pooling
your money with others to buy larger commercial real
estate projects is a great idea — if executed well.
It is a proven path for wealth creation — if bought at the right price and managed well. But not all real estate classes are created equal — and not all operators are equal either — and this recession is a case in point. There are eight typical mistakes in real estate syndication projects that you must avoid! What are they?
By Thomas Beyer, President of Prestigious Properties
Overpriced assets sold to
innocent investors at a huge
premium.
Often an asset is purchased by the syndicator, and then sold to the “innocent” public for a lift up from a low of around 20% upwards to 200-300% on some land deals. This used to be “OK” in a very strong market.
Let’s use an office or retail syndication as an example: an office tower or larger retail center is bought for $10M, which was perhaps fair market value in 2006 or 2007 or 2008. It carries a 70% Loan-To-Valule (LTV) mortgage, say $7M. $6M is now raised... $1M in cost for commissions and for other soft costs like marketing and legal expenses, and $5M to syndicate the asset for $12M. Everything works our for syndicates and their investors as long as the asset provides cash-flow and can be exited in 5 years for say around $15M.
However roll forward to 2009 and with rising office vacancies and higher Capitalization (CAP) Rate demands by banks this asset is now worth $9M. It’s down 10% from the original purchase price, and in some cases perhaps down 20% to $8M. Deduct the $6.5M mortgage (now paid down a bit) and you see equity of $1.5M: a 75% drop in equity from $6M raised!! There are some private REITs or commercial property syndicators out there that pretend the world still looks like 2008 with low CAP rates and flat values. HELLO. Let’s assume the asset was bought in 2006. Roll forward to 2011: the 5 year mortgage is now due. It is now maybe $6M. The asset is worth $8M. Most lenders today would not lend 70% on a retail or office tower. Maybe 60 to 65%. Thus, only a $5M mortgage can be obtained and the syndicate finds itself $1M short in a relatively normal market. This is a recipe for bankruptcy, and huge investor losses in any case, despite a minor market correction in value of only 10% to 20%. Thus: To avoid making a mistake, check the true asset value if you intend to invest with a syndicate, and do not accept their excuses for uplifting the building value because there are none! Then hopefully you can co-invest with one of the many ethical syndicators out there!
