Is there ever a major loss of capital in a syndication investment?

Short answer: yes. You can lose all of your original investment and get nothing back.

In an earlier post, we covered the topic of what could go wrong with a syndication investment. We got a follow up question from a thoughtful reader: "yeah, OK, but can we lose all or most of our capital?"

It's a very astute--and totally fair--question. The answer with anything in investing is that of course, a major or total loss of capital is always a possibility. It would be crazy for anyone to answer that question with a "no." Even if someone hasn't experienced it themselves, that definitely doesn't mean it couldn't happen.

One way to look at this question that may be helpful: we should ask instead, "compared to what?" So, compared to other investments, is it relatively more or less likely that there should be a major or total loss of capital?

Let's take the comparison of a multi-family real estate syndication in a single deal vs. another common type of private investment, an angel investment in a high growth tech start-up. In our experience, it might be the case that the same investor is considering $50,000 or $100,000 as a Limited Partner (LP) in a multi-family investment or making a similar angel investment in, say, a promising FinTech start-up in that person's home city.

The likelihood that the multi-family syndication would go to zero in value is not likely but it is well above 0%. You'd like to think that a strong GP would never let it happen, but it can. Throughout the hold time of the investment and through to the end, at a bare minimum the syndication's investors own the underlying land in the deal as well as the buildings. Even if there are liabilities on the property, the likelihood that there is no value to the asset is pretty low.

Now, an operator who is not skilled might still have blown up the deal--it is possible that the investors' capital would evaporate even if there is value in the underlying asset. That's most recently been true with floating rate debt that results in the deal becoming unsustainable.

How likely is it for an investors' equity to go to zero? It was once fairly rare, but has become more common as rates have risen and stayed high (note: this is updated as of 2024). Most of the time there are things the operator can do: a capital call is unpopular, but it can give the deal a new lease on life. Depending on the rate environment, there could be a refinancing opportunity. Or the property can be sold. An operator has a lot of choices for how to keep the syndication's LPs from losing all their money. It can happen, but it probably means curtains for that syndicator, at least for a while and certainly with those investors, so it is likely they will try to figure something out.

With the angel investment, it's probably the case that there's a higher return possibility (IPO!) as well as a higher chance it can go to zero. To use investing terminology, the tech company is likely a higher beta investment than the private real estate syndication. There's greater risk and a greater possible return. If the company's technology doesn't pan out or the customers don't want to pay what the founders thought they would or if the economy crashes at the wrong moment, the company's valuation can quickly fall to zero. There's no underlying land and buildings to sell at that point--most likely, it's just a winding down and/or bankruptcy proceeding or a sale for pennies on the dollar of the remaining assets. The investors absolutely can lose their capital. It's part of the business of angel and venture capital investing: only a subset of the investments have to hit in order for the angels or VCs to make a great return. There is an expectation that some will fail.

OK, compared to something else that's less risky? Private real estate syndications vs. certificates of deposit (CDs) or Treasuries? Of course, the likelihood of default on an FDIC-insured CD or T-Bills backed by the full faith and credit of the US government is not going to be a close call. Even, say, municipal bonds held to maturity in a big city with a strong tax base or blue-chip stocks with a loyal customer following and a world-class management team--these investments are much safer. They also will almost certainly not offer the same returns and tax benefits as a private multi-family real estate syndication--they are lower beta.

To answer our reader's question: it's unlikely (though still possible) to lose all your money in an apartment building syndication if you go with a solid operator and choose your deal with care. You have to choose to put your money somewhere. The mattress (or the local bank's checking account) will be safer but the returns and tax benefits are certain to be much less appealing, too. What matters most is "compared to what".