What could go wrong in a syndication investment?

There are some really appealing things about investing in a syndication. As eager syndicators (or sponsors or operators or deal promoters etc.) will tell you over and over, you get to invest passively in an appealing asset class, you don't have to do much work, you get a monthly/quarterly/semi-annual/annual check, you get some terrific tax benefits, you own an inflation hedge, and you have essentially no liability if and when things go wrong.

Sounds pretty terrific, right? So, is it true???

Yes. That's typically true, so long as you are a limited partner in a standard GP/LP structured deal (GP = General Partner, LP = Limited Partner), so long as you choose a good syndicator (a place we can help, here at Syndirater), and so long as things essentially go well in the deal. We also recommend using one or more LLCs for your investments to keep things straight and separate from your personal finances--but we are not acting here as your lawyer, of course.

We've invested in dozens of syndicated deals at this point. Most are in apartment buildings but we also have experience in self-storage, hotels, office buildings, parking lots, crowdfunded deals, hard money loans, angel investments in tech companies, and other similar deals. The vast majority of these deals have worked out well.

There are a few downsides:

1) Private syndications are fairly illiquid deals: you can't put in money that you'll need soon. You are getting paid in theory a nice premium known as an "illiquidity premium" for agreeing to tie up your money for a while. That could be a year or two or it could be seven to ten years--or more.

2) You give up control. As a Limited Partner (LP), you give up the right to say much about how things are going, whether it is time to refinance or sell, or much of anything at all. This relates to the illiquidity point above: if you run into a cash crunch in your personal or business life and you need you initial investment back, you may be out of luck. Oftentimes a sponsor will agree either to buy back your initial investment from you at a discount or to offer it to other existing investors, but that's typically not up to you and it's not a guarantee. Read your offering memorandum with care!

3) You can be asked for more money. The DREADED CAPITAL CALL is in fact a thing. In good times, a capital call in syndications is pretty rare. We experienced one related to a hotel / office deal during COVID-19 when things screeched to a standstill (and the property has since recovered nicely). What happens is that the sponsor or operator of the deal will write to all the LPs, explain the situation, and demand additional investment--or "calls capital" from the existing investors. If an existing investor meets the capital call--sends in the cash demanded by the operator in a timely fashion--then typically the investor is treated as still owning the same percentage of the building, only with a higher cost basis. If an investor does not meet the capital call, that investor is typically still in the deal but at a diluted amount--so the percentage of the deal that they own goes down. If they owned 2% of the deal after the initial investment; they failed to meet a proper capital call and are given timely notice and so forth; then they might own only 1.5% of the deal after that. At least in theory, that's because other investors stepped up to cover the needed capital costs that the investor was unable or unwilling to cover. Yes, it can happen and does happen--mostly due to weak management of a deal but sometimes due to truly extraordinary, unforeseen problems outside of management control.

4) The deal might just be a dud and not return what you expected. In our experience, no deal in the private syndication space has actually gone to zero--become worthless. We have experienced that in the case of angel investments and venture deals, but with, say, a big apartment building, the operator would have to mess up pretty colossally for the value of your investment to go to zero in ordinary times. (Is it possible? Sure. But lots would probably occur in the meantime to stave that off--see (3) above, the capital call, or a refinance or sale.) There's no guarantee of any return ON capital much less a return OF capital. But it's our experience that projected returns (set forth in pro formas) are occasionally missed and deals can disappoint--but good deals with good syndicators are pretty unlikely to go to zero. It's still a valuable asset and there are usually ways to monetize or save it, even in a crisis period.

What's the takeaway? The worst when you are investing in syndications in typically not so terrible. Sure, you can lose money and you can be disappointed when returns don't meet your expectations. However, you're pretty unlikely to be sued for an investment in a private syndication if you are an LP and there's not a big chance that such a suit would succeed (recall: we are not your lawyers!).

BUT: as in any business, it helps to have some cash on hand at all times. Warren Buffett famously notes that when the tide goes out, it becomes apparent in a hurry who has been swimming naked. Don't let that be you. If a capital call comes along--and it might--you want to be in a position at least TO CONSIDER whether to meet the capital call and remain at your initial ownership percentage level rather than letting yourself get crammed down. So keep a few of those distributions in your investing LLC checking account in case you need to redeploy them if a deal runs into headwinds. You won't be sorry you prepared for the worst even if it never comes. Here's hoping.