estate syndications when investing in multifamily properties. The reasons may vary, but they all come down to the fact that passive investors don’t have the experience, time and necessary funds to purchase multifamily properties on their own.
The syndicator, or sponsor, has the knowledge and experience to locate and purchase a multifamily property with excellent investment potential. They also have access to other investors who can help fund their deal.
Real Estate Versus The Stock Market: A Liquidity Issue?
Many investors who stay away from real estate do so because liquidity is key for them. They like the freedom to buy and sell when as they see fit, and view real estate as an investment type that locks their funds for a long period of time. However, when investing in the stock market, investors cannot enjoy the many tax benefits that real estate investments carry, such as depreciation and expense write-off. Yet liquidity is the No. 1 reason why some investors choose to invest in the stock market and not get into real estate.
The Biggest Misconception: Lack Of Liquidity In Syndication
Many passive investors have the misconception that when investing in a syndication, their money will be tied up during the entire hold period. A hold period is the amount of time that you hold on to the property after buying shares in the LLC that owns the building. The time period is usually measured in years, and most syndicators hold the property for five to seven years.
Most investors believe that means their money will be locked in for five to seven years, and feel uncomfortable with the lack of access to their money for so long. However, this is a major misconception when it comes to investing in a syndication. In truth, when you buy a property in a syndication, you are part of a group of investors who all own shares of an LLC that owns the property. Hence, technically you have the ability to sell your shares to other investors in the group or even to an investor who wasn’t part of the original group.
The Syndicator Determines Your Investment Liquidity
The fact is the investment’s liquidity is dependent on the syndicator. There may be cases where an investor or their family was involved in a serious accident, became ill or had a similar type of hardship, and they need cash. The syndicator may allow the sale of shares in some specific cases, but not all. As a passive investor, your due diligence should include inquiring if the syndicator allows investors to sell their shares and how easy is it.
The best thing to do is to ask the syndicator directly about their approach to selling investors’ shares. Another source is the private placement memorandum (PPM) that you sign when making an investment. It’s a legal document (required by the SEC) and includes the partnership agreement. The PPM also outlines all the information about the project, how the sponsor and investors are compensated, fee structures, preferred returns and how the rental income and appreciation will be distributed. It also contains information about the circumstances in which an investor can sell their shares due to hardship.
In some cases, the sponsor will have the right to refuse the sale of the investor’s shares. Remember, the sponsor vets investors the same way investors vet sponsors, and they want to know who is going to be their new partner. Their decision could be based on a variety of reasons, but the bottom line is the sponsor makes the decision.
On the other hand, some PPMs indicate that the investor can sell their shares without any constraints. As a syndicator myself, I chose to give investors the ability to sell their shares at any time in order to allow them full flexibility with their money. I do this because I believe it creates a perfect platform that combines the strength of owning real estate with the flexibility that the stock market provides.
How To Price Your Shares
If the PPM has a provision for an early sale to another investor and the sponsor will allow a “hardship” sale of your shares, how do you price them since the property hasn’t sold yet? It’s tough to calculate, because a good portion of the investment’s return is based on appreciation at the time of sale — and you can’t accurately state the amount of appreciation if you sell your shares early.
The best approach is to look at the return projections outlined at the start of the deal. Another approach is to look at the average returns for a multifamily property. For example, cash on cash returns average in the 6-8% range, but if you’re exiting the deal early, that number might have to be adjusted.
Another way to determine the price is to calculate the total return over the stated hold period, and then prorate the share price based on the year in which you want to sell your shares.
Summary
Passive investors often have the misconception that their money will be tied up during the entire hold period of a multifamily syndication deal. The reality is that many sponsors allow investors to sell their shares. If an investor wants to leave prior to the property’s sale, the process must be stated in the deal’s private placement memorandum. Investing in a syndication deal that allows you the flexibility to sell your share at any time combines the benefits of investing in the stock market with the strength of owning real estate.