Apartment Syndicators Active Again In Seattle

BY MIKE SCOTT
Dupre + Scott

Apartment syndication is back in style.

Syndicators pool money from groups of investors, usually in $25,000 to $50,000 chunks. Local syndicators raised enough capital that way to buy almost $100 million of apartments since the beginning of 1995. Syndication volume is a significant share of all market activity. Our region averages about $500 million in sales per year.

The most active local apartment syndicators are Jim Potter's Kauri Investments, Ltd. and Mike Sauter's Jones & Murphy, Inc. Kauri purchased $40 million of apartments in six properties in the past two years. Jones & Murphy also bought six deals, totaling $25 million. One, Crystal Point, is a 105-unit complex scheduled to close late this month at $4.85 million.

Most apartment investors look to generate profit through an expected general appreciation of real estate. That does not always work. Last year we published the appreciation trends for all of the sales in the market in The Apartment Advisor. Our study found 20 percent sold for less than their original acquisition price. Two primary strategies for actively creating value are condominium conversion and renovation. Few investors have the time or expertise to take advantage of either strategy.

Make sure the property is one you want to buy and the syndicator is someone you want as a partner.

Most syndicators in the early 1980s followed the general pattern of buy and hold, waiting for appreciation. Many extolled the tax benefits of real estate investing. Indeed, tax benefits were significant back then. I remember the sales pitch was something like "You will get your original investment back from tax savings alone within three years."

That happened, but many of the investments were unsound, leaving investors without profit or even their original investment and hitting them with a large recapture bill as well. There are still worthwhile tax benefits, but that should not be the focus of any investment plan.

Instead, today's breed of syndicator usually implements one or both of the strategies for actively creating value: renovation or condominium conversion. That gives investors an opportunity to participate in an aggressive investment plan without having to spend the time or develop the necessary construction, marketing and property management skills. There are pitfalls to investing in syndications, but first, some examples.

Two of Jim Potter's recent acquisitions were condominium conversions. Investors in the 129-unit Hidden Creek conversion in Bellevue last year got their capital and profit back within nine months. Then he raised $650,000 in equity to buy Pheasant Hill in December. The goal is conversion. His investors were offered a preferred return of 8 percent along with 25 percent of the conversion profit.

John Downing, a broker with Westlake Associates in Seattle, has put together a dozen partnerships over the years.

"Don't call me a syndicator," says Downing, "I haven't done enough volume to fit that description. I'm just a real estate investor with holes in my shoes, so I need to find partners to help me buy properties that interest me."

Each syndicator has a different style and each investment is structured to provide a custom-tailored set of results for the partnership. As an example, Downing bought the Hillree Manor, a 34-unit property on Capitol Hill for $1,490,000 a couple of years ago.

Along with four others, the partnership invested over $400,000 cash and began a three-year renovation. The original goal was to use cash flow to pay off the mortgage over the next seven years. That meant the investors wouldn't see any cash return for 10 years. However, at the end of 10 years they should enjoy a significant annual income from a debt-free property, as well as inflation protection.

Downing is closing another $1.5 million deal in March. This time the partnership totals 10 investors. Each put up $55,000 cash. The plan is to spend a couple hundred thousand dollars in renovation over the next two years. After that Downing anticipates each investor will begin receiving monthly cashflow checks starting at around $600.

Don't bother calling him to get in on this deal, he already raised the cash needed. That seems to be the case with the successful syndicators. Their current investors become repeat buyers for new ventures.

Downing points out that selecting partners requires as much care as selecting a property. There needs to be a good balance of personalities. Also, everyone has to share the goals set up for the investment.

Iain Moffat, president of American Properties, has put together a half dozen partnerships over the years. His focus has been 1920's vintage classic brick buildings on Queen Anne and Capitol Hill. Although he began with limited partnerships, Moffat's most recent acquisitions were general partnerships.

Investors have a say as general partners in how the partnership operates, what to do with the property and when to sell. That level of control is valuable. By comparison, limited partners have no say in the affairs of the partnership. However, limited partners are not on the hook for making the mortgage payment or dealing with other potential liabilities.

If you are looking to participate in a syndication, which structure is more important to you?

In addition to the legal structure of the syndication, there are a number of other factors investors should consider before jumping into any deal. Moffat advises investors to study the property in question and not become blinded by projections or forecasts. Also, look for a definite investment strategy and end date.

Most local syndicators today plan on a five to 10-year hold. Others have a longer view, like Downing, based on developing significant cashflow. These variations give investors options to select specific syndications that fit their goals.

Morris Piha, president of Morris Piha Management, Inc., put together many successful syndications over the past 20 years. Along the way he picked up some of the finest buildings in Seattle, including Marlborough House and the Lowell & Emerson.

Piha says, "I don't like forecasts because I can not know what the growth factor will be, but I should know what the mission will be." He explains that when the market has a lot of money, like right now, people forget the tough times. There should be a mission for each property bought. Each investor needs to understand what the goals are for the syndication, then monitor the progress of the investment.

It is easy to make a five or 10-year projection that looks good. It is much harder to find a property that fits an aggressive investment strategy. Bruce Thayer's Thayer Donovan Partnership likes the Puget Sound region. However, he has purchased only a few properties here in the past decade because he could not find many that met his group's goals. Instead, his investors turned to Alaska in the 1980s and Arizona in the 1990s. They have a $100-million portfolio in Arizona alone, and have begun selling now that the market has risen.

Thayer advises investors to study the accounting assumptions prepared by the syndicator. He also says investors need to understand the level of the syndicator's authority. The more limited the better.

Thayer believes many of the syndications that unraveled in the 1980s did so because the syndicator had too much authority. He remembers one active syndicator who lost a number of properties in foreclosure because he had the authority to borrow against the equity in each partnership. Be sure your attorney reviews any agreements.

Downing, Potter, Sauter and others readily acknowledge many people lost a lot of money in syndications over the years. The early to mid-1980s produced the worst abuses. One of the major reasons for past failures was that many syndications were organized and run by people without real estate expertise.

"Some syndications were run by deal junkies," Downing said. Their entire focus was on putting together the next deal and living from the fees they charged. That brings up another caution: Pay attention to the fees a syndicator charges the investment.

Some charge a fee, or commission, for raising the investment capital. Others don't. All charge a fee for the on-going management of the property. Is the management fee reasonable? Some charge for renovation. Some charge commissions for property acquisition and sale. A syndicator will usually take a percentage of the profit. There is nothing inherently wrong with any of these charges. Add them up to see what they total. Look over the syndicator's track record to see if the fees are worth the level of expertise you get.

Know the people you are dealing with and look into their track record. Is the syndicator putting personal money into the deal as well? Does the syndicator communicate with the partners regularly? Do you have a vote in the operation of the property or its disposition, or are you a limited partner with limited liability? What is the investment plan? Are the goals of the syndication compatible with your goals? Does the partnership have an end date? If so, how does it plan to deal with the cyclical nature of our real estate market? What buy-sell agreements exist to help you, or hinder you if you need to sell your shares?

Syndications are just one of many investment options today. You will avoid the management headaches, but you better not avoid either the initial research or ongoing monitoring of your investment's performance. Be sure the property is one you want to buy and the syndicator is someone you want to have as a partner. You will probably be together a long time since you cannot easily sell your shares, even at a discount to market value.

Here are some reading suggestions before you jump into a syndication. An excellent resource on the securities aspect of syndications is "Real Estate Investors Deskbook," by Alvin Arnold, published by Warren Gorham & Lamont in 1994 with annual updates. If you can track down a copy of "Real Estate Investment & Finance," by Stephen Roulac, published by McGraw Hill in 1976, you will find a useful resource for evaluating a syndication offering.

Mike Scott is a Counselor of Real Estate (CRE) and principal in Dupre + Scott Apartment Advisors, Seattle. His company specializes in apartment counseling and research and publishes The Apartment Advisor.