💼 Sin-dications

briefcase | invest smarter | Issue #139

💰 Pooling Money Without Getting Wet

Real estate syndications. These structures are a popular and useful way to pool money to acquire a real estate asset. In short:

• 🙋‍♀️ Sponsors/General Partners: An active partner who finds the project to raise money for and does all the boots-on-the-ground work.

• 🙋🏽‍♂️ Investors/Limited Partners: The passive partner who provides the capital but has limited ongoing responsibility and liability. Basically, the cool aunt who lends money for the candy shop but doesn't actually have to deal with the sugar rush aftermath.

Remember back in kindergarten when you shared your crayons, and, in return, got to partake in everyone's lunch snacks? Well, real estate syndication is kind of like that, but with more money and fewer crayons.

Syndications can take many forms, but here is an example of a basic split between the two parties.

The JOBS Act of 2012 relaxed investment rules to allow real estate syndication to raise capital from accredited investors. This is a specific term and typically means anyone with an annual income of over $200,000 ($300,000 for couples) or at least a $1 million net worth, excluding a primary residence.

…And business is booming for good reason. The real estate crowdfunding space is currently valued at over $10B globally and is expected to grow by an annual growth rate of 50% between now and 2032.

Real estate syndications help pair up folks who want to do the work but don’t necessarily have the capital, with those who have the capital but don’t want to do the day-to-day.

In this sense, syndications do help investors diversify their portfolios and earn passive income. It's also a way for normal folks, who don't have Bruce Wayne's bank account, to invest in bigger real estate projects.

There are a lot of upsides to syndications, but there are also serious risks.

😬 Sinking Syndications

Since the JOBS Act made these investment vehicles more accessible in 2012, we’ve lived through an era of free money.

This has meant that the debt stack for syndication deals required little attention as the debt is available at record-low interest rates. Find a deal, build your capital and debt stacks, and then execute.

Syndicators typically invest minimal personal funds, instead collecting acquisition fees (2-5% of purchase price) and management fees (2-3% of gross income) from investors. Reading between the lines, this means they can still profit from failed investments.

Unfortunately, the debt part of that equation is getting harder, and syndication deals that had poor underwriting and didn’t account for rising rates are now feeling the pinch. Well, it's more like a face punch.

The WSJ reports on Texas-based investor Jay Gajavelli, an IT professional turned real estate syndicator. After graduating from YouTube University (taking a lead from the likes of Brad Sumrok and Grant Cardone), Gajavelli began amassing a sizeable portfolio of value-add multifamily assets.

Last year, Gajavelli owned over $500 million worth of Sunbelt apartment buildings with 7,000+ units, making him one of Houston's largest landlords. Over the last 5 years, he grew his empire faster than you can say "Houston, we have a problem."

📉 Houston, We Definitely Have a Problem

Gajavelli promised Texas-sized double-your-money returns in enthusiastic talks at investor conferences and on YouTube, detailing his strategy of purchasing buildings, upgrading units, increasing rents, and selling for a profit within three years.

And, in Gajavelli’s own words:

Well, he should have been worried and in fact, lost all his and his investors’ money over the span of a few short months.

Primarily due to poor debt control, this April, Gajavelli’s company lost over 3,000 apartments to foreclosure. This was one of the biggest real estate foreclosures since the financial crisis, per the WSJ.

This is when Gajavelli’s tone began to change slightly:

🛟 Anyone Got A Floatation?

What is the largest problem with Gajavelli’s syndication model? Interest rates. Much of the debt taken out by Gajavelli and similar investors was low-rate floating debt.

This means that the rates change periodically, and once the Fed started leaning on the rate increase turbo lever, syndications that rely on this type of debt stack start sinking.

I guess he missed that YouTube video.

Gajavelli is only one of thousands of syndicators who are both slowly and quickly drowning amidst increased debt costs. Between 2020 and 2022, real estate syndicators in the U.S. raised $115 billion from investors.

So What? Despite what the gurus say, there is no easy way to make money in real estate.

Syndicators who didn’t pay attention to the first rule of real estate investing are slowly beginning to sink. Gajavelli’s experience is an early case study of what will come over the next 12-24 months as rates remain elevated and real estate asset prices cool.

Real estate's no fairy tale, even if YouTubers and influencers try to sell it with a sprinkle of magic dust.

PS: There’s nothing wrong with making $400K a year.