We all hate market downturns, and this was bound to happen. We just didn’t know when, exactly how, or how things would get worse. But now we know the answer to the first two of these three questions.
- When, currently underway.
- How, see below.
- how bad, No one knows.
The purpose of this article is to find out what led to the recession leading up to what is happening now. Then, based on the 10 items below, investors can draw conclusions about what could happen next and how bad it could get.
Recently, The Wall Street Journal informed of Thousands of investors lost millions of dollars in a series of multifamily deals. This article highlights a mid-level Dallas IT worker who built a 7,000-unit multi-family portfolio in only four years. Unfortunately, it lost 3,200 units to its lender in Q1, defaulting on $229 million in loans and losing syndicated investor capital.
I’ll comment briefly on what happened here, what’s happening with many syndications at the moment, and why this failure certainly won’t be the last. Then I will tell you one important thing which you must do before investing again.
nevru effect
I have often discussed The dangers of investing with neuroses. “Nevaroo” is my tongue-in-cheek label for promoters who weren’t in real estate until recently but are now promoting themselves as experts who syndicate deals and raise millions of dollars from thousands of investors. .
nevru = novice master
Word hasn’t caught on yet, but I’m counting on your help. To be clear, there is nothing wrong with being new to investing and getting involved in syndication. What can go wrong when some of these people say to others, “This time it’s different.” They often take huge risks and persuade others to follow in their footsteps.
Neurus has risen in prominence over the past decade through various convergence factors. This includes:
- Enhanced syndicator capital-raising opportunities as a result of the 2012 JOBS (Jumpstart Our Business Startups) Act.
- The massive popularity of real estate investing because of trendy HGTV and other network shows.
- Self-promotion opportunities afforded by ubiquitous social media and other online advertising platforms.
- A movement away from the casinos of Wall Street toward alternative assets.
- A record (timing and growth) bull market in commercial real estate coincided with the fast-fading memory of the 2008 disaster.
- Significant growth in wealth and investable capital among millions of Americans.
- Investment flows from the three I’s: institutional, international and (self-directed) IRA investors.
- The popularity of trainers who promise freedom from the daily grind and great wealth by becoming a syndicator (“no experience required, and yes, you can try it at home”).
- Tax law changes in late 2017 that gave a huge boost to commercial real estate investors.
- A common realization by HGTV watchers (see #2) is that they love and believe in real estate but hate dealing with toilets, tenants, and garbage. Investing in syndication is a natural next step.
Do not get me wrong. I generally do not criticize most of the factors that lead to this problem. Wellings Capital and many of you have benefited from this environment.
I criticize how these factors converge to produce a new breed of inexperienced, inept and sometimes unscrupulous operators. Syndicators who collected hundreds of millions of dollars of investor capital gambling on multifamily properties that, and properly managed, should have produced reliable investor returns.
This house of cards was bound to fall apart, and most of the issues were predictable. But there was one problem that I failed to foresee in my countless articles and videos, which was a warning of the outcome we are experiencing now. I’ll get to that in a moment.
If you’ve lived in Texas, especially these past few years, you may have heard radio commercials enticing listeners to join one of the many multidisciplinary training programs. Thousands paid the fee and took the plunge in Texas and across the country.
These gurus are lured into being syndicators with the opportunity to profit from acquisition fees, asset management fees, and other fees paid independent of the success or failure of the deal – an easy path to riches.
Jay Gajaveli is the subject of a WSJ article. He is a Texas IT guy turned student turned syndicator who lost 3,200 multifamily units and millions of investor dollars. Quote from the article:
“After finishing an exhausting week, he said, he was struck by a thought that changed his life: ‘I’m tired and weary of working for my money.’ That’s when he decided to become a landlord, he said. Over time, ‘I was able to transform my IT income,’ he told potential investors in a webinar last year. ‘I live on my own terms.’
He was quoted as saying in an investor webinar: “I never worry [the] Economy now. “even though [the] When the economy goes down, I still make money.
These programs are heavy on raising capital and finding deals but light on asset management. I heard a teacher say that getting the money and making deals is the hard part. But managing the deal with a good property manager is a lot easier.
Ah
Even programs that teach property and asset management can’t build on the experience that only comes from years in the trenches.
Here’s another quote from the WSJ article highlighting Gajveli’s lack of asset management skills and financial woes:
“A video for prospective Applesway investors posted in December 2021 featured a 704-unit Houston apartment complex called Timber Ridge. Applesway, Gajaveli’s company, bought the complex that month for $56.7 million, with a plan to double investors’ returns by raising the rent and adding tenant fees for washing machines and covered carports.
The investor video shows a neat complex of apartments arranged around a shimmering swimming pool. By the summer of 2022, the pool water had turned a sickly green. There are piles of garbage in the parking lot. Tenants complained to city officials about rats, mold, illegal evictions, and management’s failure to properly maintain the buildings.
So these programs marketed thousands of inexperienced students to disaster (see list above). And these students started competing, outdoing each other in a race to the bottom.
And the continued CRE and general economic boom acted as a rising tide to lift almost every boat. Even neuro bots.
Millions were made. New students signed up. There was even more brightness in the market. And successful investors and their friends vied with each other to invest in the next soon-to-sell deal.
Dazzling capital raisers often rise to the top. But the best promoters are often not the best asset managers. Yet few people cared as they collected quarterly payments and went into debt to invest even more.
With hundreds of syndicators competing for every deal, something had to give. Syndicators had to:
- Significantly overpaid for the property.
- Cut costs by financing with short-term, floating-rate loans.
- Employ more aggressive growth assumptions to convince interested underwriters and unsuspecting investors of the deal’s merits.
But here’s what actually happened:
- Interest rates rose at an unprecedented pace, in some cases doubling loan repayment costs.
- Fare increases were halted and in some cases even reversed.
- Operating expenses continued to rise in line with inflation. For many, insurance and property taxes soared from 50% to 75% or more in the past year. Insurance seen in some Texas and Florida properties double or triple,
- Short-term debt faces refinancing, but the math no longer works.
- With the refinancing crisis, banks are lending less and tightening terms.
To many of us this was no surprise. But here’s one I didn’t see coming.
Many syndicators with floating rate loans paid for interest rate caps. good for them. These caps are temporary and must be renewed, often long before the loan becomes due. Lenders have a contractual right to require that syndicators hold cash reserves for future rate cap renewals. And they are doing so.
These interest rate cap reserves are crushing many syndicators.
I’ve heard firsthand reports of syndicators setting aside a few thousand dollars monthly in a reserve account for their next interest rate range. His lenders increased this mandatory monthly reserve by the tens of thousands of dollars. Sometimes increasing the required reserves by 50 times or more (you read that right).
Last week I heard about a successful syndicator who made $60 million in his career. He is now facing complete ruin due to this convergence of financial problems on top of this interest rate cap reserve issue.
So Neurus, which hoped to raise capital and continue sailing through “easier” acquisition-to-sale cycles, hit a formidable roadblock. Now we’re hearing about suspended deliveries, capital calls and a handful of foreclosures. as i write this, Today’s CRE Daily says:
“Multifamily asset values are still above pre-pandemic levels, but some owners who opted for risky loans and wanted to sell quickly are finding a desert where they least expected buyers. The multifamily market saw lenders issue highly leveraged bridge loans to meet demand in previous years, but many investors are now struggling to cover these loans, and Domino’s made headline defaults in short order. Might fall down.
what to expect from here
I sincerely wish that none of you are on the investing end of any of these deals. But I know many of you are.
While getting 9% to 5% inflation was less painful than expected for most workers and consumers, I believe that getting to the Fed’s target 2% inflation rate from here could be excruciating for America.
Meanwhile, we expect many more apartment projects to return to the lenders. This will cause more trouble to thousands of investors. This position will also provide opportunities for syndicators and funds with cash and conviction to step in and acquire these properties. While we hate to see the pain it causes, we are watching the market for opportunities.
housing demand strength Not a question at all. And it’s likely that this downturn will put the brakes on new supply, resulting in better opportunities for syndicators and developers when the time is right.
A Fantastic Takeaway
I have a way out of this depressing comment. The two most essential words in passive investing, for our team and all investors: Due diligence.
I highly recommend that you get Brian Burke’s complete treatise on due diligence for passive commercial real estate investing. The big pocket has been published. hands-off investor in 2020, and you can get some great bonuses by ordering this here at BiggerPockets Bookstore,
Some of the greatest wealth was amassed while blood flowed in the streets. We’re not there yet, but that day may be coming soon. will you be ready
Invest passively with syndication
Want to invest in real estate but don’t have the time? No matter your experience level, real estate syndication offers the opportunity to invest in real estate without tenants, toilets, or litter – and this comprehensive guide will teach you how to invest in these opportunities the right way.
Note by BiggerPockets: These are the views expressed by the author and do not necessarily represent the views of BigPockets.
