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- Syndicators are dropping like flies
Syndicators haven’t had this hard of a run in at least a decade. Several are facing cash calls, missed payments, defaults, and even foreclosures. The primary source of this is refinancing debt, perhaps shorter term debt, with a new rate that is substantially higher than when it was originated. This creates a deficit in the cash flows and starts off a timer for when the project will miss a loan payment. The real kicker is to know what the value of the property is compared to the size of the loan. If that number is bigger, that is the rest of the pie that will be divided up among investors when the payment can’t be made and the property is forced to be sold.
However selling under those circumstances is not likely to get the best price as the lender just wants their loan amount back and will not be concerned about retaining owner’s equity in the case of default.
I stepped on the landmine, now what?
If you have already invested with a syndicator that has an asset that had to refinance its debt you have a couple of options. First see if the promoter will be honest about the situation and ask if there is a deficit for the project. If you were receiving distributions and are no longer getting them, that is probably to help prevent or reduce any deficit. If there is a deficit even after the suspension of distributions, find out how long before it runs out. Then ask what their plan is for when that date arrives.
If that date is more than 2 years out, you might get lucky and be able to refinance before then while increasing rents only if that is possible in your market. Rents actually may be falling depending on where your asset is. The reason I am saying 2 years is simply because of a general consensus on how long the Fed expects to be in a loosening cycle. No one can know for sure where rates will go or how long, so this is only an opinion.
If that date is less than two years you have two options really. One you can sell now while there is still some equity left. You will very likely take a loss. The promoter may be more optimistic or want to hold off, but time is against you.
The other option is to bring cash to the table to refinance a lower amount so the property cash flows and then operate it for several more years to reach better markets in the future where you might be able to regain that value.
There are more complicated combinations of the two that might involve a merger or partial buy-out but they get more complex than I want to get into here.
What went wrong?
Commercial real estate life cycles are long. They can be 20 years or longer. We have had a long bull run for over 12 years so a lot of syndicators got started early in this cycle and have known nothing but up and to the right success never imagining a down turn.
Many deals just got passed from one investor to the next at a 20% markup two to three years later over and over for the length of a decade. That much time will really program you to think the opposite side of the curve can’t happen, especially if it happens when you start your career. As such, the more leveraged you were the more you made until the shoe dropped. Did you hear that… men’s size 11? The more conservative syndicators are still operating albeit in a more challenging environment but the aggressive ones are losing equity and investors.
A lot of these distressed assets are going to fall into the market at discount prices, especially in 2024. Financially strong and conservative buyers will pick them up and do well with them in the coming decade and a lot of lessons will be learned. I for one am very thankful that I get to learn the mistakes of these syndicators while not losing money for any of the investors in the deals I am working on. I may not grow as fast, but I can keep growing and keep investing.
How do I pick a good syndicator?
There are three things to look for in a good syndicator. They are track record, track record, and track record. If a sponsor has been successful for 30 years, they know what they are doing, they have return investors that have been investing with them for decades, lenders, brokers, and relationships that are crucial to make purchasing and operating these properties. You just can’t last that long without all of those requirements. Also make sure the leadership is either the same or contiguous. If the 30 year CEO left last year, really dig into the new one to make sure the organization is sound. Deep decade long relationships that are still there and still working rule the day in this asset class.
2024 should be a good year to pick up distressed assets at new prices with long term debt that works. I’m looking forward to what our team at Darwin German will do.
For further discovery, a great book on the financial details of underwriting a syndicated deal that I like very much is Brian Burke’s Hands-Off Investor. This is a great read for anyone thinking of investing in a syndication. I refer to it regularly and have derived great insights from this book. I hope it does for you as well.