Have you ever wondered what to do with your money when you feel you have enough to do something profitable, but not quite enough cash for an independent project? Or have you ever thought you have the talent to run a business, but unfortunately, your budget doesn’t agree? The right solution can be “real estate syndication,” or what some might call “real estate crowdfunding.” Read on to learn more about how to start a real estate syndication.
What Does Real Estate Syndication Mean?
Syndication is the concept of bringing together multiple real estate investors or pooling capital from several different sources to do a large commercial real estate deal. This allows cost-prohibitive investments in real estate to become a lot more accessible for individual investors.
(What syndication?) The real estate syndication, founded by Helmsley and Malkin, is one of the most famous examples. They led a group of investors that bought the Empire State Building for 65 million dollars in the 1960s. The majority of those investors contributed only $10 k each.
Why Real Estate Syndication?
By giving us several income sources to live our dreams, smart investments will change our lives for good. Investors are filling up their portfolio of shares and bonds, but most of them forget the real estate sphere. Buying a house is one of the best and most profitable paths to create wealth.
Compared to conventional assets, real estate as an inflation-hedged asset class provides a lot more efficiency and tax advantages, while also reducing the risks. Typically, people who want to capitalize on this asset class assume that they need to have a lot of money to enter the market, but that isn’t exactly true.
This challenge can be quickly addressed through innovative investment methods. Nowadays, you can find a vast range of plans to invest in real estate. Real estate syndication is one of these investment types, helping everyone engage in a vibrant industry despite each individual’s moderate financial resources.
What is a Syndication Deal?
As mentioned earlier, the syndication deal is an effective approach for investors to pool their money together. However, the type of project impacts the deal structure. For instance, deals are usually structured as capital structures, equity partnerships, or private loans.
Before you decide to embark on a real estate syndication, it is essential that you know exactly how it is structured, the details of the operating agreement, and the private placement memorandum (PPM). The latter two components will describe who is in control of what as part of the deal.
Equity
In an equity partnership structure, costs and profits are shared between the property developer and you, as detailed in the offering documents. Compared to a private loan, equity partnerships tend to be a higher risk in general. However, if the stakes are appropriately alleviated, the equity partnership will typically produce a higher return for investors.
Private Loan
In a private loan, an investor lends the money to a property developer, who must pay it back in return once a profit is made on the property. In most cases, such deals are organized into a limited liability corporation (LLC). This adds a level of protection, alleviates risks, and generates an opportunity for investors to become members of the LLC, buy a set of real estate, and then enjoy the benefits.
Capital Structure (aka Capital Stack)
A capital stack is the arrangement of all financial sources that are contributed to syndication. It is essential to know that the capital stack details who has the rights (in a chain of command format) to the asset’s revenue and profits during the hold period and upon its sale. It also determines who has rights to the actual property in case of default. The capital stack details in what order investors will get compensated.
Sponsors and Investors
Syndicators or sponsors are the first ingredients for a real estate syndication. They are responsible for locating, purchasing, and managing real estate. They usually have a history of real estate experience and the ability to underwrite and conduct due diligence in this field.
The investors are the other party, the people who invest their money and thus, own a share of the real estate. They have all the advantages of land ownership. However, they are not interested in purchasing the property, financial management, and daily supervision.
In some transactions, there is also a third party, the joint venture (JV) equity partner. JV partners often have access to investors and act as a conduit between the syndicator and the investors. Apart from helping with finances, they will assist the union with monitoring, correspondence, and even tax documentation.
Which Role Is More Suitable for Me?
A real estate syndication is a contract between a sponsor and an investor party. The sponsor plays the role of the manager and operator of the deal and invests the sweat equity. This involves scouting and raising funds. Moreover, the sponsor acquires and monitors the daily activities associated with the investment. Meanwhile, the majority of financial equity is provided by investors.
The sponsors typically are responsible for spending approximately 5-20 percent of the entire equity. Real estate syndication investors then put in 80-95 percent of the total capital. From a perspective of business risk for the investors, if the sponsor invests higher, their risk will be lower.
Depending on your charisma, energy, mindset, and of course, budget, you can decide which role (sponsor or investor) is more compatible with you.
The Structure
As a limited partnership, syndications are commonly organized to safeguard all parties. The sponsor takes part as the general partner (GP), or the manager. The investors play the role of LP (limited partner), or passive participants who delight in the sheer joy of income.
Notably, the LLC operating agreement and LP relationship agreement are essential documents for the deal. They help to guarantee the rights of the sponsor and the investors. These agreements include delivery rights, voting rights, and the sponsors’ rights to control investment fees.
The limited partnership or LLC structures can provide protection; if the transaction goes south, they secure both the sponsor and the LPs rights.
What Can a Real Estate Syndication Invest in?
Typically, real estate syndications aim to invest in more extensive and exclusive properties with more profitable yields and greater credit than what ordinary individual investors could obtain independently.
Some investment projects can be challenging for you to acquire on your own. Professional syndicators typically have better bargaining, equity, and borrowing power; consequently, they can buy more expensive real estate properties or a portfolio of properties. They can also obtain appropriate financing terms not often available to individual borrowers, causing a higher yield for the same asset.
Syndication enables you to diversify your investments. In exchange for a fractional corresponding ownership interest in the real estate property, you put in only a part of the total equity. Therefore, you can extend your capital among multiple properties instead of investing all of your resources in a single asset.
In some syndications, it is possible to invest in a portfolio of real estate assets, such as industrial buildings, medical offices, drugstores, or student housing. In some cases, syndications use funds to buy a single asset, usually a commercial property. They make it possible for you to deploy your capital into some smaller investments. Each syndication has its prerequisites concerning minimum and maximum amounts to participate.
Investing in a real estate syndication will not need property management responsibilities; other than the invested capital, there is no personal liability for any mortgage on the property.
The sponsor provides financial and operational reporting services and distributes periodic cash flow or proceeds from selling or refinancing the underlying properties.
Liquidity Issues
The real estate universe is not an appealing choice for many investors due to probable liquidity issues. They like to have the freedom to sell and buy whenever they want, so they consider real estate investing as something that could potentially lock their funds for an eternity. Since liquidity is the number one priority for some investors, they may choose other markets, such as the stock market.
A general misconception exists among many passive investors; they think investing in syndication equals fund lock, at least during the whole hold period. This period is the duration you have to hold on to the property after buying shares in the LLC that owns your real estate property.
Typically, the period is measured in years, and the majority of syndicators hold the property for 5 to 10 years. Many investors feel uncomfortable with the idea of not having access to their money for so long.
This is a significant misconception. When you buy a house through syndication, you will be one of the shareholders of an LLC. This LLC owns the property. Therefore, you are technically entitled to sell your shares to other investors or even to a third party, i.e., an investor who wasn’t a member of the original group.
How much do Real Estate Syndicate Participants Make?
Depending on your role in a real estate syndication, your share of the benefits and revenues will be different.
Sponsors
In real estate syndications, the sponsors commonly charge acquisition and management fees which can be anywhere from 1 to 5 percent of the project and 1 to 5 percent of the property’s gross monthly income, respectively.
Investors
In a real estate syndication, investors make money from two sources: the rental income or cash flow the property generates during the period of the investment, and the upside profit produced when the property is sold at a higher price at the investment termination.
Preferred returns: These are cash dividends paid for the syndication project period according to the rental income that the property makes from its tenants. Annually, real estate syndication investors receive 5-10 percent of the initial money invested. The majority of deals pay this dividend to investors on a monthly or quarterly basis.
For example, if you join a syndicated deal as a passive LP, investing $50k, and the preferred return is 8 percent, then you would get $333 monthly in your bank account ($4,000/12), which would reach a total of $20k by the end of the 5-year project.
Typically, preferred returns are distributed monthly or quarterly, but this is not guaranteed. Suppose the project needs additional reserves or is not performing; the GPs reserve the right to withhold the payments. That being the case, your earnings will be paid out later or when the property is sold.
Equity splits and profits from sale: In syndication, the LP and the GP own the asset together. The typical structure applied to share this ownership is a 70 to 30 split. In so doing, the LPs get 70 percent of the total ownership of the asset for bringing the money, and the GP receives 30 percent of the equity for finding the deal and executing the plan.
In most real estate syndications, the ultimate goal is selling the investment property at the end of the project at a higher price. At that time, the investors are compensated according to what they own.
For example, the asset is sold, and the profit from the sale is nearly $10 million. 70 percent, or $7 million, would be paid to the LP investors based on their investment. The other 30 percent share is distributed to the GPs. This is the primary source of an investor’s projected return.
Where Can I Find Real Estate Syndication Deals?
Since the only publicly advertised real estate syndication deals are just for accredited investors, finding appropriate deals can be a little bit tricky for ordinary individuals.
You can always try a Google search, but how will you make sure that the opportunities that pop up are legitimate ones, planned by experienced professionals with vital track records who will safeguard your capital for several years? The honest answer is that you won’t!
The best approach for finding syndication opportunities is to get out there and talk to experienced experts in the real estate syndication space. This community is relatively small. As soon as you get connected, you should easily find sponsors and deals that are compatible with your investing goals.
How Do I Join a Real Estate Syndication Deal?
For entering into a real estate syndication deal, you have to follow these steps:
1. Read all offering documents carefully and ask for all the details. Consult with your attorney regarding the deal and real estate structure.
2. Determine the mechanism you intend to hold your investment (e.g., with your spouse, in an LLC or trust, etc.).
3. Fill out and sign the documents based on the mechanism you intend to hold your investment.
4. If you are applying online, you often need to upload your paperwork to a secure page associated with the syndication deal. Stay alert for a confirmation email/message within 48 hours of submitting your documents. This message will inform you about a green light to invest, or if not, that you are missing paperwork or something is incomplete or incorrect.
5. If the process is old-school, the professionals will examine your documents and let you know any further information.
6. After the final confirmation (online or offline), you will invest your budget and officially become an investor in the desired real estate property! You will receive a copy of the deal that describes everything in detail.
Conclusion
Investors have to assess the real estate deal and evaluate if it aligns with their risk tolerance. These should be clearly described in the offering memorandum, which investors should always understand and read before investing.
When assessing a real estate syndication, the most critical parameters to consider are the sponsor’s credibility, experience, and sophistication.
It would be best if you were sure that the sponsor has a track record of purchasing, managing, and successfully finalizing similar investments. The professionals responsible for the syndication must have an outstanding reputation within the real estate community.
Since you (as an investor) will cede control over the asset to the sponsor and the experts they engage, you barely have any “say” in decisions related to the property. Always consult with an experienced expert or your attorney to be 100 percent sure about every detail.
