In 2005, the real estate market was booming. Houses sold within hours of listing, and speculative investors bought properties, confident in making a quick profit. Then came 2008, bringing the financial crisis and Great Recession that sent it all crashing down.
This history lesson reminds us that investing in real estate isn’t just about buying low and selling high or finding the next hot deal. A lot happens after the purchase. It’s the day-to-day work—managing tenants, overseeing renovations, marketing the property, and implementing risk mitigation strategies—that determines an investment’s success.
A sponsor might uncover a property that looks fantastic on paper. But if they can’t handle challenges after closing, even the most promising deal can become a disaster for investors.
The Importance of Both Property and Sponsor
You’re about to board a cross-country flight in a state-of-the-art plane, loaded with every safety feature and amenity imaginable. Just before takeoff, you learn the pilot’s never flown a commercial flight before. How confident would you feel buckling in for that journey?
No matter how advanced the plane, if the pilot can’t manage through turbulence and execute takeoffs and landings flawlessly, you’re not any safer just because of the advanced equipment. Both matter, but the pilot’s expertise is what makes the difference.
In reality, this scenario wouldn’t happen, of course, as pilots clock hundreds of hours, gradually working their way up from training flights to major airlines. But investors put their trust in syndicators every day who have never “flown the plane.”
In real estate syndication, both the property and sponsor matter. Sure, a great property might have strong financials, a prime location, and tons of upside. Yet even the best property needs a strong sponsor to steer through market turbulence, execute the business plan, and safely land the investment at its maximum value. Without that expertise at the controls, even a standout property can fall short of its destination.
Beyond these two core elements—the sponsor and property—every syndication also has a third factor: the market environment. We can have periods of great upswings, but then suddenly, conditions can take a nosedive.
In our current environment, this includes challenges like:
Interest rates
Interest rates started climbing in 2022, impacting everyone in the real estate market and signaling the end of inexpensive debt. Investors now face higher borrowing costs and restrictive bank lending, requiring larger loan-to-value ratios and the need for bigger cash reserves.
Cap rates
Commercial property prices have doubled since 2010, leading to compressed cap rates. Combined with higher interest rates, this challenges both new acquisitions and existing investments. Sponsors relying on short-term exit strategies now face difficulties finding buyers at premium prices, potentially forcing longer hold periods or strategy adjustments.
Economic impact
Local economic changes can affect property performance. For example, from 2022 through Q1 2024, over 460,000 layoffs hit the tech industry alone. Shifts like this can impact rental demand and increase vacancy rates, damaging a property’s bottom line.
Market supply
Across various real estate niches, increasing supply impacts demand. For example, multifamily completions jumped 22.1% in 2023 to 438,500 units, the highest number of annual deliveries since the late 1980s. This flood of new units challenges existing properties to maintain occupancy and rental income levels.
Operational costs
Inflation took off in 2021, peaking at 9.1% in June 2022 and sitting at 3.3% as of May 2024. This creates rising expenses for everything from personnel to resources. These increased costs eat into profit margins, which means sponsors need to figure out new ways to maintain returns.
Regulations
Changes in laws or policies can alter everything from operational procedures to profitability. For example, New York City’s 2019 rent control expansion impacted multifamily profitability, while California’s Title 24 energy standards affect commercial building renovations and new construction costs.
A successful syndication needs both the property and sponsor. But without the sponsor adjusting the controls, the entire syndication is at risk.
When the Unexpected Strikes: A Case Study
Being aware of those market factors is key, but nothing illustrates the importance of a capable sponsor more than how they perform in a real crisis.
In November 2019, a hotel syndicator closed on hotels with great numbers and several demand drivers, including:
- Stable local employers
- Nearby entertainment like casinos and sports facilities
- Close to major freeways, with new infrastructure coming
- Value-add potential through upcoming improvements
Then in March 2020, COVID-19 hit. This completely unexpected crisis struck right during the hotel’s peak tourism season. Virtually overnight, occupancy went from 90% to single digits. Many of the demand drivers disappeared in a single week as employers sent workers home, casinos shut their doors, and venues scrapped events. 2020 broke records as the industry’s most devastating year and triggered widespread closures.
As the pilot of this plane that could now barely fly, the sponsor took immediate action:
- Negotiating a one-year payment reprieve with the bank
- Applying for available loans like EIDL and PPP
- Submitting applications for local government-funding grants
- Directing staff to target groups still traveling, like nurses, construction workers, truckers, and youth sports teams
- Adapting the property to accommodate semi-truck parking, attracting new bookings
- Utilizing the downtime to complete required franchise renovations
- Shutting down floors to save on utility and labor costs
- Stopping all sponsor fees and halting investor distributions
This sponsor focused on doing everything possible to keep the investment stabilized until travel rebounded. To provide transparency during this uncertain time, they increased investor communication from monthly to weekly updates throughout the next two years. This wasn’t just a rough patch—it was a full-blown crisis that put all of their experience to the test.
These actions paid off. While 1,651 hotels closed permanently from 2020 to 2022, this hotel property stayed open. As travel restrictions eased, occupancy began to climb. By 2023, the hotel reached 2019 occupancy levels and resumed investor distributions.
Market dynamics still demand careful management. Increased labor and supply costs impact the hotel’s bottom line, requiring ongoing strategic decisions. However, the property’s location, appreciation potential, and local growth trends support the original investment goals. The sponsor maintains their seven-to-10-year hold strategy to return investors’ original capital, plus favorable returns on exit.
The COVID-19 pandemic was extreme, but it’s not the only crisis sponsors face. Many have successfully managed investments through tough times. When you evaluate options, ask potential sponsors how they prepare for and handle unexpected challenges.
The Pitfalls of Short-Term Strategies: A Case Study
It’s not just unexpected global events that can challenge real estate investments. Let’s look at another scenario that’s becoming increasingly common in today’s market.
Since 2010, multifamily properties have seen strong appreciation, attracting many new sponsors to this investment niche. These sponsors often adopted a common strategy:
- Find the lowest-cost loans possible by choosing variable over fixed terms, assuming interest rates won’t rise
- Make quick renovations to the property to add value
- Raise rents
- Refinance or flip the property in two to three years
This approach worked well in a rising market, along with low interest rates and easy bridge debt, but many newer syndicators haven’t experienced market downturns. Now, they’re facing a new reality:
- Risky loans now carry higher interest rates.
- New multifamily supply is creating pressure on rent growth.
- Renovation costs are higher than expected due to higher labor and supplies.
- Operators struggle to cover loan payments with current rents.
Take a syndicator who bought a 200-unit complex in 2021, following this exact playbook. They used a floating-rate loan, planning to renovate units and raise rents by 20% within 18 months. Their exit strategy relied on selling by 2024.
By 2023, interest rates had doubled, renovation costs were 30% over budget, and a new 300-unit complex opened nearby. Rent growth stalled, and the syndicator is now barely breaking even on monthly payments. With no substantial cash reserves and limited experience in dealing with downturns, they need to scramble for solutions.
Effective sponsors implement conservative underwriting and comprehensive contingency plans and adapt to current market conditions, rather than relying solely on experience. They prepare for both upswings and downturns, ready to handle various scenarios and protect investor capital regardless of market fluctuations.
The Answer: The Sponsor Matters More
These examples demonstrate that while a great property is valuable, it’s the sponsor who determines an investment’s success. This is clear when you look at key areas like:
- Adaptability: Changing strategies when market conditions shift
- Crisis management: Handling unexpected challenges
- Financial expertise: Making sound financial decisions that protect investor capital
- Long-term vision: Planning for various scenarios, not just ideal conditions
When evaluating sponsor experience, look beyond years in the business. The real test of an operator’s skill lies in their performance during challenging markets. Consider how sponsors managed deals during downturns, their communication strategies, and lessons learned. While actions like pausing distributions or initiating capital calls aren’t automatic red flags, the context and transparency surrounding these decisions speak volumes about a sponsor’s capability and integrity.
Today’s tough market exposes the strengths and weaknesses of operators across the industry. Going forward, how well sponsors weathered this storm might matter more to investors than their resume.
The Risks of Focusing Solely on the Property
Syndication presentation decks spend a lot of time talking about the investment itself. And while that matters, focusing only on the deal is risky. So while you definitely should review the offering memorandum or private placement agreements, you’ll also want to evaluate the sponsors themselves.
The best property can underperform or fail if it’s not managed well. Market conditions change, unexpected situations happen, and someone needs to make smart decisions to keep things on track. That’s where the sponsor comes in.
A property is just a building. It’s the sponsor who brings it to life, handles problems, and implements strategies to make the investment successful.
Final Thoughts
Real estate syndications combine property potential with sponsor expertise. A prime property offers a solid foundation, but a skilled sponsor can transform an average property into a profitable investment. Meanwhile, a poor sponsor might undermine even the most promising property.
Perform due diligence on the deal and the team behind it. Choose sponsors with a proven track record, experience in similar investments, and the ability to adapt to changing market conditions. Investments don’t always go as planned, so it’s also key to work with sponsors who can communicate effectively, honestly, and often.
Syndications are your vehicle to financial growth, but it’s the right partners who serve as the expert drivers on this journey.