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In finance, the phrase “skin in the game” is commonly used for when someone has taken on risk by being involved in achieving some goal. More practically, this typically means that a person, investor, company, etc. has taken on risk by investing money in an asset such as stocks, real estate, etc.
In the world of multifamily real estate syndications, the phrase of having skin in the game refers to the sponsor (i.e., general partner) investing money alongside their investors. It is industry standard for sponsors to invest some percentage (typically 5-10%) of the total capital raise to show investors that they have something on the line and thus are motivated to successfully maximize the returns of a project. The thought here is that if the sponsor doesn’t invest alongside their investors, then their risk is limited only to the split of profits they have and fees. Since most firms take an acquisition fee, it’s easy to think that once they close the deal and collect the fee then they are less motivated to maximize the returns for the deal on behalf of investors. From an investor’s perspective, this line of thinking is warranted, hence why it has become an industry standard for sponsors to invest in their own deals.
At JP Acquisitions, we normally invest in our own deals and as such we have skin in the game. Although, their are often overlooked pieces of the equation as they relate to this topic. That said, in this post I will breakdown why it’s more complicated then one might think for sponsors to invest in their own deals. Additionally, I will cover how the capital raising process works.
Note – The definitions of the technical terms in any of our posts can be found in the glossary section of our website.
Note – I will use the words “sponsor”, “GP”, and “syndicator” interchangeably to reduce repetition.
The Capital Raising Process
When sponsors raise capital, they often talk to numerous individuals ranging from high-net-worth individuals to family offices to new investors. The investors that syndicators target depends on where they are in their journey of growing their business. Nevertheless, syndicators are working behind the scenes to make sure that their deal(s) is fully funded to be able to close. Since syndicators are putting in the work to find the deal, close it, and execute the business plan, they charge fees that go towards things such as covering overhead, salaries, office space, marketing, etc. I wrote a post on fees (linked here) so I won’t go into too much detail. The important fee to understand as it relates to this post is the acquisition fee. This fee is a percentage of the total purchase price (typically between 2-3%) of the deal and goes to the syndicator after closing. For example, if the purchase price of a deal is $1M and the fee is 2%, then the sponsor would raise an additional $20k from investors and collect that at closing. Thus, at a high level, the process of capital raising involves having numerous investor meetings in which the sponsor is trying to balance the needs and wants of investors all the while working to close the deal at hand.
The reason why the acquisition fee in particular is talked about in detail here is because it incentivizes the sponsor to look for deals, but there is also another reason. The sponsor fee is often used by syndicators to invest in their own deals. Taking the example from earlier, as opposed to the sponsor pocketing the acquisition fee, sponsors could leave the sponsor fee funds in the deal which in turn would be equity. As to whether using the sponsor fee can be considered truly having skin in the game is debatable to some investors and real estate professionals. As a result, sophisticated investors will ask what the sponsor’s net investment after fees is. In other words, those investors are asking how much the sponsor team is investing above and beyond the acquisition fee or other fees they collected at closing. This brings us to the crux of this post and why co-investments from sponsors aren’t as simple of a topic as it may seem.
What Sponsor's Consider When they Co-invest
When sponsors invest in their deals, they make careful considerations that impact parts of their business that investors can easily overlook. While syndicators can invest their acquisition fee into a deal, the question arises of whether there are more effective ways of spending that money. Additionally, if an investor(s) want to see an investment net of fees then things can get more complicated. This topic is something that we’ve been wrestling with at our company (i.e., JP Acquisitions) and the factors we’ve been weighing are the same that many small but growing syndication shops/firms run into. That being the case, I’ll provide you with a look into how we’ve been balancing the concept of co-investments and how things will change in the future. By explaining our thought process and considerations, I hope to shine a light on how difficult it is to balance growing a business with limited resources and satisfying investors.
Up until now, we can confidently say our team has skin in the game and we don’t want that to change. To the best of their abilities, the team invests their personal capital into our deals and at least a few members have invested in every deal we’ve done thus far. While that’s great, the issue is that there is likely to come a point where they’ve tapped their resources and need the money for personal matters. Another more pressing hurdle is that no one on our team is being paid a salary, everyone is still working full-time jobs, and we don’t have an official office space. If our company continues to grow in this way, it’s easy to imagine a point where everyone is overworked and underpaid. This especially applies to our property management team which puts in the real on-the-ground work. With that in mind, you can see why the fees we collect are better spent on putting our property management team on salary first. They are the people who drive the great returns that our investors have been experiencing and have a huge impact on our ability to scale. After the property management team has salaries, then we’ll pay the members of our team who focus on acquisitions, running PM operations, and various other parts of the business. This realistically isn’t likely to happen until we have an exit (i.e., sale of a property) large enough to fund those salaries. While an investor might think a syndication shop such as ours earns enough capital to fund operations, they often don’t have visibility into the cash flow a syndicator is collecting. As such, it’s easy for an investor to lack the perspective that would allow them to be more understanding of how the syndicator decides to invest alongside their LPs (i.e., investors).
Conclusion
After reading this post, it’s understandable as to why there could be a gap between investor and syndicator expectations for GP co-investments. Syndicators have a lot to weigh before making a significant investment in their deals. Such considerations include expenses like overhead, staffing, subscriptions, leases, etc. By providing you with a look into some of the challenges we’re working through at our company, I hope you can respect a syndicator’s viewpoint a bit more as it relates to this topic. This is not to say that all investors are the same and don’t consider a sponsor’s perspective. The relationship between investors and sponsors needs to be one grounded in clear communication and transparency to come to conclusions that serve all the parties involved.
If you have any questions regarding the terms and concepts in this post or previous ones, please reach out to either me (tedi.nati@jpacq.com) or someone on our team so we can help explain further. If you’re interested in investing with us at JP Acquisitions, you can contact us via our contact form, by emailing a member of our team, messaging us on LinkedIn, or signing up for our investor portal to set up a meeting.
As always, I hope you enjoyed reading this post as much as I have writing it. Best of luck!
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About the Author
Tedi Nati is the Managing Partner of JP Acquisitions. In his role he is responsible for broker outreach, establishing deal flow, underwriting, marketing, investor relations, and assisting in the closing process. In addition to his role at JP Acquisitions, he is an Assistant Equity Underwriter at Cinnaire, a non-profit Community Development Financial Institution (CFDI). In his role at Cinnaire, he is responsible for assisting the underwriting team in evaluating and structuring real estate equity investments and assessing the risks and mitigants associated with such. Tedi earned his Bachelor of Science in Finance from DePaul University, where he graduated Summa Cum Laude. In his free time he enjoys reading, looking for multifamily deals, and working out.
Make sure to always do your own research before making any final decisions on buying/investing real estate, stocks, or other securities. I am not a CPA, attorney, insurance, or financial adviser and the information in this blog post shall not be construed as tax, legal, insurance, construction, engineering, health and safety, electrical or financial advice. If stocks or companies are mentioned, I sometimes have an ownership interest in them – DO NOT make buying or selling decisions based on my posts alone. If you need such advice, please contact a qualified CPA, attorney, insurance agent, contractor/electrician/engineer/etc. or financial adviser.
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