Nov
16
If you own securities in five different corporations and one starts to lose money, you may lose all or part of the money in that particular corporation, or you may sell the stock in the corporation which loses money. Your investment in the others is not affected. But if one of five buildings owned by the same syndicate begins to lose money, your income from the other buildings may possibly be endangered. The syndicate will probably want to keep up the tax and mortgage payment on the building which loses money, so that the property won’t be foreclosed. To do that, they may have to use the money from income of
the other buildings. Thus, in the case of the syndicate, if one building begins to lose money, your investment in the other ones may be in danger. There is another possibility or rather another risk. Suppose that one building is suddenly in need of substantial repairs. The income of other buildings may have to be used to save the investment of the one which threatens to turn sour.
Therefore, let us not rely on slogans. If you must have one, let’s say that a chain is as strong as its weakest link. All this means that if there are several buildings or leaseholds or a combination of buildings and leaseholds combined in one offering, you must examine each building and each leasehold separately. Do not be satisfied that one property has a good tenant and a long term lease. Be sure that along with desirable property, they do not palm off something which you would not buy if it were offered alone.
Look for the weakest link. Only if all properties satisfy you, can you be satisfied with the syndicate.
Nov
16
Multiple Properties, Increased Safety or Increased Dangers?
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Let’s look at a syndicate which owns a leasehold of a hotel. Suppose the hotel cannot make money in that location. Where will the investors be? The answer is simple. They will lose their money. True, the hotel business is carried on in a building, but your syndicate does not own that building. What it owns has little to do with real estate. It owns part of a business. We do not say that there is anything wrong in investing in a syndicate which is more in the nature of a business than real estate venture. But if you invest in a more speculative venture, you should be entitled to a higher return.
Do not consider only the percentage return offered by the syndicate. You must weigh the risks of the venture too. The return and the type of the venture will determine whether the promised yield is high enough for the risks which you are taking.
53. Multiple Properties, Increased Safety or Increased Dangers?
Lately, we have seen offers of participations in syndicates which intend to acquire several properties. There are also the combinations of existing properties and properties under construction, or of leaseholds and properties under construction. The sales argument given to you on these offerings is that diversification offers greater safety. The diversification slogan is taken from the stock market, but is it true when it comes to syndicates? In the stock market, you take your pick. There is no tie-in sale. When it comes to the multiple property syndicate, you buy a package deal. You take the bad property with the good ones.
Nov
16
This fact has also found recognition in the market for syndicate participations
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There is a syndicate which also owns real estate, but of a special nature, or a special business. Motels, hotels, garages, bowling alleys, sanitariums fall into that category. You realize that the success of such a venture is linked closely to the success of the business which occupies the premises. Such a syndicate owns real estate but in many cases there may be a greater business risk. This is recognized by syndicators and investors alike. Syndicators project and investors seek and obtain a higher monthly distribution on these specialized ventures.
Usually the syndicate owns real estate. There are many syndicates which own long term leases on real estate, so called leaseholds. Their earnings are based on the difference between the rent which they must pay to the owner of the land and building and the rent which they collect from their sub-tenants. You just can’t generalize in a field which offers such great variety of values in investment. Certainly a sound, long term leasehold with good tenants may be an investment far superior to outright ownership of an overpriced overmortgaged dilapidated property. But one thing is certain. A leasehold, even a long one, will come to an end. If all other things are equal, outright ownership of the real estate is usually preferable to a leasehold. This fact has also found recognition in the market for syndicate participations. In order to sell participations in a leasehold, the syndicator has usually to pay a somewhat higher return than if the syndicate owned the building outright.
Nov
16
A large return may be necessary to attract investors
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Some states must still pass or modify legislation to permit the creation of these real estate investment trusts. Experienced syndicators say that the Real Estate Investment Trust will open new vistas in the field of syndica-
tion, that the easier transferability of shares in such a trust will create a broader market for syndicate participations. At the time of the writing of this book, no one has sufficient experience with the Real Estate Investment Trust to tell exactly how it will work out. However, it appears to have such an unusual potential and has aroused so much interest, that we have devoted a separate part of this book to it. (See Appendix, E).
52. Real Estate or Business Syndicate
You have seen syndicates which offer initial yearly distributions of 8%. Others offer 17.5%. There may be numerous reasons for these differences. Perhaps the growth prospects of the first syndicate are substantially greater than that of the second one. Perhaps the first syndicate is safer. We hope that by this time you know that a larger monthly distribution is not necessarily the sole factor which determines the quality of your investment. A large return may be necessary to attract investors to a more speculative investment. If you want to speculate, that is your privilege.
The possibility of what syndicates may own are almost without limit. But let us try to find some classifications or groupings.
When the syndicate buys an apartment building, an
office building, a mixed store and apartment building, or a shopping center, you would consider it a real estate syndicate in its purest form. Tenants may change, but presumably there will be others. Such a syndicate is engaged in operating real estate and ordinarily it comes closest to the ideal of safety and increase in value associated with investment in real estate.
Nov
16
Other business organizations avoid this double taxation
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51. What About The Real Estate Investment Trust?
The ideal type of business organization for the investor would have the following characteristics.
First: Limit the investor’s liability to the sum invested.
Second: Continue in existence even if the principal (syndicator) dies or goes into bankruptcy.
Third: Not be subject to federal or state income taxes, but pass on all of its earnings to its investors free of taxes.
Fourth: Enable the investor to sell or transfer his investment freely in the open market without any permission from the business organization.
Fifth: At a readily ascertainable and fair price.
None of the various types of business organizations which existed until recently will fill all of the above desirable requirements. At least there was no such ideal business organization suitable for the syndicate. Take a
real estate corporation. True, you could sell or transfer your shares of stock merely by endorsing your name on the back. But to obtain that right, you have to pay a high price. The corporation is a separate entity for tax purposes. It has to pay taxes on its profits. You have to pay taxes once more on any dividends which you will receive. Because of this double taxation, the corporation is not a good medium for the syndicate.
Other business organizations avoid this double taxation but have other drawbacks. Some do not protect you from personal liability over and above your investment. Others make the transfer of your investments more cumbersome and at times dependent upon the consent of one of the principals.
In 1960, the Federal Government passed legislation which permits the creation of a new type of business organization, the Real Estate Investment Trust. Such a trust, properly organized and managed in conformity with the law is intended to give the investors the first four advantages set out at the beginning of this chapter. The larger trusts will probably seek stock exchange listing, so that you would have all five advantages.
Nov
16
Frequently, the consent of the syndicator is required
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50. Can You Sell Your Unit If You Want “Out”
What Price?
We have tried to examine the factors which determine the value of the syndicate and the participating units. Value is relative. You have certainly heard of cases where a person has some valuable property—a painting or ob-
ject d’art—but cannot find a buyer who wants to pay the price which reflects the true value of the object. There is no ready market for it. Value is often said to be “what a willing buyer would pay to a willing seller.”
When we think of the value of an investment of a unit in a real estate syndicate, we must think of it two ways. First, there is the real value of the income-producing investment. Next, there is the value—the price you will receive—if you want to dispose of your investment in a hurry. These two values may not be the same. If you own a unit in a syndicate which in turn owns good real estate, you have probably a good and safe investment of stable value. But what if you must sell it in a hurry? It is not the same as calling your stock broker, getting the quotation on your stock, and giving the order to sell it.
There are firms which sell syndicate participations and who will also try to sell your unit. But you cannot be sure that there will be a ready market for your investment at the time you want to sell. Presently there is no true market for syndicate units similar to the stock market, where you can get immediately the fair and prevailing price for your investment.
Frequently, the consent of the syndicator is required before your buyer may obtain all the rights which you had as a limited partner or a member of the syndicate. Such consent will, in most cases, be readily given. Some-
times a charge is made to make the necessary changes on the books of a syndicate.
At the time of making an investment, you should ask yourself whether in the near future you may have to turn your investment into cash on short notice. If the answer is yes, think again before you buy a unit in a real estate syndicate.
Nov
16
Nothing is said about the specific power to sell
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48. Management of the Syndicate’s Property
What are your rights to participate in the management of the syndicate and in the major decisions? The brochure will state all that. You may be reasonably sure that you will have no voice in the management. That is probably what you want. Anyhow, it would be rather difficult to manage a building, if you have to call a meeting of all the investors, each time a decision has to be made.
There is, however, one decision on which you would
like to be consulted. The decision on whether or not to sell the property. After all, this is a decision, whether you stay in business or not.
49. May the Sndicate Sell or Mortgage Its Property Without Your Consent?
Whether the syndicator may sell or mortgage the property of the syndicate without your consent or even without consulting you depends entirely on the agreement. Very often the management has the power to make these decisions. In other cases, the brochure states that the management will not sell unless it obtains the consent of a stated percentage of the investors, for instance, one-half or two-thirds of the investors. Such a clause is important where the syndicator gets a substantial percentage of the profits on a resale. If he gets 50% of a $200,000 profit, that would be $100,000. If the object is a large one, the remaining $100,000 divided among a large number of investors may be peanuts. The investors may want to retain a building which yields a good income and promises future growth. The syndicate manager may wish to sell because he sees a fast profit. If the syndicator gets a substantial part of the profits of the sale, it is particularly im-
portant to ascertain whether the sale must be approved by a majority or two-thirds of the investors. Examine the following clause:
The general partner has all the rights and powers as provided in the Partnership Law of the State of New York.
Nothing is said about the specific power to sell. Yet under the law pertaining to limited partnerships the general partner may have the right to sell property of the syndicate without even consulting the limited partners. The following provision will offer you protection against an unwise sale:
The general partner has represented in the partnership agreement that he will not sell the property without the consent of 66¾% in interest of the limited partners.
Nov
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47. Are You Liable for the Debts of the Syndicate?
When you make your investment in a syndicate, you participate in a business. Any business, even a well managed one, may fail. The question is whether there is any possibility that you, as a co-owner of the business may be called upon to pay its debts. The chances that such a situation will arise with a real estate syndicate are probably slim. But there are quite a few speculative ventures which bear almost no relationship to investment in real estate. Whether you plan investing in a conservative or speculative venture, you would probably like to be sure that your risk is limited to your investment and that under no circumstances can you be called upon to pay the debts of the syndicate. Some brochures contain this information in plain language.
The liability of a limited partner is limited to the
amount of Ms original capital contribution.
Any participant may be personally liable to a person
outside the venture for the full amount of any obliga-
tion of the agent as a partner in Associates, or any liability of the partnership, which arises after the effective date of participation.
Nothing difficult about the two clauses. In the first case you are not personally liable for any debts. In the second case you are or may be liable for debts. Other brochures may and probably will tell you whether you will or will not be personally liable for the debts of the venture, but they use legal phrases which may not be quite clear to you. If your status concerning liability is not fully spelled out in the brochure, or if you are not sure that you understand it, don’t hesitate to ask for legal advice. This is a highly technical matter and it cannot be discussed and explained here in all its details.
Nov
14
In the second place, it is rather unlikely that a long term lease negotiated with a nationally-known tenant at arms’ length will contain provisions that the tenant gets any benefits from mortgage refinancing. That important growth factor will not be impaired.
Finally, a lease with an AAA tenant would at least
provide reasonable assurance that the rent will be paid in good or bad times for the duration of the lease. You would probably be willing to take the risk that General Motors or Sears Roebuck will continue to pay rent even during a recession. The syndicator’s corporation, which may be the tenant under a long term lease prepared by him will probably have no other assets but the leasehold. So if things go bad, it will fold. In fact, the syndicator will probably advise you in the brochure that your distributions are dependent on the ability of the property to produce income, not on the syndicator-tenant’s financial status.
In the long term lease with an AAA tenant, you will probably have three features which make it vastly preferable to a long term lease given to a corporation controlled by the syndicator or another insider:
1. There would be reasonable escalator or anti-infla-
tion clauses.
2. The tenant would ordinarily not share in the bene
fits from any refinancing of mortgages or from the resale
of the property.
3. You would be reasonably sure that you would
receive your distributions for the duration of the lease.
The above statements are necessarily of a general nature. They refer to the situation as it will probably be. Of course, it is impossible to form a judgment on any
lease without knowing its provisions. The main features of a long term lease will probably be set forth in your brochure. Read these provisions. The brochure may state that you may examine the long term lease or an abstract of its major terms at the office of the syndicator. Don’t be bashful. Go and take a look. The lease will affect your income for many years and may have substantial bearing on the growth factor of your investment.
46. The Form of the Syndicate— Types of Business Organizations
Some syndicates are organized as corporations. Others as trusts, partnerships, joint ventures, tenancies in common, or limited partnerships. You may and must assume that the syndicator has chosen the form best suited for your syndicate. In any event, you will have no say on that matter. When you receive the brochure, it will tell you the type of business organization selected for the syndicate. You cannot change it.
We have no room for a discussion of the legal differences between the various business organizations. Probably you are not interested. But you should be interested in finding out whether you may be personally liable for
the debts of the syndicate, whether you have any voice in the management of the syndicate, and whether the property can be sold and the syndicate liquidated without the consent of the investors.
Nov
14
Does the net long term lease to the syndicator provide for the possibility of an increase?
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The syndicate is set up to provide a certain yearly distribution to all who have units, including the syndicator. The subordination of the syndicator’s interest provides a true cushion. If there is not enough money to make the projected distributions, the syndicator will receive none. The syndicator is under no obligation to subordinate his units, and they are only subordinated if it is specifically
stated in the brochure. The brochure will also state whether the syndicator’s units are permanently subordinated, or subordinated just for one or more years. The longer they are subordinated, the better for you.
We examined subordination of income on the syndicator’s shares. The agreement could further provide that in case of a sale the investment of the cash investors must be repaid first, before the syndicator will receive any money for his share. Such a clause is also beneficial for you. If the property in our last example were sold for $450,000 above the mortgage, there would not be enough money to pay $500,000, the full value for all the units outstanding. If the syndicator had subordinated his units as to principal, the cash investors would get all their money back, and the syndicator would get nothing.
The subordination clause is usually easy to find and offers no difficulties. Sometimes such a clause is worded as follows:
For a period of three years after the date of the acquisition of the property, the limited partners (investors) will have priority both as to distributions and as to proceeds of liquidation over the general partner (the syndicator). (The words in parentheses were added by us to make the clause clearer). Giving to the investors priority amounts to the same thing as subordinating the syndicator. The effect of the
above clause is to subordinate the syndicator’s interest in distributions and proceeds of sale for a period of only three years.
45. Long Term Lease to AAA Tenant
We discussed the effects of a long term lease to a corporation controlled by the seller or syndicator or other insider. We pointed out many of its drawbacks. Is a long term lease to a national corporation different? A national corporation, rated AAA (over $1 million), will, at the time of the leasing probably require certain concessions, since it is such a desirable tenant. The rent will probably be low. But at the time of making projections of distributions from the property, the amount of the rental income will have been considered. The projected distributions will be based on the rent. So you don’t have to worry about the fact that the rent is too low.
The rent will be stable for a number of years. The very reason that the nationally-known tenant enters into a long term lease is that it wants to be sure that the rent will not suddenly be increased after it has been on the premises for a few years and has built up good will. On the other hand, such a lease should contain reasonable es-
calator clauses or inflation clauses, which provide for reasonable increases either based on increased sales or on an increase in the cost of living index.
The following is an excerpt from a brochure explaining the operation of a long term lease to a large mail order house. (The name of the tenant has been deleted.)
“Based on the lease now in effect, the tenant would have paid a total rental of $105,000 in 1959. Based on presently projected sales of $700,000 for 1960, a rental of $122,500 is expected.”
Compare these provisions with the ones of a net lease to the syndicator or seller in the brochure which you examine. Does the net long term lease to the syndicator provide for the possibility of an increase of 16% in a single year?
A lease negotiated at arms’ length with a national tenant would probably contain clauses which offer better protection against inflation than the lease which the syndicator prepared for the benefit of the corporation which he, himself controls.