Unleash the Power of OPM: Real Estate Syndication Explained

As you're going into syndication is you're really learning two skill sets: underwriting and operating deals, and then building relationships with and curating money from your investors.

Today we're talking about syndication, so stay tuned. Welcome back to the channel. My name is Cody. I am joined here with Drew Niffen, and we are talking about how he acquired 2,500 apartment units over his lifetime. Drew, welcome back to the channel.

Thanks. Good to be here, Cody.

Yeah, excited to chat about this because this is a model that Christian and I have not used. So can you explain just for folks who are brand new to the real estate game, what is syndication?

Yeah, I mean, syndication is no different than when you hear about some company that does IPO, right? They're going to the financial markets and they're saying, hey, we got small parts of our company, whether it's Target Corporation or Amazon or General Electric, Why don't you buy a little bit of it? Syndication is that same sort of thing. We, we're going out to the world and we're saying, hey, we got a business that we want to buy. It's this apartment building. Would you like to own a slice of it, a portion of this business? And we'll present why we think it's a good opportunity, why we think we could add value to it. You know, if you invest $100,000, what kind of cash flow would you get over the hold? And what do we expect within 3 to 5 to 7 years? And then you're going to make a decision just like you would if you're going to buy some stock. Do you want to buy in this company and be a part of this partnership? So syndication is really just a way for people to pool their money together and buy something that they probably can't buy by themselves.

Now, let's say that you've got a deal that you're working on. Let's say it's a 140-unit complex. You need $5 million down, and I've got $100,000. If I give you the 100 grand, do I get to have a say in how that's run, or how does that actually operate?

No, you don't, right? And you don't want to because your whole idea is to be a passive investor, just like you would get if you bought that stock. Like, you know, the CEO of Amazon isn't like, hey, what do you think I should do on Prime Week? Right? You just know what bothers you, right? So that's what we get to do is take on all that headache, take on all those thoughts, know the market dynamics, know what the other communities nearby are doing as far as their rents, and make decisions based upon that information and based upon our experience doing this for a decade, two decades, so that you don't have to, right? So the syndication is split into two different groups. The passive investors, which we call LPs or limited partners, and then the active partners, which is kind of the syndication group that's responsible for bringing the whole syndication together, finding the deal in the first place, buying the asset, and then executing on that business plan. So those are the two big buckets, your passives and your actives.

So the limited partner, they have limited, like really abilities to do anything. They don't really get to have a say in what color you paint it. Is there anything else limited as far as exposure or?

Yeah, they have limited liability. Limited liability, right? So it depends on what kind of deal you buy, but there are deals in which us as general partners have what's called recourse coming to us. So let's say that the deal goes terribly wrong. And the mortgage or the debt on it was $5 million and we're only able to pay back $4 million to the bank. Right. The bank might have recourse to us if it's structured in a way that there's recourse, but there would not be recourse to the limited partners. So they have unlimited upside and they have limited downside. That's why they're limited partners.

Yeah, well, I like unlimited upside and limited downside. Yeah, I'm not super good at math, but that, that pencils out to me. And as far as actual syndication goes, that, that is an equity structure, right?

Correct.

That is, that is for the equity down because on our channel we talk a lot about the debt.

Yeah. Yeah.

Okay.

Well, yeah, I mean, first of all, on that sort of like limited upside or unlimited upside, limited downside, like that's the definition of a smart bet, right? Something where essentially the worst you can do is lose your nut, your investment, but the best you can do is sort of to infinity, right? And so I've actually thought about that concept, whether it's spending, investing your time watching something on YouTube so you can be a better investor, right? Getting a coach, getting an investment like this, that sort of asymmetric upside bet is the smart thing you want to do. But going back to your question, you could theoretically syndicate debt. Right. So you could, you could say, hey, listen, here's a pool of private notes or mortgages that are paying 8 to 10%. But, you know, the seller doesn't want to sell them at $25,000 a pop. They want to sell them at $20 million a pop. I could raise $20 million and go buy that and then parcel out that cash flow to the investors. So you could syndicate that. It's not something that we have done in the past, But I think that has lower risk because there's an asset behind it and there's monthly cash flow on it. So it is an idea.

Well, the reason I ask is our whole business model and how you buy real estate is you find a deal you want to purchase, then you line up the debt and you line up the equity. And for our equity, we've always done one equity partner, maybe two on a deal with a buyout agreement. But my thought was you guys are going out and buying 100, 200, maybe 300+ unit deals, and you're probably putting 30, 35% down on a lot of them. What if you did seller financing and you syndicated the 10% down? The IRR would probably go through the roof.

Yeah. Yes, I think theoretically the answer is right. It gets harder to get seller financing the larger the asset you go. Right. So you and I have actually talked about this. I think you guys have found a sweet spot where they're large enough to matter to you, but they're small enough that they end up being owned by a single individual. Number one, so it has to be, it's much easier with a single individual. And then it's much easier if they have no debt on it to begin with.

Right.

If they have debt on it, it's kind of, it's harder for them to seller finance it. And so just right in the sandbox that we play in, that hasn't been the case very often. One creative debt strategy that we do see often that you guys would be aware of is assuming the debt, right? So if someone bought 15-year debt at 3% a couple years ago and we can acquire that, it's like having a time machine and getting those rates that may never be here again. Right. So but if you can find that strategy that what you're, what you're talking about, it's awesome.

Okay. Well, as far as using syndication to scale, what are some of the drawbacks? Because I've seen some people go super fast and then they get caught up with CapEx. How do you avoid that? Because I've seen people, they start out maybe with a 300-unit deal and they realize, well, I can, I can budget for general maintenance, I can budget for my cost of capital, the operating expenses, but the capital expenditures of turning a property can eat them alive. Where would you say the sweet spot for someone that's trying to get started? They love the syndication model. They're going to raise a little bit extra for CapEx, but they don't want to get completely buried if they make a mistake.

I mean, it's, it's so— it's such a personal answer to that question. Depends on someone's experience, how much money they can stand losing, how much money, how much time they can commit to the asset, how fast they want to grow. You know, it's really hard to answer on that. 50 units in Seattle is a lot different than 50 units in Memphis, Tennessee. So a unit count is not necessarily indicative. Overseeing a brand new 50-unit A-class property is a much different load of work than a 50-unit C-class property. Right. So it's another metric right there. But one thing I would say, and I've told this to people I've kind of mentored or coached in the past, is I always say apartment buildings age in dog years. And what I mean by that is, you know, one year in apartment building life, you're going to learn so much. You're going to be so much different in one year. And if you bought 10-year debt with yield maintenance and you're stuck with that property, that property that was the biggest deal to you in the world 10 years ago is now a rounding error to you 2, 3 years on. And so you might want to recycle that money and get out of that property that's no longer that important to you and put it to work on a new asset that's the right size for you. So as people think about their scaling plan, I tell them if they can, to look for like community banks where they can get out of the debt without prepayment penalties, because as they scale, as they're trying to grow, they don't want to be encumbered or handcuffed by the debt structure that they have in place.

Okay. And as far as on the note of scaling and making sure you're not making those mistakes, getting into those first few deals, where are you sourcing capital from to actually go out and close these? Because whether you do a 50-unit in Memphis where you're going to have a lot more turnover, CapEx, or you do a 50-unit Class A, I mean, where does the money actually come from? How did you build those relationships from your experience buying the duplex, triplex, sixplex, nineplex?

There's a couple of different answers to that, right? So some people essentially don't syndicate the first few deals. They're doing them on their own. So they're sort of, you know, learning the business on their own dime. That's one way to go about it. It could make sense for some people. Other people have money, right? And so they're going to syndicate from day one. Usually at that point, it's friends and family. It's, it's your, it's your siblings, it's your parents, it's your relatives, it's your, your buddies from college, you know, and they're willing to put a check in, right? Like one, one neat trick is you can, you can take your 401(k), take your IRA money, and put it in deals. So some people are like, I don't have any money that I can invest. And it's like, well, if you have a 401(k), you have a chunk of money that's meant for investments, and this could be a vehicle for that. So friends or family is one answer. The other answer, you know, Cody, you're doing this on some level, right, is building an electronic platform, right? So building a community of people using the scalability of social media to get people to hear what you do and trust you and reach out and say, "Hey, what you're doing seems to make sense. I don't have the time to do that myself, but if I could put some money to work with you, I'd be happy to do that." And that's the other way that someone can get investors into their deals.

Okay. And then for those actual deals, are you sourcing those from brokers? Are you going direct to owner? How did you build your pipeline?

Yeah, it's overwhelmingly mortgage brokers. I'm sorry, Brokers.

Real estate brokers.

Real estate brokers. Yeah. Right. So we have had one deal that we got off market. You guys will kind of love this deal. This week we reached out, talked to a whole bunch of owners. This guy just called us up like 9 months later and said, I'm ready to sell my asset. He told us he wanted to sell it for $50,000 a unit. And I think we had a contract in his inbox like in 2 hours. Right. We didn't even find an attorney on it because we wanted to get it signed so fast. We knew that it was worth a lot of money and he signed it and then he actually tried to get out of the deal a little later because he realized he had sort of just given away a lot of value. So that was the one that we got basically direct from owner. But the majority of them have been through the brokers.

And did you close that deal?

Yeah, closed it. It closed it and put a 10-year fixed debt with no prepayment on that asset. And you were asking me a little bit ago, are there any deals that you would desire to have just done with your business partners? And that's one where we actually talked about just doing it, just the 3 of us together, me and my 2 partners, because we knew it was a phenomenal deal. We knew that the day you bought it, you were already in the money, $1 million or so. But we felt like we owed it to our investors to share it with them. And we actually, on that one, we just basically emailed like our top 20 investors. We said, hey, you can put in X, we'll just close this right now. So it was like the fastest we've ever raised money, and we never did a formal raise with a webinar and a campaign. And, you know, even in this downturn, that deal is just doing really well. So that's really fun.

So you do webinars. I mean, I've never had to do that for capital. I've also never raised $20 million. What does it look like actually making the the pitch to people and for folks who are getting started, I'm just trying to think from their point of view, they're worried because they've maybe done 1 or 2 deals and they're working on doing a 50-unit. How do you inspire confidence to investors when you're doing that over a Zoom? Is there a standard format that you have for these pitches?

Yeah. So I mean, first of all, if someone's getting on your webinar for the first time, they're not going to wire that money. I think almost no matter what, right? So if they're going to get on the webinar, it's because you already had touchpoints with them many times, maybe coffee together, maybe, maybe just having an email campaign where they're hearing about your thoughts on the market, right? So you have to, I mean, just think about like a personal relationship, someone doesn't get married to you right away, you date for a while and figure out whether they're a good fit before you make that relationship, that commitment. Right? And it's the same thing with capital. It's a long-term commitment. We are going to own this asset for 5 to 7 years. So once they are at the webinar, hopefully they've already had enough touchpoints with us that they're like, as long as the deal makes sense, we trust Nighthawk Equity. We trust Drew and the other members of this firm. Right? With regard to the actual content of the webinar, it's pretty similar. Right? And if anybody ever wants to email me, we can just send you like, you know, some of our past ones. But it's, hey, here's the market, here's why the market makes sense, here's our experience, here's what we've done in the past that have worked, and then here's the deal itself and sort of the reason this deal makes sense. So you want to just, first level is who are the people behind the deal and then what's the market it's in and what's the deal itself? Those are kind of the 3 tiers to a good presentation in my mind.

Okay. And then lastly, to wrap up this call, there's a couple of different types of syndications and regulations to follow there. I don't know what I don't know about it because I've done it, but I know there's one where you can do it for your acquaintances. There's one where you can do it for sophisticated investors, accredited investors, and then non-accredited. Could you break those out and then which ones you do and why?

Yeah. So I— there's— it's called 506(b) as in Bravo and 506(c) as in Charlie. Right. And I always— the B's are be careful. That's how I think of it. Right. Okay. And you need to be careful because the B's allow you to take money in from persons that are not accredited investors, which is a fancy way of saying people that are wealthy., right? And you think about it from a public policy perspective, lawyers and judges are going to be much more sympathetic to kind of a little old granny who lost all her money than some wealthy person that loses, you know, $100K, right? So the rules are going to be sort of stricter in a 506(b). The upside is that you can take investments essentially from anybody, you know, essentially there's some rules around it. And the downside of that 506(b), or the other downside, is you cannot advertise it, right? So if anyone that's listening here, if you've ever been on social media flipping through your phone and you see advertisements for a deal, that's a 506(c) deal, which means C for accredited. You can take in accredited investors. So on those deals, you could only take investments from people that have been verified through a CPA or a third-party firm to be accredited, which basically means wealthy. And the idea behind that is these are big boys. If they lose all their money, it's their fault. They should have known better. Right. So those are kind of your two main worlds. And, you know, there's pros and cons to both of them. We've predominantly done 506Bs because part of our mission as a company is to provide an avenue toward financial freedom to the guy on Main Street. But it cuts both ways. There's, there's logic for both of them.

So if someone's watching this, they want to go build a relationship with you because you're not marketing a 506(b), they want to chat with you, grab coffee with you. You're in the Pacific Northwest. What would be the minimum investment on a typical 506(b) deal that you're going to take? Is it $5,000, $10,000, $50,000?

No. Well, so the answer is no, it's not going to be— it's going to be higher. We ask for an initial investment of $100,000. Right. So there's, there's tension on that number. What's your minimum?. But think about it from our perspective. If we're trying to raise $10 million and you're doing it $10,000 at a time, you gotta find this. That I think it's 1,000 people, right? That's just really hard. That's really hard. And for the actual syndicators out there, you know, you think about the 80/20 rule, 80% of your questions or your drama or your issues with investors comes from 20% of them. And then in what we found, and this makes sense, not enough investors, but those that are brand new to the game investing for the first time, they just have a lot more questions, right?

Yeah. So I wouldn't, I wouldn't want 200 people being mad at me if there was 8, 20%. Yeah. You know, it was 1,000.

That would suck. You, you, you were, we were talking a little bit ago about what are the plus and minuses of syndication. And one of the, you can call it a minus, but you now have to get really good at two skills, buying and operating deals, and then looking after and communicating with investors. And it's one thing if you have one investor, you just call them up and text them and send photographs, but you have to have a system to manage 100 investors per deal when you have 10 deals. And so that is a challenge. And so that's one of the things that it's both a real responsibility and sense of pride that you are entrusted to look after people's money, but also just, it's a lot more work. So if you have one person that can write that check for you and boom, you're buying a deal and they can write a check on the next one, you can focus all your energies just on the operations. So that's one thing you have to be aware of as you're going into syndication is you're really learning two skill sets, underwriting, operating deals, and then building relationships with and curating money from your investor base.

Awesome. Well, that's a wrap for today. If folks want to find out more about syndication, you can message Drew at Drew Niffen on LinkedIn. But I appreciate you joining, and we'll see you again next week.