In a recent Wall Street Journal article titled “A Housing Bust Comes for Thousands of Small-Time Investors,” the foreclosure woes of Jay Gajavelli, the head of Applesway Investment Group, were brought to light. Gajavelli’s ownership of multiple units across Houston took a turn for the worse, shedding light on the risks associated with syndicators in the multifamily real estate syndication market. However, it is crucial to note that this case does not represent the entire landscape of multifamily apartment syndication itself, as many success stories are worth highlighting.
Drawing parallels between the medical profession and the syndication business, it becomes apparent that generalizations based on a few individuals’ actions can be misleading. Just as a few doctors making poor choices does not discredit the entire medical community, a select group of syndicators’ actions should not tarnish the entire industry’s reputation. Trustworthiness and credibility depend on how syndicators handle their responsibilities and their chosen partners.
Recognizing the significance of the limited partners, it becomes evident that selecting the right team is just as important as the investment itself, if not more so.
Important Factors to Consider During Multifamily Syndication
To prevent a repeat of unfortunate scenarios like the one involving Applesway, there are the key factors to consider when assessing syndication deals:
- Alignment of Interests: While making a real estate syndication deal, it’s important to have a shared vision between you and the co-investors to avoid misalignment and risk of availing incentives. Clear and upfront communication leads to a long-term and trustworthy relationship with the potential of staying on the same goals and strategy.
- Avoid Overpaying for Properties: Prices have surged over the past few years, leading to inflated payments. This phenomenon is reminiscent of the 2007 collapse when many individuals bought homes beyond their means. Syndications operate on a larger scale, emphasizing the investor the need for cautious evaluation to avoid overpaying for properties.
- Emphasize Cash Flow: Investing in multifamily syndication deals that generate cash flow immediately is crucial. Such investments cover all expenses, maintain substantial cash reserves, raise capital, and provide regular distributions to investors. By prioritizing cash flow, multifamily investors can fortify their position against economic downturns.
- Opt for Fixed, Long-term Debt or Interest Rate Caps: The risk of failing to meet mortgage payments poses a significant threat to property investment. In recent years, adjustable-rate mortgages have been popular due to low-interest rates.
- Evaluating the Real Estate Market: Thoroughly analyze the current state and trends of the real estate market to ensure the investment process aligns with market conditions.
- Assessing the Investment Opportunity: Carefully evaluate the specific multifamily property or project, considering factors like location, potential for appreciation, and rental income and generation capabilities.
- Reviewing the Syndication Deal Structure: Examine the terms of the real estate syndication deal, including profit-sharing, management fees, and exit strategies.
- Analyzing Passive Income Potential: Consider the stability and longevity of the asset and the passive income that can be generated from the investment.
- Tax Benefits: Familiarize yourself with the tax advantages associated with real estate investing, including deductions and depreciation for rental property used.
- Risk Assessment: Be aware of the risks involved in real estate investing, including market fluctuations, property management issues, and potential vacancy rates.
- Group of Investors Dynamics: Understand the dynamics and composition of the group of investors, including their experience, financial strength, and investment goals.
- Due Diligence on Properties and Sponsors: Conduct thorough due diligence on the property being considered and the sponsors passive investors’ or general partners’ reputation and track record.
However, concerns regarding potential rate hikes led to the purchase of interest rate caps, ensuring that rates do not surpass a predetermined threshold. Applesway’s failure to secure rate caps left them vulnerable to an interest rate hike from the low 3% range to a burdensome 7-9%. Protecting against such fluctuations, new deals should now focus on fixed debt with a consistent interest rate throughout the term, guarding against potential interest rate increases by the Federal Reserve.
The Wall Street Journal article exposed the poor conditions of Applesway’s properties and the detrimental impact on tenants and investors. However, it is crucial to distinguish responsible real estate syndicators from those who neglect their duties.
Unlike the properties highlighted in the article, responsible syndicators prioritize the well-being of their tenants. They strive to provide safe, clean, and attractive living spaces, fostering a sense of home for residents. Many syndicated multifamily properties even go beyond the basics, offering afterschool programs focusing on financial education or English as a second language. Some properties have earned special green loans due to their environmentally friendly and energy-efficient features, demonstrating a commitment to sustainable practices.
The unfortunate investors who suffered losses in real estate deal in the Applesway case deserve empathy and support. Their hard-earned money, their real estate investments upon which they relied to sustain their lives and support their loved ones, is no small matter. While there are avenues for leveraging tax benefits from such losses with the guidance of knowledgeable CPAs and tax advisors, it underscores the importance of selecting the right team from the outset.
Syndicators can mitigate risks by avoiding overpaying for properties, focusing on cash flow, managing it and opting for fixed, long-term debt or interest rate caps. Responsible syndicators prioritize tenant welfare, with property management companies offering safe and attractive living spaces while investing in educational initiatives. Through education and a diligent selection process, investors can participate in syndication deals emphasizing capital preservation and cash flow, ensuring a secure and profitable investment opportunity.
Education is central to empowering investors and ensuring they make informed decisions. Syndicators and funds who focus on capital preservation and cash flow prioritize educating their investors about the intricacies and potential risks associated with multifamily syndication.
By providing comprehensive educational resources, they equip investors with the tools and knowledge to navigate the multifamily syndication investing landscape and make sound investment choices