Feeder Funds Funhouse, Iran on Fifth Ave & Special Servicer Season

The Feeder Funds Funhouse

Back in the glory days of eBay auctions, some entrepreneurs I knew in college devised a nifty side hustle: They found some of the most coveted items up for auction (True Religion jeans, Juicy 🍑 sweats) and set up landing pages that would allow visitors to access those items for a small fee. Once you paid, you were guided to the reseller page 🤷‍♀️ . This charade didn’t last long, but it was fun (and lucrative) while it did.

Those memories have resurfaced as I watch some of the goings-on in the multifamily syndication world, where a large chunk of the LP cash isn’t flowing directly to the GP, but rather via these nebulous entities known as feeder funds. It’s a construct that needs to be better understood, especially in the downside times (i.e. Now), and luckily we at The Promote have the perfect person to break it down.

Feeder Funds (cont.)

Aleksey Chernobelskiy advises LPs on structuring their real estate investments, and a lot of his time nowadays is spent on deciphering exactly how so many of their “passive” bets went awry. One key pain point has been the proliferation of feeder funds, which he says accounts for a fat chunk of retail LP capital raised in the past 5Y. I’ll let him take it away - HS

By Aleksey Chernobelskiy 

Feeder funds are meant to give an LP two key benefits: increased due diligence – you’re assuming an experienced investor is doing the vetting for you – and access, where the appeal is getting into top-tier deals (usually determined by min. investment req) that you wouldn’t be able to tap into otherwise. 

The access bit is sort of moot: most feeder funds are syndicating into sponsors that would take most, if not all, of the calls ☎️ from LPs directly. And the due diligence part is up for debate, as we’ll see in a minute.

Unfortunately, many LPs don’t realize what they’ve bought into until deals go south. That’s when the LP may learn that they weren’t dealing with the actual sponsor and just the middleman – a middleman with very little contractual leverage to right the ship. (Feeder funds generally do not have legal recourse to remove/replace the “actual” GP, unlike a typical JV agreement where the partner puts up a much larger percentage of the LP equity.) 

Another thing that happens is a communication breakdown: as things go bad (delinquencies, defaults, lawsuits etc.), the GP may go dark, and the information that flows to the LP from the feeder funds tends to be incomplete and/or months late.

Now, the due diligence. Alignment of interests is somewhat funky here: as the LP, your going-in assumption might be that the feeder fund is picking the best risk-adjusted deal on your behalf. However, such deals often come with an upfront placement fee for the feeder fund – a percentage of equity – that’s payable on top of any acquisition fee or closing costs etc that the GP pockets. Moreover, many of the feeder funds negotiate pieces of the promote 🥧 from the GP to raise capital. So what could happen is that a feeder fund picks a deal not necessarily on the financial merits, but rather on the upside for them in the fee structure. Some feeder funds focused on maximizing economics for themselves, at the expense of the LP paying for their services. 

The LPs need to understand that the downside for the feeder funds – let’s put ethics and reputation aside and talk purely money for the purposes of this – is nothing, while the upside is at a minimum the placement fee (+ in some cases a 2nd asset management fee) and at most the fees PLUS a cut of the GP’s promote. So if you can maximize the latter, you start playing a little bit with the incentives.

RealPage Takes States Heat

“The important thing you guys gotta keep in mind is that these things gossip. They get together and they gossip.”- Donnie Azoff, The Wolf of Wall Street

The hits keep coming for top property management software RealPage. Last month, we learned that the DoJ had upgraded its rental price-fixing investigation into the firm – it is now a criminal probe. 🔍️ Now, WSJ reports that state AGs and DAs in Arizona and Washington, D.C., are piling on, suing RealPage and over a dozen of its large landlord customers (including Equity Residential, UDR). North Carolina’s AG is also looking into whether RealPage is violating antitrust laws with its algorithmic pricing system, which advises landlords on how much to increase rents on renewals and charge for freshly vacated apartments. And in Colorado, there’s a proposed bill that would restrict the use of algorithmic pricing systems to set rents.

“There is no competitive rental market in Arizona anymore, ” Arizona AG Kris Mayes Mayes told the publication. “Because RealPage sets the price.” The firm contends that its pricing systems are compliant with federal laws and blamed the “severe shortage of supply in the rental market” for rising rents, “not the use of revenue management software.”

RealPage and its key rival Yardi are also facing class-action suits from tenants.

Iran on Fifth Ave

“We’re crazier than you realise.” - Iranian regime insider 

The government of Iran is back in the news for all the wrong reasons. So my mind immediately went to the yearslong drama over the US govt.’s attempt to seize Iran’s Manhattan trophy at 650 Fifth Avenue. The Feds first tried to take control of the office portion of the 36-story building, which they alleged was an instrument of Iran’s supreme leader Ayatollah Khamenei, in ‘08. In ‘14, they reached a deal to seize the tower based on financial sanctions imposed on Iran in ‘95. In ‘17, the Feds won a court battle that allowed for the asset forfeiture, and planned to sell the property and direct the proceeds to victims of Iran-sponsored terrorism. In ‘19, however, that verdict was overturned. The building’s website touts it as the best option for flex space for corporate tenants.

(Bonus: For a deep dive into how asset forfeiture works in real estate, check out this banger.)

Quickies

• L&L lands fattie refi for 425 Park: $911M from Sumitomo

• Sterling Bay butting heads w Wells on Fulton Market loan workout

• Special servicer flex: Rialto, via its Rialto/Blackstone/CPP JV that took control of Signature’s CRE book, is suing Aby Rosen’s RFR, alleging failure to pay off $39M in promissory notes. (Special servicers are the ones to watch at this stage of the cycle- they’re both printing money and catching 🔥 from sponsors, as I break down here)

• Nightingale’s Elie Schwartz 😍 misses deadline 👏 for $3M repayment to crowdfunding investors he allegedly scammed (Please remember that this man is actively raising $$ for new deals)

A Syndicator Peer Review

If you’re a multifamily syndicator or an LP in one of them, I’d suggest parental guidance before diving into this: @mu2myoc (vetted, legit) takes a close read of a current offering from Rise48 (a 288-unit project in DFW called Rise Fossil Creek), with LP capital being syndicated by Cochran Capital. He asks several tough Qs worth asking, in a vital thread that rhymes with today’s opener.

We’re Cookin’ on Insta

If you want quick, sharp video breakdowns of some of the hottest trends & stories, look no further than ten31’s new Instagram: We’ve already examined Frum-friendly EB-5, the luxury space race on Fifth Ave, the Special Servicer drama and Blackstone’s megadeal for AIR. Think of it as The Promote’s video soul sister 📹️ 

Meat on REITs

Readers of The Promote who want a thoughtfully curated digest of REIT news should check out David Auerbach’s Daily REITBeat. He somehow vacuums up every bit of content on that strange world and makes it readable.

Unquotable Quotes