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SHOW NOTES FOR EPISODE 471: DARK SECRETS OF SYNDICATIONS
Investors in real estate syndications are making record returns. However, a syndication can also be very complicated and may appear to be a better investment than it actually is. In this podcast, veteran Old Dawg Podcast guest, engineer, real estate investor, syndicator, educator and best selling author James Kandasamy shares some dark secrets of syndications and how you can avoid high-risk, low-yielding deals.
What You Will Learn
- How you can invest in single family homes and leverage into large apartment buildings
- Subtle syndication structures that can increase your risk or reduce your risk
- Why you should hold on to your multifamily properties for the long run
- Maximizing your profits by eliminating the “middlemen” in the search for great off-market deals
- Tips for finding the best off-market property deals
- How to manage your risk when investing in syndications
About Our Guest
James Kandasamy
James Kandasamy is a real estate investor, sponsor and syndicator who has been in multifamily acquisitions and asset management since 2015. He has special expertise in finding value-add multifamily opportunities. He has identified, underwrote and overseen the acquisition process of over 1,700 multifamily units worth over $160 million and also ran the execution of each business plan in the portfolio, averaging 20% IRR. James has a Bachelor of Science in Electrical Engineering from Science University of Malaysia and an MBA from the University of South Adelaide in Australia.
- James’ Recent Book: Passive Investing in Commercial Real Estate
- James Previous Guest Appearances on the Old Dawg’s REI Network Podcast
More About James
- He lives in Austin, TX
- Electrical engineer
- MBA
- Recently got a CCIM (Certified Commercial Investment Member) designation (The CCIM lapel pin denotes that the wearer has completed advanced coursework in financial and market analysis, and demonstrated extensive experience in the commercial real estate industry.) – The blackbelt for commercial real estate
- He moved to U.S. in 2010
- Had job as Senior Electrical Engineer Manager
- He didn’t really have any retirement funds
- In 2010, he spent $80,000 (his entire savings) to purchase their first home in the U.S.
- Even though he made over $100,000, it was hard to save because of he was raising a family and had many obligations
- Traveling back to his home, with his entire family, to visit family would cost $20,000
- He could only save $20,000 a year and had to cash in stocks to get additional funds
- Started side businesses – web development, stock trading
Getting Started in Real Estate Investing
- He took out $50,000 when he re-financed his primary residence to get started
- He could buy two houses ($20K down on each) to buy homes in Austin
- A friend told him to invest in San Antonio ( he could get houses cheaper – $40K per house – than buying in Austin) but he thought it was too far (1.5 hour drive away from Austin)
- But James didn’t want to buy houses at market value
- He did direct mail, direct text, direct calls to find motivated sellers who would sell below market
- Distressed houses
- Double closing – hard money loan to rehab, re-finance after repaired with conventional loan
- He was doing what wholesalers were doing – learned all their tricks by listening to podcasts, reading books
- By doing his own wholesaling and rehabbing, he eliminated the wholesaler and flipper, thereby getting the maximum value on the buy – 60-70% ARV (after repair value)
- From 2013-2015, he started buying single family houses in Austin and San Antonio markets
- He bought 11-13 houses for only $50,000
- Ended up with 11 rental houses and 2 flips
- Refinanced personal home 2-3 times
- Ended up with $400,000 in equity
- Bought mostly off-market houses, direct to seller, not on MLS
- He utilized the BRRRR (Buy, Rehab, Rent, Refinance, Repeat) strategy
Moving Into Multifamily
- He re-financed each home twice (in portfolio loans through a private bank) to get the funds to start purchasing multifamily properties
- He only has two single family homes left today. The others were sold as they went all-in for multifamily properties in 2015
- His first multifamily property was a 45-unit apartment, then 174-units and 115-units
- He has 2,000 units today (11/20/2020)
His Criteria
- He likes to buy deals that makes him happy
- The deals that make him happy are the deals no one else can get
- If he goes to a broker and makes it to the “best and final,” that doesn’t make him that happy
- If he makes it to the best and final, that means there’s 20 other people who don’t want to pay what he agreed to pay – he would be the highest paying guy
- When you buy things below market value, that’s where you make the most money for you and your investors
- That’s how he grew to where he is today
- When you buy below market value, you don’t worry so much about the economy – you have a buffer
- It’s all about “risk management”
- When you buy at the “top of the curve,” you can only hope and pray that things will keep going up. If they don’t, you have to be concerned
- Since Covid, many who paid too much are suffering
- He also buys for longer term, not the typical 3 to 5 year hold
- He likes to do a re-finance, cash-out re-fi and pay back his investors
Syndication
- “The hardest part of syndication is carrying the investors’ burden on your shoulders”
- As a GP or deal sponsor, he takes his responsibility very seriously because he doesn’t want to lose investors’ money and preserve his reputation
- Because of that, he likes to do only low-risk deals
- Low-risk deals are deals that have a lot of buffer on them
- High-risk deals are the types of deals you do through normal channels
- Real estate syndication is getting very popular
- For the past 10 years people have been making a lot of money in real estate
- Many are investing because they don’t want to miss out on the great returns
- There’s a lot of education focusing on syndication right now
- If you read Mastering the Market Cycle by Howard Marks
- The former effect is what will cause the market to peak and crash later on
- Everything is human nature
- Liquidity is high
- Banks will be lending like crazy
- That’s when it peaks
- When it crashes
- Lenders will tighten-up on lending
- No one wants to invest
- That’s the definition of recession
- Because of the risk-adjusted concern, he always likes to buy deals that make sense from day-one!
How James Finds Off-Market Deals
- You have to do the things that not everyone is willing to do
- Direct-to-Seller marketing
- Off-market strategies
- Cold calling
- Cold texting
- Sending letters
- The same things brokers do to find new deals and listings
- Later, once he closed on a number of deals, brokers were approaching him on good off-market deals
- From brokers you get:
- True off-market deals
- Deal only offered to you
- Only 3 people involved: the buyer, the seller and the broker
- This is the one James likes best
- Premium off-market deals
- They say it’s off-market but they tell 10 other people about the deal
- Everyone thinks it’s off market and they keep bumping up the price
- He always asks the broker what “the story” is on the deal
- He asks the broker, “Why are you offering this to me?”
- “Why should I buy this deal?”
- They need to justify why they are offering hi this “great deal”
- If you carefully listen to “the story,” you can tell if it’s a good deal or not
- If the broker has a good explanation of why he feels you are the best person to close on this deal, you can analyze and close quickly
- He likes this type of deal where he can close on his own with no other GPs
- It all depends if you are:
- A local guy
- An experienced guy
- Experienced operator
- Capable of closing
- He asks the broker, “Why are you offering this to me?”
- True off-market deals
- From brokers you get:
James’ Passive Investing in Commercial Real Estate
- James’ book Passive Investing in Commercial Real Estate was announced on his last interview on the Old Dawg’s REI Network Podcast
- English is his 3rd language so he didn’t really expect that it would do that well
- Has sold over 2,000 paid copies
- Simple but goes deep technically
- Good reviews on Amazon
- Good book to learn how syndication works and how to choose your first syndication investment and sponsor
- Selected as one of Top 15 Real Estate Investing Books by Jim Cramer from MSNBC’s On the Street
- James is thinking of writing another more advanced version of the book for the “next level” of passive investors – things he has learned that he didn’t cover in the first book
Dark Secrets of Syndications
- Syndication structures that are a gray line — walking the line of illegality – especially on the syndication structure
- He didn’t know about these things when he was writing his first book
- 6 months after writing his first book, he started listening to people about
- Different syndication structures
- Different ways to do syndications that many passive investors don’t even know
- Very subtle structures
- Examples of these different types of structures:
- FIRST CONCEPT: IRR Partitioning
- How the “Wall Street” of commercial investment is measured
- You can measure investment returns by two different options
- Based on IRR you can measure which is the better investment
- If you’re doing ground-up construction and the first 2 years don’t pay cash flow, but the third year they pay a big amount of money and that continues, compared to a “Class B” multifamily which, in the first year, pays money – you need a way to compare the deals and that’s where you use IRR
- When you see IRR, there is always something hiding behind the numbers
- For example, the sponsors say, at the end of 5 years, you will be earning 15%
- But behind the 15%, there is a risk factor – what is the risk of you achieving that 15% – how do you know it day zero – now?
- How do you know if it’s a good 15% or a shaky 15%
- To analyze, you look at “risk-adjusted return”
- A deal that gives a lot of cash flow and a deal that gives a lot of back-end are very different
- For example, the sponsors say, at the end of 5 years, you will be earning 15%
- Based on IRR you can measure which is the better investment
- For commercial real estate, the cash flow you are receiving is of less risk than the big pay-out you’re supposed to get in the backend of the sale
- Cash flow is considered lower risk
- Backend sales – higher risk
- Professional commercial investors say they pay more for cash flow up front than for backend sales payouts
- For a 15% IRR on cash flow the “Risk adjusted Return” is higher
- With IRR Partitioning
- He has a spreadsheet that uses to evaluate this type of structure
- You partition the total return of the 15% into two parts:
- Cash flow
- You take all the cash flow and bring it to day zero to find out what the value is compared to the cash flow you’re getting now compared to the day of the sale
- Cash flow
- The backend
- In summary, you’re taking the 15% and you’re splitting it into two to see what the ratio is between cash flow and the backend sales
- The bigger ratio you have on cash flow means the lower risk you have on that return and higher return
- If you have bigger ratio on backend sales, the higher risk on the deal
- Therefore, when you’re comparing 15% deal A to 15% deal B, you can determine which has the higher risk
- His Master Class covers this concept in detail
- Here’s a link to his classes: https://achieve-academy.net/
- SECOND CONCEPT: A Change of “On” and “Off”
- References how you’re treating your operational cash flow
- Some syndication structures are different
- It’s structured in a way where you’re getting your own money back
- In this concept, you invest your $100,000 to get a cash flow of 10%
- But if you read the company documents you’ll see that the 10% is actually your own money – Your remaining cost basis is $90,000
- It’s a very subtle difference in company agreements – he’s seeing it in many syndications today
- James doesn’t even see this as even an investment – it’s more of a “quasi loan”
- He recommends that each investor carefully read the company agreement
- Make sure operational cash-out/operational pay-out is always being treated as “return-on-capital”, rather than “return-off-capital”
- You could be getting $10,000 every year for 5 years, thinking it is the return on your investment when, in fact, it’s just your own money — not a cash-on-cash return. You’re making zero money on your investment of $100,000. Your entire profit is being made at the sale!
- The right way it should be done is that you are earning on your capital investment and, at the end, you’ll get your entire investment back, having earned 10% on your investment, plus backend
- THIRD CONCEPT – Paying High Dividends From Day One
- Sponsors are paying 8% preferred returns to investors on day-one on a value-add deal that was just purchased at a 5% cap rate, 75% LTV
- They buy the deal very quickly and want to make the investors very happy so they start paying from day one
- With James’ value-add deals, he usually waits 6 to 12 months before he can start paying dividends because the property is what’s paying the investors
- Some sponsors over-raise, float the money, maybe later they cash back
- He sees sponsors that keep buying deals, they buy a property at 80% occupancy so they don’t have the cash flow on day one to pay dividends but they pay anyway
- The sponsors end up in trouble because they have no more money to float to investors
- The money doesn’t come from the real estate, it comes from other means
- FIRST CONCEPT: IRR Partitioning
DISCLAIMER: Many of the above strategies take knowledge and have a higher degree of risk. You need to do your research and/or work with someone who is experienced to reduce your risk.
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