6 Big Red Flags in Real Estate Syndications

When I invest in real estate actively, there is risk. However, I can do things to mitigate the risks. And I trust myself to do just that. Because, well…it’s me. And I trust me based on my experience and education when it comes to real estate. One of the biggest differences in passively investing in real estate is that you have to put that trust into someone else. Because they are managing the investment directly, not you. That’s why it’s important to spot and understand the big red flags in passive real estate investing like with syndications.

To help with this post, I asked key resource Anthony Morena, key principal at Mortar Group, to give me his 6 biggest real estate syndication red flags. Then I asked him to share how his group mitigates these risks to ensure good returns for his investors.

These common warning signs can help any investor quickly evaluate an offering or investment.

A quick review of real estate syndications…

For those not familiar, a syndication is simply a way for people to pool their resources together.

A real estate syndication structure allows individuals to pool resources together to purchase an asset. By combining each individual’s knowledge, experience, time, and capital, everyone is contributing to the project. Everyone is sharing in the risks as well as the returns.

Without pooling resources together, it would be near impossible to complete the transaction on an individual basis based on the massive capital needed to purchase the asset. This is why syndications are more commonly utilized for commercial real estate properties versus single family properties.

Commercial real estate typically includes properties such as multifamily apartments, self-storage facilities and manufactured home parks. Other common commercial real estate asset classes may include hotels, industrial warehouses, office parks and retail shopping centers.

The 6 big red flags of real estate syndications

When analyzing any new sponsor or manager – whether it’s for a syndication, real estate fund or any other investment – there will be some level of due diligence an investor must do.

Whether an investor is choosing between a large institutional fund or a smaller local deal, proper due diligence is essential to evaluating a sponsor or an investment. You need to make sure that it is a good fit for you personally as well as for your financial plan.

Red Flag #1 – Sponsor market presence

To Anthony and Mortar Group – real estate is a local business, and a sponsor should be an expert in the local market. Deal metrics and investment variables vary greatly from city to city – or state to state. This doesn’t mean a sponsor should only invest in one city, but it does mean that the team must have local knowledge.

A sponsor with no local knowledge or relying on Google data searches should not satisfy an investor. A sponsor should understand local dynamics – geography, gentrification, and pricing history, as well as understand local building codes, and also have access to local consultants or contractors.

A boots on the ground approach by a sponsor shows they’ll be able to handle the day to day responsibilities with taking a project to exit smoothly and profitably.

Red Flag #2 – No track record

One of the most important things to look for when evaluating a potential sponsor is whether or not they have experience and track record.

A sponsor should be able to share a track record and their experience on any investment they have completed. One should also ask how the sponsor performed in various parts of the market cycle. In times like the crash of 2008 or during unforeseen events such as Covid.

It’s much more likely that an experienced sponsor will be successful or better protect capital when the market is volatile or is in a downturn. Also, it is important to not only understand the hits but also the misses and one can only do that with a track record and careful digging.

This is especially important in the recent interest rate environment where many sponsors were burned by adjustable rate mortgages…

Red Flag #3 – Part-time sponsor

A sponsor offering an investment should be in the business you’re investing in full time. They should have an office you can visit. And a website with an investor portal along with a team dedicated to managing investments.

Part-time sponsors we come across are usually someone just starting out (as all sponsors were at one point). But those investments should be funded individually or by friends and family. At least until that sponsor establishes a track record and makes investments their full-time business.

Red Flag #4 – No preferred return

Most deals you see with established sponsors have a preferred return or interest distribution.

The preferred return is usually a set amount or interest that goes to the investors/limited partners before any splits or profit goes to the manager. Ideally this keeps everyone’s interest aligned. It makes investors feel more comfortable. And it incentivizes a sponsor to outperform so they can share in the backend gain.

A sponsor that doesn’t provide a preferred return is telling you that they’re not confident in that deal. They may just be looking to make money off the fees.

Red Flag #5 – No skin in the game

This is an important question, and one of the first that comes up often with potential investors. The sponsor should be investing a significant amount of his or her own capital along with the investors or should be providing some sort of guarantee on the senior debt. A partner having ‘skin in the game” ensures that all parties align to have the same successful outcome on a project.

Simply put – A sponsor will fight harder to ensure an investment’s success if they have something to lose and not just make money off the fees for a particular deal.

Red Flag #6 – Unresponsive investor communications

Communication is often overlooked, but it is essential to a successful sponsor/investor relationship. Managers should provide timely and accurate communication or reporting because there is nothing worse than being in the dark and not knowing where your investment is, or how it’s doing. Investors should ask for sample reports from sponsors of recent deals and make sure they deliver them quarterly.

Another aspect is how is the information available, or where is it kept? Does the manager have an investor portal that is secure, where investors can have access to all their documents when they need them.

Every sponsor will have different answers to some of these red flags, but here is a sample of how Mortar Group would address these questions.

How Mortar Group addresses these potential real estate red flags

Red Flag #1 – Sponsors market presence

We are New York based, and that is where we work. We have in-depth local neighborhood knowledge, and focused opportunities that utilize our intimate knowledge of New York’s prime niche neighborhoods. This is our bread and butter.

Red Flag #2 – No track record

With over $420M in gross sales since 2001, we have been involved in over 30 offerings in New York. We have an established track record, and we have a team well versed in New York real estate. At Mortar, not only do we provide our track record but we also provide case studies, which allow investors to understand the nuances to specific deals rather than just the data.

Red Flag #3 – Part-time Sponsor

We have full-time staff managing all active investments and a team dedicated to investor relations. With over 400 active investors, we also have two offices (one in New York, and one in New Jersey), and a website and investor portal where investors can view how their investments are doing 24/7.

Red Flag #4 – No Preferred Return

Every offering we launch has a preferred return dedicated to the limited partner and passive investors.

Red Flag #5 – No Skin in the Game

Interests are aligned in our offerings. Mortar targets a 10% equity investment in each offering along with guarantees on the debt side by the principal.

Red Flag #6 – Unresponsive Investor Communications

We have a team dedicated to investor relations. We often meet with investors locally, we offer tours for visiting investors, and any email or phone inquiry will be responded to within 24 hours. Separately, we have a secure investor portal where investors can view quarterly reports, offering financials or obtain their tax information at any time.

At the end of the day – investors need to understand where their savings or investment is going. The money being invested is hard earned. So you need to be comfortable with whom you work with. And that the sponsor will do what they say they will do.

Real estate investing is a wealth accelerant…

…when done right.

And this goes for both active and passive real estate investing strategies. Active approaches like Selenid and I have used to this point allow for the investors themselves to control some variables. But passive investing relies on deal sponsors to invest the right way.

That requires a good deal of trust.

So make sure you know the potential red flags and ask the right questions before you jump in!

And if you would like to learn more about what Anthony and his team at Mortar Group are doing, check them out here.

In the meantime, here are some of the mistakes that Selenid and I have made and hard lessons learned in the real estate world!

What do you think? Would you invest in a real estate syndication? How would you vet the sponsors? What real estate red flags would you look out for? Let me know in the comments below!