What are the risks and returns of real estate syndications?
Veteran syndicator Kenneth Gee explains how to vet syndication deals for low risk and high returns.
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Brian: Hey, guys. Bryant Davis here from Spark Rental and I am super excited to have Ken G on with me today. Ken G has over 24 years of experience in real estate, banking, private equity, principle investing. He’s been involved in over $2 billion worth of real estate transactions in his career, which is more money than I am likely to ever put my hands on. So on that note, Ken, thank you so much for joining us today.
Kenneth: Thanks so much for having me. Thrilled to be here.
Brian: Well, we’re thrilled to have you. So, Ken, let’s rewind the clock to the very beginning and talk about how you got started in real estate. Your first deal.
Kenneth: Yeah, it’s it’s really weird how I got started. It wasn’t real estate that got me there. So I grew up in a small town in Toledo in Ohio called Toledo, got my undergraduate there, moved to Cleveland, Ohio, got my graduate degree there and started a family. So here’s where the real estate part kicks in. So it was my second child, my daughter. It was a middle of night. One night I used to I worked at Deloitte as a CPA, so I was working a lot. So the only real time I got to spend with my kids was in the middle of the night. I would do their feedings and things like that, but it was really cool because it was really quiet. Everybody sleep and it’s just her and I and there in a rocking chair and doing the middle of the night feeding. Except one night, suddenly I started to get frustrated because I realized, wait a minute, first of all, I’m a dad now. I have a family and I think I’m doing all the right things, but I don’t seem to be getting ahead financially. And it started to frustrate me because I wanted to put them through. I wanted to put both her and her brother through school without racking up a ton of debt. I wanted to provide a lot of things for my family. I wanted to stop working so much. I didn’t like working 80 hours a week, but I just I just couldn’t figure out how I was going to make that happen. So I woke up the next day and I said, You know what? I need to fix this problem because I don’t want to continue like this, never see my kids and things like that. So I had done a little bit in real estate, but I really got focused.
Kenneth: I said, All right, I got to figure this out. And a lot of my clients at Deloitte were making a ton of money in real estate. Before that, I was a commercial lender for five years. A ton of my customers made tons of money in real estate. I said, All right, this is what I got to figure out. So I got enough guts to buy a total of three small apartment buildings. Each one was in the 20 unit range, and three years later I sold those buildings and this is the mind blowing part. Back in 1997, it was just shy of the year 2000. I sold those properties and made over half a million bucks. Wow. So the first time in my life I had a half a million dollars in the bank. And I thought to myself, Wow, this is crazy. And I’m still working at Deloitte and I’m not making that kind of money at Deloitte. So I said before I couldn’t figure out how I was going to put my kids through school. I couldn’t figure out how I was going to be able to quit my job someday. And so now I not only had a plan, but I had a plan that I knew was going to work. So fast forward now, you know, 24-25 years, you know, I’m thrilled to tell you I have been able to put my kids through school. We have had hundreds of investors do the exact same thing that we’ve done by through investing in our deals. And here we are today, all of the goals accomplished. And I now am really focused on helping make sure that I have the same impact on other people’s lives.
Brian: So you bought a couple of small apartment buildings in the late nineties. How did you scale from there? What changed in your strategy?
Kenneth: Yeah, so the first ten years of the business we were in Cleveland, Ohio. It’s a not a growth market. We would do small value added deals. And I mean, Cleveland’s a hard market to make money in because there’s not a lot of growth in Cleveland right. I mean it’s a great town, but it’s just not a lot of growth. And so we would do a couple of deals here and there. And about 15 years ago, I said, wait a minute, you know, I’m doing well in Cleveland and it’s hard. What if I went to a market that was actually growing? Yeah. A place where people really wanted to live? So I said, All right, we’re going to Florida. I didn’t move there, but I started doing my on the ground due diligence, getting to know the markets, networking with the brokers. I mean, it took me a long time and we set up shop in Florida, and the way we really started to scale was through syndication, because when I was doing it on my own or with one partner, you really have limited equity, right? You can only grow so fast and…
Brian: You don’t have so much money to invest.
Kenneth: Right? You only have so much money, so you can only buy so much real estate. And so it wasn’t until, you know, I felt like I didn’t want to ask for other people’s money until I had enough experience that I felt good about doing that. Because, you know, if if I lose my money, I’m cool with that. But if I lose your money, that really is not cool. So it was important to me that I have a pretty good grasp on the business. And it was that syndication model. Now we’ve actually flipped to the fund model and we can talk about that if you want, but it’s a syndication using other people’s money to grow a real estate business that is done very, very well.
Brian: All right. So in your earliest indications, you would go out and get commercial financing, I assume, for these deals, and then you would raise a lot of the rest of the money from passive investors, probably starting with friends and family who you knew.
Kenneth: You got it? Yep.
Brian: Any tips for people who are considering becoming real estate syndicators?
Kenneth: Yeah. So the number one, you know, I have conversations with investors every single day. And the number one thing that they would need and want out of their syndication partner is that you know what you’re doing and they can trust you. And so if you’re going to go into the syndication, remember, I waited ten years, right? I don’t know that your first deal that you do in real estate should be a syndication.
Brian: Definitely shouldn’t be like that.
Kenneth: Right. Doesn’t feel good. Right. And so the number one piece of advice I have for people is learn as much as you can as fast as you can, because what you want to do is you need to be very comfortable having a conversation with an investor. And there’s not a question that he or she can ask that you don’t have a deliberate, well-thought-out answer for. See, the more I call it knowledge builds confidence. That’s my little saying. The more you can understand about the business, the more comfortable you are, the more things that you do deliberately based on what you know. When investors come to you and ask you questions, why are you doing this? How are you going to make money here? What’s the plan? You have a very well thought out answer and you’re very comfortable with that and not learning as much as you can or going to the syndication world too fast can really put you in an uncomfortable situation. And if you know the syndication market, I mean, you’re going out, you’re going to find the deal, you’re going to lock it down with some of your own money, and then you got to go raise the money. Well, you have a finite time period there, and you really can’t afford to have slip ups there. Right. You’ve got to be on your game and ready to go and and know your stuff. So that’s the number one piece of advice is just become as knowledgeable as you possibly can because most investors will figure out whether or not you’re the guy or gal that they can trust with their money.
Brian: Yeah, And you know, there is a steep learning curve with real estate investing. You’re going to make mistakes. And to your point, you want those mistakes to be on your own private personal deals and not with other people’s money. So, you know, Ken, I have always found that I learned the most from those mistakes that I’ve made as opposed to the successes. So I always love to ask people, what mistakes have you made in your real estate investing career that you learned a ton from and that ideally novice investors or intermediate investors can learn from those mistakes that you made and instead of having to go out and make them for themselves.
Kenneth: Sure, sure. So, you know, I have made 25 years. I’ve made lots of mistakes. I mean, there’s no question about that. So, you know, we don’t probably have enough time in the show to go over all of them. But one of the ones that kind of I have this conversation a lot. We do some third party management as well in our markets. And this conversation comes to mind almost every single time. So it most people want to buy the property and they want to fix it up and they want to make it nicer. And what they want to do is the moment they close go full speed ahead with their renovation plan. Well, my mistake that I made a long time ago was doing exactly that. But here’s what really happens. As a practical matter. You do your due diligence, you think you know the property, you revise your business plan and your renovation plan based on that. Then you close. Now you have full access to the property, access to the property because it’s yours. And guess what? You learn things. You learn things that you didn’t know before. So what I want investor or what I want syndicators to do or anybody that buys a property to just resist the urge to go full speed ahead on day one and just sit on your hands for a minute. A minute is either 30 day, 60 days, whatever is right, you’ll you’ll know when you feel like you’ve know the property well enough.
Kenneth: And here’s the mistake I made a long time ago. I went full speed ahead with my renovation plan, spent all my renovation budget only to learn something a little bit later about the property that I wish I would have known. Because now I need to fix it and I didn’t. I’ve spent all my money. So now I had reached into my own pocket to pay for those renovations, those costs, and I could have just as easily diverted some of that renovation budget to that issue. I didn’t remember what the issue was. Now it’s been so long, but I see people doing that all the time and they always, you know, they push back really hard. They’re like, I want to get going. I want to get going. Some things you can do right away, like if, you know, the roofs are leaking, like I said, then go ahead and get on that right away. But you want to save some of your money to figure out you’re going to learn things. I guarantee you you’re going to learn things. And I guarantee you you’re going to revise your renovation plan. And don’t make the mistake that I did a long time ago, and that is spend all your money and then realize that. Garnet I wished I had some more because I really should have been doing this instead of that. Does that make sense?
Brian: It does. Now, most of our audience are not syndicators that most of them are either single family investors or small multifamily investors or passive investors in syndications. So as a syndicator yourself, how do you recommend that passive investors vet real estate, syndicators and sponsors?
Kenneth: Yeah, that’s a great question. And over the years I’ve kind of developed four rules. I think about this a lot because I think this private money market that we find ourselves in, right, and that investors now have access to is really cool. It’s going to continue to grow, but it’s really important that investors know how to vet sponsors. I just it’s one of my really passionate topics that I talk about all the time. So I.
Brian: Developed the thing that they know.
Kenneth: It is when you think about it. I tell people, I want you to follow four rules as a potential investor. If you follow these four rules, you will probably weed out most of the ones that you shouldn’t be investing with. I’m not saying they’re bad guys, I’m just saying you probably shouldn’t be with the number one. You need to make sure they have experience. You just do because this is a business that you’re investing in just happens to be apartments. It’s going to have market forces. You know, there was a time when we didn’t know we were going to have a pandemic and then we didn’t know we were going to have inflation. Right? You need a senior management team in place that has enough experience to try to figure out how to navigate these things. So experience, although it seems obvious, it is really, really important to me. Right. Number two kind of goes along with it. And that’s your track record, right? You’ve got to have a good track record. I think you’ve got to be transparent with that track record. We actually brought in a company called Verlinvest to audit our track record, so all 25 years of our deals are sitting out on Verlinvest site. And you can see them. They came in and we paid them a lot of money to literally audit those deals to make sure that when I say to you, here’s our track record, here’s what we made on every single deal, you know that it’s legit because somebody looked at it.
Kenneth: So track record is super important. I think. Third is and this one’s a little trickier because I see people trying to figure this out, and that is you need to have a sponsor that’s going to put you first as the investor. So the tricky part is how do you figure that out? Well, you’ve got to look at the terms of the deal, the PM, the profit sharing, all that kind of stuff. And you want to ask yourself this one bottom line question, and that is, is it possible for that sponsor to do well and you not do well as the investor? If they’re able to do well and you not, then you need to revisit that and look hard at that because. In my opinion. The sponsors of the deal should be the ones to earn their bonus last. They shouldn’t own it. They shouldn’t earn it first. They haven’t earned it. They haven’t earned it yet. Right. You need to do something a little above and beyond a 6% preferred return in order to be entitled to a bonus. That’s my opinion. So put investors. Third is number three. Number four is transparency. And I kind of alluded to this already, but so many times I hear investors come to talk to us and they’re frustrated because the last syndicator, you know, after they sent their money in, they didn’t they never get statements. They don’t return their phone calls, you know, don’t do stuff like that. You we send out quarterly PnL and balance sheet and rent roll and then we tell you every quarter and more often if necessary, about what’s going on on the ground. How’s our renovation plan going, how’s our occupancy, how is our delinquency, what’s actually happening now? What did happen over the last quarter and what are we focused on for the next quarter? And so it’s that level of transparency. If you’re in one of our deals, you have my cell phone number, and if you have a question, just call me. I’ll answer the phone and I’ll tell you what’s going on, because I feel very strongly that you deserve that because you gave us your money. At least I could do you is telling you what’s going on with your money, right? So those four things, I feel like if you follow those four rules, you’re going to eliminate most of the people that are going to get hurt with. It’s not probably not perfect, but those are four rules that you’re really going to do well by.
Brian: I think I love that you give out your personal cell phone number to, uh, to your your partner investors. That’s great. I want to dig into a little bit more into number three that you said about verifying that the sponsor will put you as the passive investor first. So you said that a 6% preferred return is not good enough as that waterfall goes. Tell us what what you look for specifically in that. I mean, is there a specific waterfall structure that you like to see? Is there a specific legal structure in the way that capital is returned to people? What exactly do you look for as the hints or breadcrumbs that a sponsor will put the passive investors first?
Kenneth: Yeah. So a couple of things. One, you want to look at the fee structure and you just want to make sure that it’s not crazy, right?
Brian: Like higher disposition fees…
Kenneth: I’ll tell you what we do and it gives you an idea. I’ve been at this 25 years. We charge a 1% acquisition fee, 1% disposition fee, certainly not. I see people doing two and 3% all the time. The asset management fee is one and one half percent in our deals. Most people do two or more. You know what I my message on fees is we need to be paid for doing work. It’s not why we’re here, though. We’re not here for the fees as a sponsor. Right. So fees is the first thing I want you to look at. The second thing I want you to look at and again, I’ll analogize this to our own fund. In our deals, you get your capital back, your preferred return, and only after those two things are paid do we get into the 80-20 split.
Brian: Right.
Kenneth: So if all you do in our fund is make 6% annual return. Personally, I don’t think deserve a bonus. I didn’t do anything cool. I didn’t do anything that is extraordinary that deserves a bonus. So if that were the case, that’s never happened to us. But if that were the case, we would have zero bonus. So that is how we put into practice what I mean by put investors first.
Kenneth: Now there are as many different waterfall structures and everything else out there as probably there are syndicators. I mean, there are so many different. Takes on it. The thing I will tell you is sometimes people just make this a lot more complicated than it needs to be. And I don’t know why they do that. The last thing I want to do, if you’re talking to us about investing with us, I don’t want to have to spend a half hour try to help you understand the waterfall. Right. I mean, I’m having a half hour discussion with you about something that we really shouldn’t even have to talk about. Right. Make your make your waterfall simple. It doesn’t need to be that complex and help people to spend the time on understanding the deal and why they’re going to make money and why you think you’re going to make money on this deal. That’s where I want people spending their time and energy, not on. How did this how does this waterfall work if you earn this? And I get that. But if it’s that, then you get something out. Too much, Too much, too much craziness. So that’s kind of how we put our investors first.
Brian: Well, I love that. I want to get your take on our current environment, our current investing environment. So we’re in kind of a goofy place right now where we have high interest rates. We have cooling real estate markets. There’s potentially a recession looming in the next year. So how are you approaching this market? I mean, how has your strategy changed if it has changed at all in response to this kind of weird market that we’re in at the moment?
Kenneth: Yeah, So really good question. So our discipline hasn’t changed. Remember, let’s go back to the experience rule, right? Everything we do in our business plan is very deliberate. I don’t mean to keep referring back to our business plan, but you use it to illustrate what we do and why. So we buy good apartment communities, right? We don’t buy stuff that’s vacant and everything. We buy good apartment communities in growing markets, in good neighborhoods that we know that we can go in and physically improve and add value to. Right? When we make them nicer, we can charge more rent. Now, let’s analogize let’s connect all those dots to the current situation that we find ourselves in. We like good neighborhoods. Why do we like good neighborhoods? Because we know in recessions it’s the lower income neighborhoods that it gets just get hurt. The worst. I wish it wasn’t true.
Brian: High default rates.
Kenneth: Yeah, it just is. It is what it is. So we tend to not stay and we don’t like those markets. We prefer to be in good neighborhoods. We like to be in growing markets. Why? Because if demand exceeds supply and we do most of our stuff in Florida, in the Southeast, we already have a massive demand supply imbalance. So now think about you said the housing market is cooling off. Well, what’s happening is we have inflation because we have inflation. The Fed is using interest rates to try to beat down the demand. When you have higher interest rates, what happens to the homebuyer? They’re not able to buy a home anymore. So what do they do? They just added to that massive demand supply imbalance that we already have. They stay in the apartment.
Brian: Stay as runners. Yeah.
Kenneth: So remember when I said we in growing markets. So even if we have a little bit of demand fall off because of a recession, because, you know, son/daughter moved in back in with mom and dad or boyfriend go with household together. Yeah, we get a little bit of consolidation, but usually it’s not much. So we’re already we have this massive demand supply imbalance going on and it just continues to support our value added business strategy. So we’re everything is pointing to us having pricing power because demand exceeds supply because of the market we picked, because of the neighborhood we picked, because of the type of quality asset that we buy when we have a recession hit or something like that. It really isn’t. I mean, this is multifamily, right? People need a place to live. That’s probably not going to change. So now when we put our value add business plan, so when we look at deals, we’re projecting 3 to 400 a month in rent increases, not organically. It’s because we’re going to go in and make it nicer. And we know because we’ve done our homework, we know what that nicer property will rent for. And so we’re looking for that value add bump on top of an organically growing market and the returns just go nuts.
Brian: Right? Forced depreciation, you know, forced market rent increases.
Brian: So looking over your website at KRIPartners.com and by the way, we’ll put a link to that in the comments here. You know, there was a nice chart that I appreciated there where you broke down the two main pillars of your strategy, one being a little bit more conservative and one being a little bit more aggressive, the more conservative model being a cash flow model where you buy properties that are already cash flowing well and and you are just going to keep them stable. And the more aggressive model being the value add model, sort of the glorified flip model where you go in and basically flip an apartment complex. But what I appreciate about what you’ve said just now is that even your quote unquote more aggressive value add model is still on the more conservative side. And looking at this kind of goofy market that we’re in and the potential for recession in 2023, you know, you’re still positioning yourself to win no matter what.
Kenneth: That’s the plan. Yes, sir. You got it. That’s what we try to do. Yeah, I agree with you 100%. And by the way, I do. I kind of interrupt. I didn’t mean to do that. But one thing on our value add deals, I mean, we still have cash flow in our deals. If there’s no cash flow on day one, we’re not buying it. So we you still are going to get cash flow with our deals and we’re adding value at the same time. So very, very important thing. It’s just the buy and hold strategy, the buy, let rents organically grow over ten or 15 years. That’s the alternative. And we just don’t do that very often because it relies on a lot of people don’t aren’t that patient. Most of them are not that patient. They love in 3 to 5 years.
Brian: Yeah. And there is something nice about going into a value added deal where you have a measure of control over the returns. You know, if you buy a property that’s already renovated and already rented at the max, you know, you just don’t have any control over what the market does from there. But, you know, you buy a you know, an underperforming fixer upper, then you have some control in boosting those rents and the value of the property. Well, I want to be respectful for your time here. But before we wrap it up for today, I want to learn a little bit more about KRIPartners and what you guys are doing today. And one question in particular, because a lot of our audience are not yet accredited investors. Do you do any deals that allow accredited or non-accredited investors or is it accredited investors only?
Kenneth: Yeah, currently we’re accredited investors only, and the only reason for that is that we do a lot of outward marketing from just being on this show. Talking about our current fund is really kind of solicitation. And so we’ve always chosen the 506 C route. You know, it’s just what we’ve always done. But that doesn’t mean that accredited investors, I mean, it only takes a couple of deals to get you there and then you get access to even more and large, maybe larger deals.
Brian: So with your fund… It’s a revolving door. People can buy in at any time and sell at any time. Or you have a minimum hold period.
Kenneth: Yeah. Yeah. It’s kind of not how it works. So what happened is we flipped to the fund model. If you think about private equity, this is very much how private equity works. So we are in hypercompetitive markets like Florida, and it’s hard to find deals because everybody wants to buy there. So when an offer comes 10-15 offers you’re competing with, and if you’re just another syndicator, right, the seller knows, hey, this guy’s still ask you to raise the money. So I said, All right, we have happen to pay up. We have to pay up in order to get the get awarded the deal. So I said, wait a minute. We need I mean, the answer is right in front of us. We flipped to the fund model. So rather than finding the deal and then go find the equity, we now find the equity, go raise the money, get the commitment, and then we go to the broker community and we say, Hey, guys, we’ve we’ve raised 15, 16, 20 million. Whatever it is, we’re ready to buy. Those brokers go crazy and they will stop at nothing to find your deals.
Kenneth: And what happens is you’re the strongest buyer in the market now because sellers know that equity rate risk is off the table. They know that fund managers are generally more experienced. So in our last fund, the first deal we put in the fund never saw the market, it never got marketed. The second and third deal, we were not the highest bidders. So I know the fund, the process works and it works really, really well. And from an investor standpoint, you get a lot of benefits. Like our last fund has a deal in Tallahassee, Daytona and Bradenton, all inside the fund, like great diversification, great different building types, so on and so forth. So and I mean, there’s all kinds of other synergies you get. I only have to do 1 p.m., one operating agreement for, for everything. I don’t have to raise money three, four or five times. We do it one time and it’s done for the fund. So lots of reasons that we made that switched to the fund model, but it is proven to be extremely successful for us.
Brian: But these are still closed end funds. So when, when you sell off these properties, you just return the capital to investors. And when you sell the last property, that fund closes entirely.
Kenneth: Then. Fund Yeah. So we still have the same limitations of 506b fund would have we’re being five or six C so you can’t go out and just go sell your, your interest. It’s got to be restricted and you can sell your partner. We allow transfers, but it’s not, there’s not an open market for that. Right. So if you’re in one of these deals and it’s probably true and every syndication, I mean, you have to set aside money that you’re willing to leave there for a little bit of time. Right. And let it do its thing right. It’s going to take a minute. That’s not to say that if you fell on hard times, I’m always happy to buy our members interest back. I love investing in our own deals. Obviously, I invest my own money in our deals, so I’m happy when I can to help them out that way. So it’s not like you have no way out, but it is not like you go to the stock market and click a button and it’s gone, right.
Brian: Well, Ken, any final pieces of advice for real estate investors, whether they’re trying to buy properties directly or invest in real estate syndications, any piece of advice that you have for them, things that you wish you’d known ten, 15, 20 years ago?
Kenneth: Yeah, 10-15 years ago, I would say. And I wasn’t afraid of this, but I see this a lot. Make sure you’re Will. If you’re going to be the syndicator, make sure you do the work, do the heavy lifting, do the underwriting, make sure that when you’re on a conversation with an investor, there’s probably no question they couldn’t ask you that you wouldn’t know the answer, right? That’s the number one thing that I see people they they don’t want to necessarily do all the work because it is a lot of hard work. But look, if you’re going to be in this business for the long run and you really want people to trust you with their money, I think you got to do that. So that would be the number one piece of advice. And then on the investor side, follow my four rules, man, because I really think if you follow those four rules, you’re going to be in pretty good shape in terms of finding an investment firm to invest with.
Brian: Well, Ken, thank you so much for joining us today. This was a great conversation and we really appreciate your time.
Kenneth: You bet. Thanks for having me.
Brian: Absolutely. Guys, check out KRIPartners to see what Ken is up to, what his fund is investing in. And we’ll see you guys next Tuesday. Happy going!
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