Written by WCI Founder Dr. Jim Dahl
We always write about real estate investments, syndicates and private real estate funds. However, much of our writing is theoretical, as these illiquid investments take years to complete. There is also no central database of returns like mutual funds (Morningstar). While the expected returns of syndicates are almost always higher than the expected returns of stocks, bonds, and even publicly traded REITs, the actual returns people achieve are more uncertain.
I think it's useful to explain how these investments actually perform from time to time, so every time one of my investments goes full circle, I write an article about it.
But that's not what today's post is about. The text of today's post is based on a recent quarterly update I received from one of the equity real estate funds I belong to. I invested his $100,000 into this fund in 2017, and from 2017 he was invited to contribute from 2019 to 2019. Capital returns began in 2020 and were then accelerated from 2021 to 2022. Most of the capital has now been returned, but the fund will probably not be completed until the end of 2023 or even 2024. We are not going to spend a lot of money. Time to talk about the overall returns of this fund, at least until it's back and forth.
We'll focus on one of the fund's 17 properties.
Syndicate becomes zero
This particular property has completely lost its capital. Below is an excerpt from a quarterly update email from the fund with further details.
“Dear investors,
We would like to inform you of the latest information regarding investment in the fund. As of September 30, 2022, the Fund is projected to generate a return of 57.5% on its invested stocks, reflecting a total return of 14.1% over the past 12 months. Assuming full liquidation as of September 30, 2022, the fund will generate an internal rate of return of his 12.9%. As of September 30, 119.8% of invested capital had been returned to investors through operating cash flow and distributions from asset sales. . .
Only one office investment remains in the portfolio. Significant adverse changes in the capital markets for office assets over the past quarter have resulted in asset values being lower than outstanding debt. It is possible to continue to hold assets, but debt restructuring will be required in parallel with additional capital injection. Despite recent strong leasing activity and lenders' willingness to enjoy discounted gains, new equity investments fail to generate satisfactory risk-adjusted returns. Therefore, the net asset value is reduced to zero to reflect the full loss of the Fund's initial investment.
Despite further capital amortization, net IRR is expected to be 12%-13% and net multiple is expected to be 1.58-1.60x. Full and final liquidation of the Fund is expected to be completed by the end of 2023 or early 2024. However, the ultimate timing of any final asset sale is subject to change based on strategic decisions to optimize value creation in line with real estate and market conditions. ”
lessons learned
This is the second property I have invested in where the investor's money was completely lost. The other was a syndicate that I owned directly, rather than through a fund. I'm actually not quite done yet (I'll write an article about it when I'm done), but I'm confident that I'll end up with almost a complete loss of capital. This doesn't mean the return is -100%, but it's not far off. Additionally, as I've discussed in previous blog posts and podcasts, the single-family REITs I've invested in are in trouble.
I think there are some lessons that syndicate investors can and should learn from this situation.
#1 Diversification is important
Imagine if I put all $100,000 into this property. It will cost you $100,000. But because he used a fund instead, he only had about $5,000 of my money invested in the property. This variance limited my loss to $5,000 instead of his $100,000. And in fact, the rest of the portfolio performed well enough to make up for that loss, still delivering double-digit gains.
Click here for details:
Private Real Estate Investment Update: My CityVest DLP Access Fund Round Trip
#2 Past performance does not predict future performance
Almost all the operators and fund managers I have seen have had great past performance. But I can't buy that. His two previous funds with this manager had equity multiples of well over 2x. That won't happen with this fund, in part because of the performance of this property. Expected returns are exactly that. Past returns are exactly that. Neither can be purchased.
#3 These are high-risk investments
Real estate syndication is a high-risk investment. Not only can you get returns in excess of 10%, but you can also get returns in the 20%-30% range or even more. However, it is also possible to lose your entire investment. There's a reason you have to be an accredited investor to invest in these. Accredited investors should, in theory, be sophisticated enough to evaluate the merits of an investment itself without the assistance of a financial professional. Perhaps most importantly, you must be able to lose your entire investment without significantly impacting your financial life. The reason is that you can actually lose your entire investment. That doesn't happen with index funds.
#4 Leverage risk is real
The value of this office building did not fall to zero. It's still worth something. This particular fund uses leverage of up to 70%. This means that a drop in value of more than 30% will wipe out your entire investment. Everyone loves talking about “leverage” and “other people's money” and “borrowing at 4% and investing at 10%.” But leverage works both ways, and sometimes it takes a wipeout to remember that.
Click here for details:
Portfolio performance in 2023 (including real estate!)
#5 Operator is more important than investment, but investment is still important
You've probably heard me say that the operator (manager, syndicator, general partner, etc.) is much more important than the investment. Because a bad operator can ruin a good investment, and a good operator can make lemonade out of lemons. I still think that's true. Perhaps this fund manager made the right decision not to put bad money in its wake (I've seen a similar I made a decision). However, even a good operator cannot save every trade. I went back and read his thoughts on investing in office buildings in 2016. Here's what they said:
“The emergence of Generation Y has created a younger workforce that continues to redefine the nature of demand for office assets. Our analysis shows that the majority of the U.S. workforce is replacing Generation X with Generation Y. As it continues, two trends in office space have been identified that will continue.
- Reducing office space per employee. Tenants, particularly large publicly traded companies, are increasingly downsizing their offices, adopting non-dedicated office sharing policies and increasingly deploying technology to support employees' ability to work remotely.
- Change workspace setup and feature settings. Companies are increasingly seeking more collaborative workspaces for functional project teams, increasing the demand for more on-site office amenities.
We also believe that we can continue to benefit from positive supply and demand dynamics in the office market due to increased construction costs and a reduced supply of office real estate as liquid assets are being diverted to other uses. Masu. We conduct specific submarket analysis in all target markets to understand the complete picture of these demand and supply drivers. In Chicago, 4,122,124 square feet of office space has been taken off the market since 2007 due to conversion to hotels or apartment complexes. ”
The operator clearly doesn't have a functioning crystal ball. Little did they know that 2020 would bring about a global pandemic that would dramatically accelerate the work-from-home trend and dramatically reduce the value of office buildings. Diversity protects you from what you don't know and can't know. I still like this fund manager. I have invested in another of their funds and will probably invest again. But they're humans just like us.
Real estate syndications can and do deteriorate even in relatively strong markets. When the market goes against them, even more companies end up with defective products. Invest with caution and approach these illiquid investments with your eyes open. If you would like to learn more about personal real estate investing, consider signing up for our free real estate newsletter and check out our partners in the table below.
Features real estate partner
DLP Capital
Offering type:
fund
Main focus:
For multiple households
Minimum investment amount:
$100,000
Year of establishment:
2008
Origin Investments
Offering type:
fund
Main focus:
For multiple households
Minimum investment amount:
$50,000
Year of establishment:
2007
37th parallel
Offering type:
Fund/Syndicate
Main focus:
For multiple households
Minimum investment amount:
$100,000
Year of establishment:
2008
Southern Impression Homes
Offering type:
turnkey
Main focus:
single family
Minimum investment amount:
$60,000
Year of establishment:
2017
Wellings Capital
Offering type:
fund
Main focus:
Self storage/trailer house
Minimum investment amount:
$50,000
Year of establishment:
2014
MLG Capital
Offering type:
fund
Main focus:
For multiple households
Minimum investment amount:
$50,000
Year of establishment:
1987
mortar group
Offering type:
syndicate
Main focus:
For multiple households
Minimum investment amount:
$50,000
Year of establishment:
2001
Acre Trader
Offering type:
platform
Main focus:
farmland
Minimum investment amount:
$15,000
Year of establishment:
2017
*This is an introduction to these companies and is not a recommendation. You should perform your own due diligence on any investment before investing. Most of these opportunities require accredited investor status.
What do you think? Have you ever had a syndicate go awry? What happened and why? Comment below!
