Should I Invest in Syndications Today?

There was a recent news headline in the Wall Street Journal: A Real-Estate Haven Turns Perilous With Roughly $1 Trillion Coming Due

As more and more real estate syndications fail and default, I wanted to discuss the lessons learned from these bad investment decisions and what you should look out for if you are looking to invest in a syndication.

How Investments Go Wrong

We had a 14-year run-up out of the great financial crisis back in 2008-10. Most investments did well and all assets increased in value – the stock market, crypto, real estate, you name it.

This was an era of cheap money and low-interest rates subsidized by the government that allowed a frenzy of speculation. This is what leads to investments, like syndications, going bad.

The article mentioned above discusses an example, the Tides Equity Group. Warren Buffett’s often quoted saying, “When the tide goes out, we see who has been swimming naked.” This directly applies to this group. 

Tides Equity Group and many others are being exposed for their lack of understanding of a full market cycle.

When we have a bull run market (like the previous 14 years), it's easy to make money and look like a genius. In raising capital to fund projects/asset classes where the profit is in the turnover, you run the risk of being the last fool.

Profit made in turnover projects is based on the Greater Fool Theory – the next person who buys the project thinks they can sell to somebody else at a greater price. The price can only go so high. Eventually, there is no one willing to buy. In musical chairs, when the music stops, a chair is pulled out and somebody loses.

The Tides Equity Group bought a group of apartment equities out of Houston worth $7 billion with floating-rate mortgages.

A floating rate means that the mortgage interest rates are not fixed. The interest rates could fluctuate over time. People or syndicators only get into a floating-rate mortgage if they think interest rates will not go up. If they think interest rates will stay low forever.

This is the lack of knowledge or experience of a full market cycle. They only know half of the cycle, the portion where everything rides up and money is easy to make.

This is very dangerous. 

These syndicators bought these properties cheaply, with low underwriting and low friction to acquire. Now, as they seek to refinance with their short-term variable rates, they are finding they can’t. They need more money from investors or more profit from their operation to do so. The chickens are coming home to roost. It turns out, they are the greatest fool.

The apartments the Tides Equity Group purchased, due to valuations coming down, never increased in occupancy level. This means less profit from the investment. This is a big problem I'm seeing across the board in syndications in multifamily, self-storage, mobile home park communities, or any other real estate asset class.

Syndicators buy projects claiming to be these great operators, but they don't know much beyond marketing and raising capital. They raise all the capital with low-interest rates they can pay for at the time. But as soon as interest rates increase, as they did, it is Game Over.

The net operating income is squeezed and they have no more cash flow. Tides Equity Group is now asking their investors, who have already pumped millions of dollars into their equity investments, for more capital.

Not to mention that the syndicator has non-recourse loans. They can walk away and just trash the whole thing if they want to.

Of course, if there is corruption or fraud in their books then it would be a different story. However, if they simply mismanaged the properties, investors are out of luck.

A Warning to All Investors

If you are an investor who has been investing in any kind of syndication where you do not know how it works, I’d be very wary. In the past, you might’ve been lucky. But going forward in this current market, I’d be very careful with who I invest with.

There are still many people out there raising capital hand over fist because they have to. That is how they make a living. Through fees from raising capital. They do not care if the deal goes to fruition and gives the “promised” IRR or multiple.

It is great when that happens. It is a win for everybody. But that will no longer happen.

Syndicators will want to keep the pipe churning, raise capital, earn their fees, and avoid risk tied to the actual investment. You as the investor in equities, are the one at risk. You are the one who is going to lose your capital if you do not understand how it works, how their operation makes a profit for investors. 

It’s tragic, but most do not have a clue how the investment they poured their money into works. They just ride the wave and expect it to rise. Well, that luck is running out.