A few days ago, the the wall street journal published an article about real estate syndicator Applesway Investment Group (owned by real estate entrepreneur Jay Gajavelli), which lost more than 3,000 apartments in four rental complexes to foreclosure.
What caused one of the biggest commercial property booms since the 2008 financial crisis? In a nutshell, Gajavelli’s company held floating interest rate loans where payments were skyrocketing. Inflation led to higher expenses, but rental income could not make up the difference. Thus, the invoices became overdue, which eventually led to the seizure of these properties. Thousands of individual investors looking to generate passive income (without being an owner) now find themselves empty-handed.
Should individual investors be worried about a possible real estate crisis?
Between 2020 and 2022, syndicators have raised a staggering $115 billion. Additionally, more than 300,000 investors participated in syndications in 2021, according to financial samurai.
As much as I’d like to believe this is a one-time scenario, I’m leaning that it could have a ripple effect that could affect the industry.
Assuming other large syndicators offer variable rate loans (without interest rate caps), they will feel the financial pressure of increased payments. This is due to the aggressiveness of the Federal Reserve rising interest rates for the 10th time in a row since March 2022. And syndicators probably won’t be able to escape renewal at higher rates in the near future.
Other than that, there are a variety of factors where things can go wrong. For example, poor property management, understating operating expenses, and a lack of rental income to keep them afloat could weaken the business model. It won’t be as devastating as the housing crash of 2008, but I wouldn’t be surprised if we saw a handful of syndicators fail this year.
What should be done to protect small investors?
I personally believe that all of this could have been avoided had the government, both state and federal, taken more responsibility for protecting individual investors.
I will give Congress the benefit of the doubt that they had good intentions in passing the Employment Act in 2012, allowing syndicators to publish real estate investment opportunities online. This has made it more accessible to American families to invest. On the surface, it sounded like a great idea. In reality, the cracks in the system led to this devastating result.
This is a complex problem that will not be solved overnight. However, there should be accountability for all stakeholders involved. On the one hand, I believe that syndicators should assume their responsibilities by being transparent about their financial performance vis-à-vis their investors. Regular reports to all their investors would go a long way in building trust between the two parties.
Additionally, there should be more legal protection offered to individual investors. If I were them, I would want to know how my investment is doing and not be caught off guard before it’s too late.
Moreover, shouldn’t syndicators have their skin in the game? If they ask investors to shell out large sums of money, shouldn’t they do the same?
These victims are hard-working citizens trying to achieve their “American dream”. Now thousands of lives (maybe more) are in ruins because of this faulty system. This is a hard lesson for these small investors who must rebuild their financial nest egg.
How can you protect yourself as an individual investor?
If you want to become a passive investor with a syndicatorhere are some ways to be proactive and protect yourself.
- Network with other investors to find a reputable real estate syndicator who can prove that they have a track record. THE Forum BiggerPocket is an excellent starting point.
- Search and verify the company to make sure they are trustworthy.
- Understand your risk tolerance before handing over large sums of money. With real estate, there are always risks.
- Don’t put all your eggs in one basket— or maybe you’re the one holding the bag.
- If it sounds too good to be true, it probably is. Don’t give in to FOMO. A business should not be too promising or guarantee unrealistic returns in a short period of time.
Hopefully, with these tips in mind, you can make informed decisions about which real estate investments are right for you. Again, we cannot predict what the fallout from this event will be. He could be isolated. But I maintain that if foreclosures can happen to a syndicator (and unless others are more diligent), then we might see more on the horizon.
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Note by BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.