Recognizing Risks, Avoiding Common Pitfalls, and Safeguarding Against Fraud in Real Estate Syndications
Common Myths Regarding Real Eestate Investment and Syndications
People often invest in real estate syndications based on the following false assumptions, which can turn into a costly mistake:
The Syndicator is very successful, so their deals must be performing well.
Syndicators can make money even if their deals don’t perform well. For example, syndicators typically take acquisition fees at closing before the deal generates any profit. The syndicator also typically earns income from property management and asset management fees, which are not dependent on the deal’s profits. The syndicators might also be getting kickbacks from various vendors that are being paid by the deal.
The Syndicators are putting up their own money in the deal (and also rolling in their acquisition fee), so they must feel it’s a good deal.
Just because the syndicator says he is investing in the deal doesn’t mean he actually is (he may “change his mind” at the last minute). Additionally, it is possible that the syndicator is making money from this deal behind the scenes, which significantly outweighs the money he is putting into the deal. For example, there may be an “internal flip,” which means that when the OM says that the purchase price is X, what’s really happening is that the syndicator purchased the property for less than that and is now flipping it to the deal for X, thus earning the difference as the “seller.”
The one who introduced me to the deal is very experienced and a good friend of mine, and he feels it’s a great deal, so it must be.
The one who introduced you to the deal is very possibly being paid a commission for bringing you into it (these individuals often do this in an unofficial capacity, so this arrangement may not be readily apparent to you). Accordingly, his opinion would be biased.
I know the one running the deal personally and fully trust him with my money, so it’s safe to invest in his deals.
It is possible that the individual who appears to be running the deal is just a front for the real syndicator. When a syndicator doesn’t have enough of a reputation to attract investors, he may partner with a better-known individual. It is possible that the only thing this individual is doing is speaking to investors, and your money is being fully managed by someone with no reputation (or worse).
There are other experienced and savvy investors investing in this deal, so it must be good.
It is possible that these experienced investors (because of their investment size or early commitment) are getting significantly better terms than you are. Just because it’s a good deal for them does not mean that it’s a good deal for you.
The Syndicator told me he will personally guarantee my investment.
This oral commitment is not necessarily binding (although it may be, depending on the circumstances).
I went through all the detailed financial information supplied to me by the Syndicator and see that it’s a good deal, therefore it is safe to invest in the deal even though I don’t know the integrity of the syndicator.
There are numerous ways that a syndicator can spin the numbers so that an unfavorable deal looks favorable. (“Cherry picking” the comps or including artificial rent are some examples.) The numbers are only as good as the person supplying them.
I did my own independent due diligence on the deal and believe it’s good. Therefore, it is safe to invest in the deal even though I don’t know the integrity of the syndicator.
Even if the deal is fundamentally good, there are numerous ways that a syndicator can potentially divert profits away from the investors. Receiving kickbacks, taking “loans” from the deal, unfavorable allocations on expenses shared with other properties they own, taking “leasing commissions” and lending to the deal at high interest rates are just some examples. Investors typically don’t have access to the deal’s books and records other than summarized financials, which can easily be manipulated to cover up such actions.
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