Cautious investors should look for these eight warning signs when considering a real estate investment syndicate.
1. Overpriced assets
Often an asset is purchased by the syndicator, and then sold to the “innocent” public for a lift up from a low of 20 per cent to more than 100 per cent on some land deals. This used to be O.K. in a very strong market, but is not common.
- 2. Check track record
Many a syndicator has had some success raising funds, sometimes for flow-through tax deals or other parties. But it takes years to understand how to buy real estate, even more years how to buy well and not overpay, and even more years to manage an asset well and then exit with a profit.
- 3. Excessive fees
Some syndicators charge in excess of 10 per cent commission. This seems to be the norm, but is still high as it has to be made up through asset performance, which takes a few years. Also, an annual asset management should probably not exceed 0.5 per cent on the asset value, or 2 per cent of the cash invested, otherwise it is too rigged towards the syndicator and not the investor.
- 4. Unrealistic ROIs
Often, the promised ROI (return on investments) are paid from your own investment dollars. It is easy to produce a 20 per cent return over five years, by paying you your money back. Thus: look at the underlying vehicle that produces this return. Any promise to deliver any distributions over 6 per cent in the current environment has very high risks.
- 5. False sense of security
Syndications often use terms such as “asset backed” or “secured by a mortgage”, but in many cases these mortgages are in second or third position and exceed by far the value of the underlying real estate. In construction or land development projects the investors’ money is often in 2nd or sometimes in 3rd position behind an expensive first position. This is not security: it is a sham. Don’t call it a mortgage if it is indeed equity or investment dollars.
- 6. Licensing requirements
There is a requirement in Canada that sales people who are “in the business of selling securities”, like realtors, have to be licensed by a provincial security commission and registered via an Exempt Market Dealer. Most provincial security commissions have a database that is accessible to check their credentials.
- 7. Acquisition fees
Some operators charge an acquisition fee of up to 3 per cent or 4 per cent. Combining this fee with sales commission, plus the usual marketing, administration, travel, legal and bookkeeping expenses and a startup might be 30 per cent in the hole after the building is acquired. To get from 70 per cent actual cash invested to 100 per cent is a 40 per cent gain that the asset must produce just to break even.
- 8. Are these returns realistic?
The advertised returns initially are usually paid for with your own money. Marketing fees often approach 12 per cent to 20 per cent of the funds raised, plus sales commission. This can be a very high hurdle as it has to be made up through asset performance.
Use these guidelines to separate the wheat from the chaff and you too can successfully and profitably co-own a larger piece of real estate or a pool of hard assets with others.