“To be successful in business and investing, you’ve got to have skin in the game, a stake in the company.” – Warren Buffett
When you are getting into multi-family syndication, there are a lot of questions that come up. You have to look at your finances, the sponsors, and the rest of the minutiae of the deal.
However, one aspect that is often overlooked is the sponsor’s investment in the property.
How much should a sponsor be putting in a deal alongside their investors?
Why is it important for sponsors to have “skin in the game?”
These questions are fantastic!
By thinking of this, you are better able to find better deals that are right for you, and you can differentiate what to look for as an investor.
Why Should Sponsors Also Invest?
As an investor in a multi-family deal, you are a limited partner. You are part of the team, but you’re not burdened with the day to day operations of the property.
Probably one of my favorite perks of passive investing!
That extra work is what the sponsors are for. (also called General Partners)
Given that these sponsors are the ones managing the funds, doesn’t it make sense for them to also have their own funds invested in the deal?
I think so!
Let’s look at Wall Street for a moment.
With the bigger funds that are run by Wall Street firms, only about 20% of funds managers invest alongside their clients.
This is one of the many benefits of multi-family syndication over Wall Street. The sponsors are most often invested right alongside their investors.
You and the sponsor now have aligned interests.
This means that your gains are theirs as well!
On top of that, there are also performance incentives for the sponsor.
The way this works is that a sponsor will have a small fee on the front end of the deal, but they will get most of their money through the performance of the deal.
A common structure that is used is that 80% of the profits go to the investors, and the remaining 20% of the profits go to the sponsors.
This split in percentages incentivizes performance. The better the deal goes, the more money that the sponsors will make.
Add that to the fact that they have their own money in the deal, and now you can see the benefits. Having a sponsor that’s also invested in the deal makes it so their interest in success is the same as yours.
As well, when an investor puts in a bit of money in the front end, it also creates a greater responsibility for the deal. It signals confidence and ownership.
I don’t know about you, but this would help put my mind at ease!
It makes it more like a team!
Limitations to Sponsor’s Investment
I have been in multi-family deals for a few years, and one of the things that took me a little longer to learn were some of the limitations of the sponsors.
One of the biggest limitations is the liquidity requirement for loans.
Many banks, for example, want you to have 10% of the total loan cost in their bank account as liquid cash.
That can be a challenge!
Many sponsors have the net worth, but their money is tied up in other deals or other investments.
There lies the challenge of the sponsor. They need to have enough cash to get the loan, and still have enough left to put in as an investment to make the deal profitable.
This is why sponsors usually have a smaller portion of the deal invested than you might expect.
In actuality though, this is one of the great things about passive investing.
If these sponsors had near unlimited amounts of liquid cash, then they would do the deal on their own. But since they don’t, they make a mutually beneficial deal and find investors like you to share in the wealth.
It also has the added benefit of the sponsors keeping a level of liquidity and thus being able to get into more deals.
The way I look at it, the more deals a sponsor has, the more deals you have the chance to be a part of!
Sponsor Investing Rules
Now, this is the real question. How much should the sponsor have invested into the deal?
I would say that they should have a minimum of 2-5% of the total amount of the investment funds raised.
This is not a hard and fast rule, but this number is substantial enough to show they have skin in the game.
That amount of money signals that they are committed to making the deal work.
For example, in a deal that needs $10 Million raised, $200,00 to $500,000 is enough to give you confidence that the sponsor is working in both of your best interests.
This is enough money that the sponsor will work their best to keep it. Skin in the game.
While the amount the sponsor has invested in the deal is important, there is something much more pivotal to the success of the deal
A sponsor can put a lot of money into a deal, and it can still do poorly.
What you need to look out for is the sponsor’s track record.
Have they had good deals in the past? If they had deals go bad, how did they handle it? How is their communication with their investors?
The sponsor should be able to show you both their record and what a good deal looks like.
As well as their track record, the sponsor’s reputation is almost more important than how much they put into a deal alongside their investors.
Investors and sponsors talk to one another. People in the community of multi-family investing know when a deal goes well.
These people also know when a deal goes bad, when communication breaks down, or the sponsor is plain old not good to work with.
By looking at all of these factors, you can look at your sponsors and find out what deals are right for you.
If you want even more information on how to find the right deal, I got you covered.
If you are interested in learning more, we have a special report about investing. It compares the stock market to real estate, and it also includes how the pandemic affects your investment future.
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