Last mile LP risk
The overlooked challenges in the final stretch of a syndication
Happy Sunday!
When you invest in a real estate syndication, there is a critical period between the time you wire your funds and when the GP actually closes on the deal.
For LPs, this moment is typically ignored because it’s “quite simple” - either they’ll investment my money or I’ll get it back … right?
After advising on dozens of counter examples, I’d like to spend some time on (1) why the statement above isn’t really true and (2) what GPs/LPs can do to avoid missed expectations and even litigation.
Let’s start with a quick summary of events to define what we’re dealing with:
LP is shown a deck and wires cash based on that deck
Between the time of the wire and close of escrow on the property something changes
Should the GP inform the LP about the change? Are they required to and is it “material enough” to warrant that level of communication?
Before I go further, it’s important to note that while I’ll cover some of the legal and practical aspects of what I’ve seen ~all of this ultimately hinges on (1) your relationship with GP, (2) the level of GP experience, and (3) the GP’s ethics:
Your relationship with GP - investors with more at stake and a closer relationship are typically treated differently. They shouldn’t be in terms of disclosure, but many times they practically are even if they didn’t negotiate side letters.
The level of GP experience - the more closings the GP has been in, the better handle on materiality they’ll have. An inexperienced manager might think something isn’t a big deal when it actually is.
The GP’s ethics - when you’re under the gun to close and something clearly changed, it’s tough to let go of the contract and lose your earnest money. This money comes out of the GP’s pocket (although we’ll come back to this soon) and we would delusional to not say that there can be a real “tug of war” between doing the right thing and just letting things slip in such circumstances.
Let’s dive into what changes most commonly prior to close: