One way syndicators con investors

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Want to take moment to explain and decry a move I see a lot of syndicators making (particularly on crowd-funded deals): Making distributions using investor capital, rather than free cashflow.

Heres’ where the problem comes from: Syndicators need capital from investors. Investors generally want both regular distributions AND high forecast IRRs.

It’s a seller’s market right now, where you can’t just buy a high cap rate, stabilized deal with some leverage and forecast a high IRR. Instead, to forecast a high IRR with a straight face, you need to buy something with a crappy cap rate and add value.

The problem: To add value to a property, you generally need to vacate some material portion of the property while you make improvements, in hopes of re-leasing that space for higher rents.

The (hopefully temporary) vacancy means there is little / no free cashflow. But the investors were promised regular distributions. What is the syndicator to do?

The answer, for a lot of syndicators, is to raise more equity than the project strictly requires, then use equity reserves to pay distributions, even while there is no free cashflow.

By over-equitizing, the syndicator drives down his eventual IRR (because he used more capital to generate the same profits)… but, by the time the numbers are printed (generally, when the deal is stabilized, or possibly not until it’s sold), the investors are already in the deal and the syndicator has made his fees.

You can get away with this shit because most people don’t read the docs, and the ones who do usually aren’t sophisticated enough to understand the con.

But it’s still a nauseating practice.

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