Episode 9 | Syndications

Episode Summary: 

In this episode, Jack & Craig are joined by Fred Lewis and Ron Phillips to discuss multifamily real estate syndications. They discuss key elements of successful syndications, how transaction volumes have shifted over the past few years, the challenges that investors face today, and what to expect moving forward. 

*The following transcript is auto-generated.

0:01 – Speaker 1
You’re listening to Real Investor Radio with Craig Fuhr and Jack BeVier, where we cover advanced real estate investing topics to help you stay ahead of the curve in your real estate investing business. Hey, welcome everybody to Real Investor Radio. I’m Craig Fuhr. This is episode nine. You’re getting up there? How about that? We’re really going to break the seal off of this thing today. Let’s just get wild with some guests. We’ve got Ron Phillips in studio today. I’m sorry he’s not in studio. He’s on our computer that everybody can’t see, I’m in A studio Craig.


0:00:32 – Speaker 2
You are in.


0:00:33 – Speaker 1
A studio. That is right. We also have Fred Lewis here. Let’s get some introductions out of the way. Ron Phillips is a friend and he’s the founder and CEO of RP Capital. Rp Capital is a real estate brokerage specializing in residential income producing properties. More than a brokerage, RP Capital is actually Ron’s platform for educating, training and empowering emerging and seasoned investors. Rp Capital has actually been ranked in the top 25% of Inc 500’s list of America’s fastest growing companies in 2015. They offer a proprietary software suite so Ron’s clients can create their own real estate wealth plan. Ron, welcome to the show.


0:01:16 – Speaker 2
Appreciate it. Happy to be here. Thanks for doing it, man.


0:01:19 – Speaker 1
Yeah, it’s going to be fun, Jack, why don’t you introduce your partner Fred?


0:01:24 – Speaker 3
Yeah, also, Ron is a member of Real Investor Roundtable, which is the mastermind that we’ve referenced in previous episodes that we run as a nonprofit just to share ideas with who we think are the best practitioners in the country. Ron’s been a member of that for a number of years and we’ve learned a ton from him. Hopefully, the feelings likewise Very mutual. Yes, very excited to have Ron join us today. On some topics that he’s had a lot of opinions in the mastermind, we wanted to share some of those ideas with all the listeners here today. So, towards that end, I’m excited to have my partner, Fred Lewis, join as well. He’s the founder of Dominion. My mentor in real estate hired me when I was 23 and really taught me everything that I know, and very proud to be able to call him my partner. Fred, why don’t you introduce yourself? Give the folks a background?


0:02:11 – Speaker 4
Yeah, great to be here. Thanks for having me. I founded Dominion in 2001 at a time where it was a different market to acquire, really focused on really looking at quality, distressed real estate, putting him into rental service, developed a flipping business, built a private lending company. It was much like it is actually today kind of very difficult in those early years for investors to get capital to do their deals. So it’s kind of come full circle. It’s been a wild ride for over the last 20, 21 years. I’ve seen so much and it’s still love every day of it.


0:02:54 – Speaker 1
Well, I’ll just add that I can’t express the amount that I’ve learned over the years from Fred, especially initially as a young flipper in the space. I could tell a funny story or two, but I won’t bore people with it. But thank you for all the advice and consult that you’ve given over the years, Ron. We’re here today to talk about syndications because evidently you’re an expert in the space and I’m just kidding, but you’ve done so much with syndications, Ron, and we wanted to just basically start off with a framework for really where syndications have been over the last, I’ll say, 10 years, and then move into where they are now, where the money’s going now, and then maybe some prognostications. It’s tough.


Yeah, that’s a big word, it’s tough when early in the morning, on where the market’s going, and so you want to jump us in here, and then I’ll step back and let you guys hash it out.


0:04:00 – Speaker 3
Sure. So like in the I’d say, in the lead up kind of late teens like 17, 18, 19, multifamily syndication. That industry benefited from declining interest rates over time. The market was just generally good, had some tailwinds behind it. Folks who got into that business made money doing it and you could always refi at lower interest rates. Rents always seem to be up, there was always more liquidity in the market and so, kind of, given that kind of long period of time with tailwinds, the industry has gotten more and more competitive.


And just to back up real quick for those who haven’t done syndications before, what we’re talking about here is someone who finds the deal raises money is going to be the operator on the business plan and they’re generally they’re typically the general partner. In a general partner limited partner structure. The limited partners are the money guys. So the general partner will find the deal, put a presentation together and then go to their network or however. They’re raising money and offer equity interests to limited partners, and so those limited partners are just passive investors and are looking for a passive return.


At some point after the general partner has executed the business model, typically there’s a refinance that brings some money back to the limited partners. They continue to get checks as kind of mailbox money as passive investors and then ultimately, in some point in the future, the general partner decides to sell the project and hopefully makes a profit and distributes proceeds to the limited partners and so that kind of typical business model. Of course, to do that you’re raising money, so you’re selling securities, so the proper way to do that is to do a Reg D offering. There’s a bunch of different sections that we could maybe we’ll go in some other time the different if you’re going to do a syndication. What the different considerations are. We’re not going to get into those details today, but today’s a bit more about the market.


0:05:57 – Speaker 1
Yeah, this isn’t a how-to today.


0:05:58 – Speaker 3
Yeah, yeah, this is more just how that business model is going, and so in the lead up to the late teens there was a lot of that activity, and then in 2020 and 2021, with just an abundance of cheap capital, that really kind of took off. The number of syndications that were happening particularly in the multifamily space is what we’re going to focus on today really kind of took off. And because of the rising rents, because people were whether you executed well or not, frankly, in the late teens you probably you did well as a general partner. Your limited partners did what tended to do well, they didn’t want their money back. Right, it was an easier time.


0:06:38 – Speaker 1
Yeah, it was an easier time Rising market, rising rents, a track record of making money, lots of capital being thrown at it. There were no headwinds, it seemed, for syndicators. Exactly.


0:06:51 – Speaker 3
And then, in 2020 and 2021, the cheap debt of that period of time put that idea on steroids, and then rents started to increase, and so you know, it’s kind of jumping the shark when you start to see guys on Instagram hyping how they can teach you how to be a syndicator.


0:07:08 – Speaker 1
Yeah, exactly yeah.


0:07:10 – Speaker 2
Yes, everything you said. In addition to that, it was sometime around 19 when all of the syndication and education happened, and I know that was going on before that, but it really caught fire maybe 18, 19. And it spawned a whole bunch of brand new people and I mean brand new like people who hadn’t really done very many small deals were now of a sudden doing very large deals in comparison with a whole bunch of other people’s money and really none of their own, and many times going out and getting another partner because they couldn’t qualify for the debt that you talked about. Right? So usually general partner has enough, you know, stones to be able to go out and get a loan for the property, and they do that.


But many times, you know, in the, in the education space, of course, they try to figure out how, how can anybody go do this? Well, anybody shouldn’t be doing this, but anybody got taught to do it anyway, right? And so now you got a whole bunch of people out there who are making deals. They’re going and getting people who do have the balance sheet to be able to get the debt, and then a whole bunch of other people with money, and you’ve got a person in the middle who’s getting a very large acquisition fee upfront, and now they just have to operate this. You know, the syndication game taught people how to do syndications and roughly what the numbers were, but they really weren’t good at teaching operations, which is the only way this thing works, and so there’s really sloppy operations going on out there and, like you said, cheap money makes sloppy operations look okay until the money isn’t cheap anymore.


0:08:52 – Speaker 1
Ron, you and I have had very recent discussions about sort of the effects of the appreciating market and how it makes everybody look like a brain surgeon, and I feel like that’s the game that’s being played or has been played for the last eight or so years. So I’m going to find an asset, I’m probably going to pay a little too much for it, I’m going to raise rents because I can, and then I’m going to sell this thing at a better cap rate and cash everybody out. I think that’s been sort of the crystal ball investing and I’d love to get your thoughts on that.


0:09:25 – Speaker 2
Yeah, I mean Fred and I think I think it was like two years ago, one of our meetings we were having a conversation about this and I was. I was telling everybody that this is going to go away, this is going away and it’s going to go away quick. Because, you know, there’s this false. There’s this false assumption that cap rates remain pretty steady and I think, generally speaking, that’s true, but not when the market gets upended.


That didn’t track last time, it’s not going to track this time and I think there’s a lot of people out there who don’t really understand loans very well because they think that leverage is always a good thing and leverage isn’t always a good thing and you know, based on your cap rate, it could be a really bad thing. It could be better to pay cash than it is going to leverage. And right now we’re pretty much there. I mean, interest rates are hovering right around exactly where the cap rates are, or in some cases it’s flipped, especially in the outside of the multifamily market, like in the single family market and the small multifamily market, it’s already flipped. Interest rates are like 7.5% and you know, people are still selling properties at a 5.5%, 6.5% cap rate. So you’re upside down, and that’s very rapidly going to happen to the multifamily market.


0:10:45 – Speaker 3
Yeah, in late 2021, one of the other reasons that it became very attractive to get involved in syndications people were making money right, so they’re starting to pay taxes. They’re looking for, you know, a lot of people get into real estate. One of the features of being in real estate is that there are some tax efficiency strategies that you can use to offset your current income. One of the major ones that is now winding down that has been a huge factor the past three or four years is bonus depreciation, where you can do a cost segregation study to have your which allows your accountant to draw the distinction between 5.15 and long-term property, and you can bonus. You’ve been able to bonus depreciate, basically accelerate all of the 5.15 year property into your year one deduction, and so that’s a huge help in terms of being able to kind of accelerate the depreciation and offset your current income.


We had that motivation in mind when we in 2021, we were doing well in the lending business, and so we said, hey, you know we want to, let’s go. At the end of 2021, we saw a big tax bill that was headed our direction. We said, hey, we want to get involved in some syndications so that we can get some bonus depreciation allocations as a limited partner. You know, basically we’ve got some money that set aside that we’ve made and we want to invest it in some deals to help offset taxes and get some exposure to multifamily, which was going great at the time. And so, with that motivation in mind, we, you know, we went out at the end of 2021. This is before interest rates started to increase and kind of did a survey of every multifamily syndication deal that we could find over the course of a 30, 45 day period. And so, Fred, we probably looked at what like 30, like probably 30 deals, yeah probably, more probably, 40 deals.


All, yeah, all over the country different flavors of stuff, and it was a really eye-opening exercise to do that, because the just the spectrum of frankly like financial competence, operational competence, like just like common sense business practices Well, how deep did you go?


0:12:55 – Speaker 1
So I mean, you got that basically their prospectus, or you know, whatever their deal break. Yeah, I got the deck Right. Yeah, the deck, that’s perfect. And so what did you discern just by looking at that? Go ahead, Fred.


0:13:08 – Speaker 4
Well, I think what’s interesting is this entire market happened because of it. One huge distortion. If you think about the amount of capital that came into the economy in general Yep, the amount of parts of COVID and into COVID six, seven trillion dollars came into the economy. The amount of capital that went into the average person’s pocket, into businesses, PPP loans so much capital was available that that distortion led to a lot of what we’re talking about today. Syndications as a business model is a good business model for experienced real estate people. There’s nothing wrong with syndications. Definitely it’s the abuse. It’s the absolute abuse of the business model that really was caused first by the distortion of capital that came into the business. What?


0:13:57 – Speaker 1
specifically, did you guys see when you were looking at decks that was like a red flag for you.


0:14:02 – Speaker 4
Well, the first thing we saw is how many brokers were hockey deals. So, if you think about it, there’s so much money at that moment in syndications that they can pay the broker or the marketer a huge fee to go find people like us or anybody else who’s got some capital to put in a deal. So really, that’s the first thing is that if you want to get into a syndicated multifamily deal at the end of 2021, all you have to do is turn your computer on and you’re going to hit 10 brokers, you’re going to email them. After all of a sudden, you’re going to get on a list and then you’re going to get 20 emails. So we just took the time, talked to the brokers, we talked to some friends we knew in the industry. We talked to who we thought were anywhere from sophisticated syndicator real experience real estate guys, all the way down to people who we met through brokers, met through various contacts and one of the commonalities we saw was the amazing lack of actual real experience in real estate.


It’s something that Rod just mentioned more in your opening about, and I like to use the 27 year old kind of example. There’s so many freaking 27 year olds who maybe did a deal with a partner. Maybe they did one deal on their own, much smaller, and then all of a sudden they realized that we can skip steps two through 10. And we’re just going to go right to 11, which is we’re going to syndicate a $30 million multi-family deal, even though I’ve never quite done that before. But I’m going to create a narrative that sounds good and I’m going to draft off of historical, historical being in the last 12 to 24 months there rents my historical right, my historical years, because I graduated college three years ago and my historical is it’s all good because rent growth has been, you know, 12 to 20% annualized for the last three years, so why would it not increase the same?


Probably, if I’m going to convert what is a C class older, multi-family into a B class, which is a great, great kind of smokescreen story yeah, it’s a great story, that is true to some extent, I mean, it certainly is, but it certainly can be played and I think that’s what we were interviewing a lot of folks. We saw the unsophisticated syndicator who basically just pounded their chest that these assumptions were correct and tried to create the best story possible.


0:16:37 – Speaker 2
Stories are great, great storytellers. It was more. It was worse than that, Fred. Like I talked to syndicators. I had guys who called me to and they very, very similar to what you said. They were like hey, Ron, can you look at this deck and tell me what you think? And I would say, yeah, like you need to go back there and ask them why they think their exit is going to be a 4.5% cap rate. You need to ask them why they think 18 months from now that the interest rates are going to be the same or lower. And you need to ask them why, in year five, they think that the rents are going to appreciate at the same rate they did last year. Every single year. You need to go ask them a whole bunch of questions. And then the guy calls me back two days later and he’s like hey, this guy’s like really upset and he wants to talk to you. And I was like, okay, cool, get him on the phone. And then I asked him his questions. He starts laughing at me. He said.


I said, listen, in this particular market, do you know that there’s going to be like 500 new units directly down the street from you in like the next 12 months he goes yeah, that’s just all. That means my, my appreciation numbers are going to be locked in. Because I got brand new properties over there and I said you’re a fool. You’re going to have 500 units you’re competing with that are all going to hit the market at the same time. Your crappy units that you’re that are not brand new, that you’re trying to turn from a C class to a B class and you’re going to be competing with brand new units down the road who are all.


Every single one of those, those buildings is going to put tons of, of give me’s on the front end because they’ve got 500 units sitting and a whole bunch of investors that they have to pay out. As you’re more on, it’s going to negatively impact the rents. And I said the cap rate isn’t going to remain at 4.5% and, by the way, your property isn’t new anyway, so it’s not a 4.5% cap rate. I mean there was so many holes in that pitch deck and the dude laughed like you were saying, like how many of these deals have you done? I’ve done this many deals. I’m like well, you’re going to lose a lot of money then over the next couple of years if you did them all this way. That’s what I can tell you.


0:18:46 – Speaker 3
So like we would get these decks, we’d be, you know, and everything was the consistent theme was that every single deal was a value add. Where we’re going to spend? We’re going to do $7,000 to $10,000 in CapEx. Turning over this. It’s rented under market right now because of because of mismanagement. Right, like everyone’s a mis-manager.


0:19:07 – Speaker 1
Everyone, who, every seller is a mis-manager.


0:19:09 – Speaker 3
Every seller’s an idiot. Yeah, Every seller’s an idiot. And they and it’s a mom and pop.


0:19:13 – Speaker 1
He’s got 70 years old. He hasn’t raised rent since. You know we’re going to spend $7,000 to $10,000 per unit.


0:19:18 – Speaker 3
We’re going to be able to increase rents from $850 to $1275 on average and we’re going to do that in a 12 month period and as if like, as if the market like, without any context of like, well, can the market, can that market, afford 12, can those humans, right, can they afford 1275?


Sure, there’s, there’s a hundred of them there at $850, like you know, for a reason, and you know that you could spend 10 grand and increase rents by 50% was like this common theme. And then, from that point forward, when you dug in and said, hey, give me the financial model, the Excel spreadsheet that foots to this, you know copy and pasted thing you’ve put into your PDF, this copy and pasted pro forma that you put into your PDF, when you actually dug into the Excel spreadsheet, you’d see that they were increasing their market rents so that upon renewal, they’re, they’re, they’re actually getting additional rent increases. Their expense ratio was, you know they lied right, Like it’s just a freaking lie when you, when you tell me that an $850 a month rent has an expense ratio of 25 to 30%, it’s a lie. Like those, you know, those units are 45% expense ratio. When you get into the 12, you know, 12 to $1500 range. Maybe you can get it down to like 35 or even 30% when you get up to like $1800 a month.


0:20:32 – Speaker 2
Rents Not on a large multifamily anyway, they don’t operate at 30 to 35%, maybe a single family home. But you, if you get over a hundred units, you have payroll and stuff. I mean you, you have staff that’s on site that you have to fund. On top of all of the normal single family home stuff that you have to fund, you’ve got a small business that you’re running there with human beings on site in addition to your tenants. Right, it’s not just a set it and forget it, it’s a business that you have to run. Most of these people didn’t have any business experience either, or if they did have business experience, it was a failed business and this was a good, quick way to go get $253,000 up front on a deal. They didn’t have any idea how to operate.


0:21:16 – Speaker 4
To run to build on what you said earlier. In our conversations with the syndicators we’d say, hey, we got a bunch of questions, we want to talk to the guy, you know, let’s put this deck out and the first thing we hear is well, what are your questions? And we would without the same questions. You put out your assumptions around, you know, rental increases, your expense ratios, your cap rates, why you buying this at a two and a half cap? Because you think you can get it to, you know, to some other number? And the common answer was well, nobody else is asking those questions. It was amazing to me how few people were asking the questions we were asking and how many people were thrown down, giving an average of $50,000, $150,000 in a lot of these deals.


0:22:06 – Speaker 3
You could tell how few people were asking those questions because of, just frankly, how unprepared the sponsor was for what we consider to be just like you know, just basic questions.


0:22:19 – Speaker 4
And to the extent they had an answer, the answer was very, very staged as a one sentence answer and they didn’t know the detail, as you said, about what’s coming to the market, why the cap rate’s appropriate. And then, when we asked for the financial modeling, as Jack alluded, they felt a lot of them just felt offended. What do you mean? You need to look at my financial model. Well, we didn’t. We wouldn’t, we wouldn’t even go to step two unless we got the financial model. And the financial models we found mathematical errors, we found formula errors, we just assumptions. That just can’t be true.


They had this concept in multifamily lost to rent. And so when you have this concept of going from a C class to a B class and you’re going to go from the $800 rent to 1200, you can one can argue that well, all the rent should be 1200. So my loss to rent is $400 unit, never mind that it’s going to cost me a ton of money and time to get from 800 to 1200. Don’t look at how long it’s going to take. So I’m going to perform a 1200 because that’s what my rent should be.


0:23:29 – Speaker 2
Yeah, on, on, on your. And here’s the other thing too is they would put these numbers in from year one as if there was not going to be a rehab. And I, you know, I would talk to these guys and what you would think would be a common sense, basic thing, right, that if you’re going to turn these units in 12 months, that means everybody’s on a month a month and you’re literally kicking everyone out, right, and you’re doing all the rehab. Now it’s the only way, literally the only way, you can do a 12 month mark to mark on a right On a property. And I would argue that even then you’re probably not going to because you still have, however many hundred of units that you’re that you’re doing this, to that you’ve got to fill back up with all the new tenants that, to Jack’s point, may or may not even be able to afford 1200 or whatever.


0:24:24 – Speaker 3
The new rent is right. Yeah, you’re going to flood the. You’re going to flood the market with $1200 a month rents. Yeah.


0:24:29 – Speaker 2
I’m going to deal right now. We’ve owned for two years and we still haven’t raised all of the rents, because we have legacy tenants that are still in there and we keep increasing their rents. Why would I take somebody who’s actually paying me rents on time, has lived in this property forever and raised their rent $450 in one whack, when I can keep them there and have income, while the other people who can’t afford it anyway I’m turning their units and increasing to 1200. Why would I kick out the person who’s performing? I can increase their rent a normal amount and I can keep doing that year over year until they move out, unless I just want to experience a full vacancy in my building, which is fine, but you have to put that in your financials.


0:25:14 – Speaker 4
Well, Ron, that’s because an experienced real estate investor understands credit loss and understands vacancy rate. Because you increase the rent on someone from $8 to $1200. A number of those folks just go vacant. They just leave because there’s a reason why they can only afford to $800. Maybe they can afford a $850. Maybe you can scale them up over time. But when you model a multifamily deal at 96, 97% occupancy, it’s not the same. If you increase rents 40%.


0:25:50 – Speaker 2
It’s just not the same math. If you’re a credit owner, Fred, it’s on a property that never, even at $850, never got to 96 to 98% occupancy. It was never there anyway. So somehow the 27-year-old who has no business experience it doesn’t know how to operate is going to make that happen.


0:26:11 – Speaker 4
So I remember a conversation with one of these 27-year-olds and I said to him so wait a minute, you’re going to get the $1200 and I don’t see an entry here for credit loss. He’s like why would I put credit loss in? Everyone’s paying, yeah, but everyone’s paying $7, $800 a month in rent and you think they’re paying because the seller, who’s selling this to you at a three cap, tells you everyone’s paying.


0:26:37 – Speaker 2
Right, let’s see the loss runs.


0:26:39 – Speaker 1
Hey, I just want to jump in here with a great story that looks like it was August 1st. It’s in therealdeal.com and it’s entitled Multifamily Maelstrom. It really speaks to this point of all the new entrants and, frankly, the new money, those distortions that you were talking about. I love this. Some big players in the multifamily market have never experienced the bad times, the rough times, right those in their 20s and 30s. The 27-year-olds were in junior high or senior high around the great recession. It’s hard to believe, but it’s so true. The current fallout hitting these investors in these rental properties is rivaling the distress scene right now in the office market, and that must be a really eye-opening moment for them. So I’ll ask you all look. I think there is that youthful exuberance and, frankly, ignorance that comes with the rising market of the last 10 years. But the amount of money. This story talks about two firms in particular Rise 48, which is a multifamily investment firm. Who’s a 27-year-old 27-year-old, very good friend Name’s Zach. Yes, that’s correct.


Because, they’re all 27-year-olds. We weren’t going to out the guy, since he’s here in the story. So in just four years, they’ve amassed $1.4 billion in assets. That is a fast-growing company, Fred, even faster than your own, and Tide’s Equity, founded by Sean Kea and Ryan Andre, both in their 30s they’re ancient. They’ve acquired an even bigger portfolio over the past few years $7 billion and so this ain’t mom-and-pop money coming at us here. This is not. You know, grandmoms got $150,000 to lend. This is big, institutional money coming at them. So I’ll ask you all are they dumb guys too? You know, do they not see the writing in these decks? Do they not look at the decks and say, hey, wait a minute here, let’s ask them tough questions? Have you seen?


0:28:34 – Speaker 2
their decks. Have you seen the institutional guys’ decks?


0:28:39 – Speaker 1
I’ve seen a couple in the mobile home space, but not in the multifamily space.


0:28:42 – Speaker 2
Look, look, some of the guys who are running large hedge funds are really, really smart and they’ve hired really good real estate operators and they know their numbers. But there’s a ton of hedge funds that have no freaking idea and, frankly, I’m not sure that they care. Run the math on this. Let’s say that you did what was the 27-year-old? He was at what? $7?


0:29:09 – Speaker 1
billion. $7 billion was the guy in his 30s. That’s tied’s equities.


0:29:14 – Speaker 2
Run 3% of whatever $1.4 billion. That’s what he made on acquisition fees alone. He’s happy.


0:29:23 – Speaker 4
So the part of the problem to your point about the institutional capital is that when you have a significant distortion, like what we saw, you do have that greater full theory that comes into play is that when and these institutional guys they make their money by deploying capital, that’s it. That’s how they make their money. They get their base salaries. It’s not what they play for. They play for getting paid to deploy money. And if they see deals that are successful and we all don’t know how long the greater full theory actually exists, because it could start in 2019. It could go to 2028.


Nobody really knew. The money was abundant, Capital was cheap, Rents were going up, Things were starting to escalate, and so there is a phenomenon that institutional money does not want to miss. They don’t want to miss the party, and that’s really what happens, and so they fool themselves. And they fool themselves because they’re incented to deploy and the syndicator is incented to deploy. Everybody is incented down that chain incorrectly. There’s no real alignment with the guy that’s going to end up losing the money and the people who put in the money into the hedge fund and the hedge fund put the money into the syndicator and then the crowd street guy that gave the syndicator some money, which I guess we’ll talk about as well. All those people are getting money from somebody else who doesn’t necessarily understand the risk they’re taking.


0:30:54 – Speaker 1
I backed out of a deal I don’t know if I told you this or not, but I backed out of a deal in the mobile home space where a company basically wanted to work with a small boutique equity firm wanted to work with us to be a sponsor. We would go out, find deals, they would put up the equity and then they would find the debt elsewhere. And we showed them a deal and I was not a big fan of it. It was 500 units, all park owned, which is not the advantageous side of being on that side of the business. I know I’m getting off on a little bit of a tangent here, but it’s for a reason. And so the performer that my partner in the business at the time wrote up, by the way, who had only raised money in the space, he had never operated in the space and now we’re going to take on this massive park in a tough area of Tampa and I just didn’t see us turning all of these things over to Tenet owned in a matter of a few years.


I didn’t see the market quite as rosy as they did, and so it was all of these factors that went into the deal that I see going into multi-family deals where people are just like, I’ll put my blinders onto that. I want to raise a billion dollars, so we’ve got to deploy that capital. As you said, Fred and I just I had to walk away and I was just. I just don’t believe in this. I don’t believe in the model that you guys are promoting here and it’s that. It’s that what’s getting it down to the guy who put the 150 grand in, like, like my father would have, and there’s no care for that guy. And I see you operating something completely different around, because I’ve seen the way you operate with, with your LP partners and the care that you take. So maybe speak to that.


0:32:40 – Speaker 2
Well, I think it’s probably a good time to bring up the fact that, right now, I happen to know for a fact that the people who are in trouble there’s a bunch of people who are in trouble now and over the next 18 months there’s going to be even more people in trouble why We’ve been talking about these, these big firms that are that are going down and they’re the ones making the headlines, but every one of them there are dozens and dozens and dozens of small time operators that we’ll never hear about. People are went out and did a billion, right, but they have 30 million, they have 10 million, and every one of them represents a whole bunch of people, just like what you were talking about. And right now, this is the piece that, over the last two decades, that I’ve never understood, because this has happened before. This isn’t the first time, right? This happened before and people went to jail, and the reason that people go to jail is because they lie to their investors.


So, right now, there are people out there and they’re in trouble because things aren’t cash flowing away that they thought they were going to and they can’t make their preff payments, and so the way that they’re doing that is they’re going and buying more deals, they’re continuing to raise money and they’re over raising on those deals and they’re moving the money into the deals that have shortfalls, which is illegal Totally, which is illegal. But these guys have no business sense. They don’t even realize this is illegal and they also don’t realize that long term this doesn’t work. It never works because in order to go get a deal right now, when there’s not very many, you have to get sucky deals, like Fred was talking about. They’re more interested in deploying capital because they’re not making any. They’re not making income either.


So the way they’re making income now is to go out and get more acquisition fees and then move money from one to the other and they’re trying to spread all of this money that they’re over raising between all of their funds so they can continue to pay people, which is literally the definition of a Ponzi scheme, and it’s happening right now. There’s an operator that I have people who’ve invested with that I know who is going down. He’s getting foreclosed on it because he couldn’t get a good loan on the last one he did. He actually cross collateralized other syndication deals that he did. Yeah, exactly, jack. You’re just like what. How does this even happen?


I’m telling you that this happened, and I know of two other guys. They’re all kind of small time guys, but this represents millions of dollars of investor money and these guys are going to ultimately end up probably going to jail. Their families are going to lose everything. This is sad for all people involved and it’s all because people are running faster than they should run because money has been easy, but over the next 18 months, as these loans, one of the things we probably ought to talk about is how these actual loans work, because they don’t operate like a 30 year fixed conventional mortgage. It’s not the same thing.


0:35:49 – Speaker 4
I want to put it out there. I think, as we go into how these deals work and who lent on them, I think it’s good to distinguish between the folks who accepted the moral hazard of doing a deal exaggerating the rental assumptions, exaggerating the expense ratio down, exaggerating the vacancy rate, exaggerating the loss to rent, exaggerating all the key assumptions of a deal because they thought that best case scenario could happen because the moral hazard was I really make money by doing this, as opposed to a guy like Ron or guys who have, because you can say it’s the more experienced guys but it’s also the guys who have integrity. There is a difference. It would be wrong of us to say that a 27 year old doesn’t have integrity. There are guys who have integrity at all ages who decide to get into the deal appropriately. We just saw a proliferation of 27 year olds into these syndications because it was a bastion of moral hazard, but it doesn’t mean that there aren’t great quality syndicators. I think we just found our show title by the way, take it personally.


0:37:03 – Speaker 1
And syndication is a bastion of moral hazard by the way you don’t have to do it.


0:37:09 – Speaker 2
I think we’re beating up on 27 year olds because of what’s going on in the headlines. But the guy I’m talking about, and all the guys that I know none of them are young and they’re not inexperienced. These are guys have been running real estate deals for a long time and they just got carried away and instead of just admitting right, you should just tell your investors hey, I effed this thing up and it’s going to take us a long time to walk out of it. I’m sorry, but instead they’re not doing that. They’re trying to save their reputations and save their face by exacerbating the problem, and they’re going to end up in jail. That’s what’s going to happen.


0:37:48 – Speaker 4
The guy that’s willing to lie on the front is the same guy as willing to lie on the back. So what’s you know? I think you know. There’s an old adage bet on the jockey. You know, in every business you invest in or every situation you get involved in and I think it plays here you bet on the team that has experience, has integrity, that actually is going to tell you the truth and has money invested.


0:38:12 – Speaker 1
The only way you find that out because you don’t know these people going in generally is by doing the kind of work that you injected.


0:38:20 – Speaker 4
Yeah, you know it’s interesting To one of the drill downs the work we did on the front. One of the things that we found interesting is how much cash they had in the deal and how they can manipulate.


0:38:30 – Speaker 1
That answer Was that where you shocked at how little they had in the deal generally.


0:38:34 – Speaker 4
I was shocked how they can manipulate the answer. Go ahead, because here’s the issue. Let’s say they’re taking a 2% acquisition fee, development fee, they’re taking a debt placement fee. They’ve taken every fee under this freaking sun, right? So by the time you’re done they’re 5%, equating the deal maybe 400 grand. Let’s I vividly remember this example their fees were 450 grand. They were actually. They actually said no, no, we’re investing $400,000 of our own money, but don’t look over here.


It’s like don’t look under the green cup, because the green cup means I’m getting 450. Just look under the red cup.


0:39:19 – Speaker 3
And we’re good. Wow, there’s alignment here. As if that was you know, as if that was alignment. Let’s talk about the. Let’s jump in. Let’s talk about the. You know, something that allowed this behavior to happen is the fact that you could get debt for it, right, we’ve told you. You know the equity, you know. That’s, frankly, a bit I feel like it’s human nature to, once you’re winning, you don’t want your money back, you just want to redeploy it right. And someone made money. You don’t really. Maybe you don’t fully understand exactly how they did it and you don’t draw the. Maybe you don’t draw the distinction between operational excellence and the market, but the. But you, you know. So you redeploy with that person, right. So it becomes easier in an up market, it becomes easier each round to raise the equity. But for that to happen, right, for that, for that to happen, the debt has to come along for the ride too. And so let’s jump in and talk about the different kind of debt markets that happened over that period of time as well.


0:40:12 – Speaker 1
Let’s do an awesome radio thing instead. Leave that as a great tease. Plus, I want to talk about sort of the you know what are we seeing now and really over the next few years? Let’s end this episode here. We want to thank everybody for tuning in to Real Investor Radio. Tune in to the next episode, Thank you. 

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