Not everything goes exactly according to plan...

Investing in multifamily real estate syndications is not always predictable. As the second quarter of 2023 gets underway, a few surprises in the past few weeks in our portfolio demonstrate this bigger point.

Of our 20 or so investments, we have been glad to see a few of these deals continuing to perform up to or better than expectations according to the most recent quarterly financials. The financial statement reporting on the performance of a multifamily is typically called an Income Statement. The top line often reads: "Potential Rent." This number shows the potential rent in total if all of the apartments are rented out at the typical rent rate for the given market, based on what comparable properties charge. The next line adjusts this "potential rent" based on "Gain or Loss to Lease." This next line shows how well the property is performing compared to the market rents in the market. An investor will typically see a "loss to lease" in this line as the property is improved based on the business plan. It's pretty rare, but sometimes a property can show a positive number--or a "gain to lease."

In the quarterly reports, a few of our investments are showing a "gain to lease." In these cases, the properties are able to capture a premium above the local market rents. Over the past few years, as rates have risen, some properties have been able to capture rents that are higher than the Gross Potential Rent (GPR) for that area. Of course, this is a rare event. And it may mean that the operator needs to recalculate the line for "market rent." But in any event it is good news for the performance of the property--and a few of our properties are regularly in this category, showing a growing Net Operating Income (NOI) in the process.

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On the flip side, we've had one capital call (reported last fall) and a second that has been threatening a capital call for about six months. That second (expected) capital call came this week. We as Limited Partners have been given a few weeks to come up with just over 15% of the initial investment with the likelihood of another 15% or so later in the year. These initial funds will be due in a few weeks. We are expected to contribute a total of just over 30% in the coming six months to carry out necessary repairs and for operating capital to get to a basic level of stability for the property.

What's confusing about this capital call is that the sponsor we worked with seems to be sending mixed signals about how smart this course of action is. In their update to us about the capital call, this sponsor made it clear that their partners, the operators of the property and majority investors, thought this capital call was the best course of action--but while noting that they were not so sure it would work. After writing to the "investor relations" lead for the sponsor we worked with to ask for greater clarity, it's been ... crickets. No reply. So much for all the promises of terrific communications, focus on investors, and so forth that this syndicator has pumped out in its marketing materials.

One reason that this is so troubling is that it seems there's a disagreement among the partners who put the deal together. There are lots of reasons why this particular deal has been troubled: poor communications, likely poor diligence up front, lots of unexpected expenses, vastly less income than shown on the pro forma, and so forth. But the apparent disagreement between the members of the general partnership seems like a terrible sign and possible cause as well as symptom of the deal's problems.

That leaves us in the position of having to decide whether to contribute more to a deal where it is unclear that the sponsor we came in through is themselves going to meet the capital call. In general, we favor piling in along with others to try to salvage a deal. We had a capital call a few years ago which we met and were glad we did. We had one capital call this fall that is too soon to tell. This is the first time we're considering accepting the dilution that would come from NOT meeting the capital call--and more or less writing off some or all of this syndication. We haven't yet lost money on any syndication but this one feels like perhaps the first.

The take-away: surely we will not partner with this sponsor again. We should have done better due diligence ourselves before investing with them. It also points to the value of investing with those who have a track record of repeated and successful partnerships.