It was a beautiful day in May. The sun was shining, birds were chirping. Life was good. I was getting ready to head out to an investor meet up when the email came out…notifying me that my distribution was going to be delayed by three months and converted from monthly to quarterly.
The email continued to explain about a variety of personal circumstances that had contributed to the operator’s decision to make the change, followed by a long list of excuses and finally concluding with the statement that they had been consulting with their attorney for weeks and months and have the right to do so. I have the liberty to call the long list of reasons excuses as none had to do with a sudden pause in distributions (e.g. business seasonality – not something new, regulatory and compliance requirements – which do not typically pop up overnight, certain transaction types falling through – which transactions were not supposed to be part of the fund structure to begin with, etc.)
My blood froze. Various emotions started going through my mind and heart. Being a full time investor, I depended on this passive income…
What followed was an initial request for information I sent to the syndicator I had invested through, followed by numerous follow ups, which yielded no results. No information was shared with me (and I was told none had been shared with other LPs or other syndicators raising for that operator).
Given the operator had gone dark, I could only think the worst – both my principal investment and income stream were gone.
Unfortunately as limited partners (LPs) we do not have control over the daily decisions. And absent fraud, the agreement had very onerous provisions re suing the operator.
The one thing I could walk away with are the lessons learned, which I thought I would share with you today and hopefully save you from entering into a similar situation and help you avoid pain.
I had done all the diligence, or so I thought, including but not limited to: understanding the business model, discussing the investment and operator with other passive investors who invested either via the syndicator I invested through or directly with the operator, checking the track record and full cycles box, understanding what type of diligence the syndicator had done on the operator, reading through the offering documents, etc.
Yet looking back and knowing what I know now, there are a few lessons this experience taught me and things I could have done better (in other words would do differently going forward).
(By way of background, this investment was NOT in multifamily. I had chosen it as a way to introduce some diversification to my own portfolio while at the same time adhering to my primary investment objective – cash flow).
Trust But Verify
Just because someone is well known or recognized on social media or been in the business for a long time does not mean they would be transparent in communicating or running a strong operation. The 10+ year period this operator had been in business coincided with the post 2009-2011 boom, i.e. a period when everyone did well, capital was abundant, and business was good.
Just because they are large or been in business for a long time does not mean they have internal operations and books and records in order.
Part of my frustration when I received the bad news was that no financial information was shared – historical or projected.
What I could have done differently was request a copy of the historical financials of the company (both for the fund and for the underlying business) as well as sample of the monthly/quarterly reporting (which I subsequently found out was none).
I also could have done a better job validating the diligence the syndicator I invested though had done on the operator. While I understood what it was, I could have requested a copy of their reports and data or even a copy of the periodic reporting they are receiving from the operators (which unfortunately turned out to be none and the syndicator had not bothered to ask).
Read The PPM More Diligently To Detect LP Hostile Terms
The operating agreement did not include any notice period for making material changes (such as changing the distribution schedule or pausing distributions).
In addition, any disputes could only be resolved in a specific state (designated by the operator) and no class action lawsuits were allowed with fees (irrespective of which party dominates) to be covered by the plaintiff.
While the operator may or may not be willing to update such clauses and sections, at a minimum having a discussion upfront about it to understand what, if any, options are available is key. How they respond to the question and what other offsetting LP friendly terms they have would also play a factor in my comfort level as I assess whether to proceed or not.
Diversify, Diversify, Diversify
Part of the reason I had chosen the investment and the operator was the stability of cash flow and ability to diversify my own portfolio (as an active investor I focus on stable value add apartments in the South East). However, over time I had increased my position with that syndicator to a point where a material portion of my passive income was being generated from this investment/syndicator. Even though things started off well and were going well, I probably should have diversified to other investments to minimize the risk of being dependent on this income stream.
Avoid Promotional Offers And Trust Your Gut
The last two funds I invested in had promotional offers (one was offering a higher dividend and the other offered to start distributions sooner than usual). Now I know there was a reason for that. Also at the time, particularly with the last fund, I recall having that gut feeling and being really torn. The funding deadline was fast approaching. Unfortunately I made the decision to move forward and increase my position. Knowing what I know now, I would have quieted that fear of missing out and the yearning for a (what at the time I perceived and expected to be) steady income stream.
What troubled me most about the situation was the lack of communication and transparency. I am not sure how you control for that (especially since all third party and LP feedback I had received up to that point had been positive…likely because the operator had not gone through a rough patch).
As I conclude writing this summary of lessons learned, I still feel pain and quite vulnerable. But I thought it is more important to put my feelings aside and share the key takeaways with you in an effort to save you from experiencing the bad situation as a passive investor.
Should you have any questions or want to learn more about real estate investing or for an overview of our target markets, please reach out to info@dbacapitalgroup.com.
Disclaimer: The information presented does not constitute legal, accounting, tax, or individually tailored investment advice. Past results do not represent or guarantee future performance.