Trust, but Verify

The front page of the Wall Street Journal recently showcased what can happen to trusting individual investors when a real estate syndicator’s internet savvy is combined with inexperience in a turbulent market. A syndicator based in Dallas, TX, who at one time amassed an apartment portfolio of 7,000 units worth $500 million, recently lost a 4-property portfolio of 3,000 units in Houston to foreclosure. His investors in that deal will likely receive nothing, not even their original investment, in what was supposed to be a safe investment.

Syndicators are people or companies who raise money from individual investors (generally accredited investors), pool those dollars together, and buy real estate. Most of the time, a syndicator will place a single property under contract with as long of an escrow period as possible in order to raise the required money. In the last five years, it has become increasingly common for groups to pitch the merits of their deals on social media and even showcase their deal on various crowdfunding websites. Syndicators generally charge a slew of fees (acquisition, asset management, property management, disposition, financing, construction management, etc.) and earn a disproportionate share of the profit. In 2021, when values were near their peak, many syndicators used high-octane, floating-rate bridge debt to maximize leverage and minimize the amount of equity needed to be raised. This also had the benefit (to the syndicator) of maximizing the potential profit and therefore his potential haul. However, most ignored the increased risk from this type of debt, which was the death knell for those Houston apartments.

The post-Great Financial Crisis (GFC) era has been a boon for owners of apartment buildings, a period of rising rents, increasing values, and a shift in population demographics. Much in the way home flipping was all the rage pre-GFC among people who had no experience in real estate or construction, it seemed like anyone who could raise money over the past decade became an apartment investor. With interest rates at historical lows, bank deposits earning next to nothing, and seemingly never-ending appreciation in real estate, it was the place to be. Now that interest rates have increased and investors have alternatives, it’s more important than ever to invest with a real expert.

Social media has also played an increasingly important role in enabling firms to broadcast their “buy apartments now” message via YouTube, Tik Tok, and Instagram. At a time when anyone with a loud voice is considered an expert, those willing to preach their message electronically found willing investors. New syndicators were raising money based solely on their ability to build trust with their investors and not because of their investing prowess. That trust was granted through shared experiences and a promise of high investment returns. Investors in these deals are successful, intelligent people who have earned enough money to be considered an accredited investor and have gained a level of sophistication to properly vet the company (person) they’re investing in. Unfortunately, many did not do enough vetting and are now learning that it’s not enough to just invest based on trust.

Our investors at Calvera are plugged in and see plenty of real estate opportunities, and we get asked to review our competitors and their deals from time to time. As Ronald Reagan said during the Cold War, “trust, but verify.” We advise our investors to do as Ronald Reagan said and ask the following questions:

1. Experience: What is the background and track record of the deal sponsor/syndicator? Have they operated through various market cycles?

2. Fees: Are the fees charged market-based? Can they name fees charged by their competitors to ensure you’re not over-paying?

3. Alignment of Interests: Does the sponsor/syndicator do well if you do well? Are you adequately compensated for the level of risk in the investment?

4. Underwriting: Do the financial assumptions make sense? Can they be verified by third-party research? Has a full competitive set of comparable rents and property sales been provided and vetted?

These are no doubt basic questions to ask, but would those Houston properties pass this test? Perhaps not. We have seen countless memoranda asking people to invest in deals without some of this basic information. Even recently, an investor sent us a package from another firm and all it had was fancy pictures of the property in question, headshots of the team, and a cut-and-paste from the selling broker’s marketing package. Investors need to ask more from their real estate expert and find one who is upfront in answering these questions. Trust, but verify.

My partners and I formed Calvera after working for a multi-billion-dollar real estate investment company. That firm was entrusted with investment dollars primarily from institutions (pensions, endowments, etc.) and we worked on all kinds of deals: apartments, condos, office buildings, hotels, distressed debt, and even casinos. We saw what happens when deals are home runs (even grand slams) and when projects don’t work out as planned. We also saw how to navigate market turmoil like the Great Financial Crisis, and those experiences have helped shape Calvera. There is a wealth of knowledge for us to draw upon, and we’ve put it to use since 2010 to produce our own track record of outperformance. Our North Star will always be an investor-first mindset where we go to great lengths to over-communicate, make ourselves readily available, and provide fair economic terms. Every real estate sponsor will have challenging investments, but it’s how you prepare, communicate, and execute that ultimately garners long-term investor trust.