Real estate investment is among the most optimum methods to achieve wealth. If you want to be rich, invest in real estate. Real estate has been an essential component of many successful investment portfolios for decades.
Syndication in real estate deals can be a viable option for passive investors. It allows them to have a wide and varied investment portfolio with reliable and continuous cash flow streams. Moreover, property builds up equity over time, independent of the stock market. Among many other benefits of syndication in real estate, is the possibility for investors to take advantage of significant tax breaks, making this type of investment even more appealing.
This article aims to provide valuable resources and data required to make rational decisions when passively investing in large syndicated deals. Another objective of the article is to help readers comprehend intricate details about the complicated world of real estate syndication and the many benefits of becoming a limited investor in it.
Furthermore, it provides a general description of a top recession-resilient asset class (self-storage) that many investors are keen on. They believe it to be a fantastic opportunity, both as a tax-efficient passive income as well as a long-term wealth-building source.
Syndication in Real Estate
Syndication consists of a group of people or companies working together and helping each other achieve a particular objective. It can also be defined as an agreement between several financial organizations to share investment risk on carrying out a specific deal/project.
A real estate syndication (property syndication) is a partnership between several investors combining their abilities, resources, and capital to own one or multiple properties. The properties are often complicated or cost a great deal of money for a single investor (hence joining forces to make the purchases a reality).
In other words, real estate syndication is an effective way for a syndicator and a group of investors to combine their financial and intellectual resources to jumpstart real estate projects off the ground. This process is nothing new and is quite prevalent. It has been around ever since the early days of the United States property market.
In the past, only the most connected and the wealthiest individuals could participate in real estate syndication. But in recent years, due to the elimination of restrictions on general solicitation and the spread of digital finance and technology, real estate syndication deals have gone mainstream and are no longer exclusively reserved for wealthy people.
Who Is Involved with Real Estate Syndication?
There are usually two parties in property syndication: syndicator and investor. The first party for a real estate syndication is the syndicator (also referred to as the sponsor, operator, or general partner). This individual or company is responsible for managing the syndicate, identifying the market, underwriting the property, securing financing, supervising the business plan, etc. They often have a real estate background/experience and are able to provide support, conduct due diligence, etc.
The other party is the investor. The investor is an individual or group of individuals who invest with the syndicator and own a part of the real estate. Investors get behind a deal based on trust (usually in the sponsor’s experience).
Investors also do have specific voting rights. They maintain all the advantages of property ownership. At the same time, they are not intricately involved with acquiring property, arranging to finance (if there is a loan on the property), doing day-to-day management, etc.
It is vital for a real estate investor to have access to a readily available large sum of money to capitalize on ample opportunities that present themselves in the market. One way to do this is by acquiring properties through syndication. Investors should always be looking for ways to syndicate real estate opportunities. By successfully syndicating real estate deals, they gain more property and earn additional profit.
What Is Crowdfunding?
Real estate crowdfunding is a method of identifying funders. In other words, crowdfunding is attracting and finding real estate investors to begin the official syndication process.
Real estate crowdfunding has become more prevalent in recent years, mainly due to the JOBS Act of 2012, aimed at decreasing regulations on small businesses and legalizing equity crowdfunding. What’s more, in the ensuing years, entrepreneurs/investors have been able to find each other in more creative ways – primarily through the Internet.
Real Estate Syndication vs. Crowdfunding
Crowdfunding and syndication are terms used interchangeably during the last decade. Both real estate crowdfunding and real estate syndication involve pooling capital with other individuals for a common goal. In real estate, that common goal is to purchase property – a physical building that can be seen and touched. However, real estate syndication and real estate crowdfunding are not directly synonymous. While real estate syndications are funding relationships or agreements between investors, real estate crowdfunding is merely one method of finding these investors.
Syndication and crowdfunding are interconnected. So, it is vital to see similarities and differences between the two patterns. Crowdfunding is a method of picking up money, and syndication refers to the funding relationship between the funded and its funders. Real estate syndications are sometimes crowdfunding, but not always, and vice versa.
Real Estate Syndication Legal Structure
Like most real estate investments, syndication deals can be risky and complicated. Equity investors join a Limited Liability Company (LLC) or a Limited Partnership (LP) to reduce complications. This enhances financial management as well as project structure tasks the syndicator has to undertake/perform. The syndicator participates as general partner/manager, and investors participate as limited partners/passive members.
The rules and regulations protect both the sponsor and the limited partners if the deal goes wrong. They include rights to distributions, voting rights, and the sponsor’s rights to fees for managing the investment.
How Real Estate Syndication Works
As operator and manager of the deal, the sponsor invests the sweat equity. This sweat equity includes scouting out the property, raising funds, etc. Also, the sponsor copes with the investment property’s day-to-day processes. Meanwhile, investors prepare most of the financial equity. The sponsor is largely responsible for investing anywhere from 5-20% of the total required equity capital. Investors put in between 80-95% of the total. The more the sponsor invests in the deal, the better it is for the investor.
Why Do People Take Part in Real Estate Syndication?
The most prominent reason investors participate in crowdfunding or real estate syndication is access to deal flow. Not every investor has the time or ability to search and underwrite numerous properties toward finding the right one to acquire. But many real estate companies do this for a living. By getting involved through a real estate syndication, investors have access to this deal flow and the ability to invest without the property management annoyances. Some of the other major benefits of investing in real estate syndication include:
- Being able to invest in larger deals than they could on their own.
- Not having to manage day-to-day details/procedures.
- Earning additional revenue (much more than solo investment).
What Kind of Profit Can One Achieve in Real Estate Syndication?
There are two primary ways real estate syndication generates profit: rental income and property appreciation.
Profits from rental income are created when a building’s maintenance costs are less than the total revenue it derives from rent. This cash flow, available for distribution to shareholders in the syndicate, is called the net operating income (NOI).
The other form of profit realized in real estate syndication is generated from a property sale. Compared to profits generated from NOI, the successful sale of a building typically accounts for the overwhelming majority of the profits a project will provide to its investors.
Ways You Can Profit from Real Estate Syndication as a Syndicator
Acquisition Fees
A real estate syndicator will typically receive compensation for finding the property, conducting due diligence, and structuring the deal. Acquisition fees can range from 1%—5% of the acquisition costs. In most cases, these fees are negotiable with other investors in the contract. Finding and structuring deals can be an exhaustive task, so a syndicator must make certain to be properly compensated for his/her time and effort.
Asset Management Fees
Another way to profit from real estate syndication is receiving an asset management fee. This fee, generally 1% of gross revenue, is paid to the investor as project syndicator due to the investor’s responsibility/duty to manage the property, syndicate the partnership, etc.
Equity Participation
Investors will be compensated via their equity participation in the project. Their equity stake in the project can vary, ranging from 5–50% depending on the investor, their experience, project specifics, contract details, etc.
Ways You Can Profit from Real Estate Syndication as an Investor
Even though investors do not have any day-to-day responsibilities in real estate syndication, they are compensated for the risk they have undertaken (providing equity in a project) in two ways: receiving a preferred return or a share of the profits.
Preferred Return
The preferred return is compensation paid to syndicate investors (share of the total amount invested). Payment is twofold: either paid from ongoing cash-flow or accumulated until the project has enough cash to make full payment. The most prevalent preferred return rate is 8%.
Profit Share
Investors are also paid for participating in the deal with profits/appreciation. A real estate syndication investor is paid via a share of profits (compliant with how much they have invested in the project).
How Do You Finance a Real Estate Syndication Deal?
Typically, a professional real estate developer will finance his/her projects with two forms of capital: debt and equity.
- Debt (banks most often provide it)
- Equity (since banks do not offer 100% of the money to buy, build and/or repair a property, real estate developers need to compensate for the difference—this is called equity)
Some real estate projects are enormous, so very few developers have enough money to provide all the equity capital required to implement the project. These developers must seek outside capital sources to provide the equity they require. The way they approach this is to ask private individuals/equity providers to invest. The ensuing group of investors altogether is recognized as a real estate syndicate.
What Is an Asset Class?
Financial advisors focus on asset classes as a way to help investors diversify their portfolios. An asset class is a grouping of investments that behave similarly in the marketplace and are subject to the same laws/regulations. The asset class is an essential and extensive type of investment.
Equities (stocks), fixed income (bonds), cash equivalents (money market), real estate, and commodities are examples of asset classes. Equities, fixed income, and cash equivalents are the three traditional asset classes. Real estate and commodities are alternative asset classes that are incredibly prevalent. Each asset class can be further subdivided.
Real Estate Property Types
Real estate asset classes are split up into four main property types:
- Residential
- Commercial Real Estate (CRE)
- Industrial
- Land
Each one of these property types can be further broken down. The purpose of this article is to focus on commercial real estate since that is what most investors are laser-focused on when they purchase a revenue-generating property.
Types of Commercial Real Estate
Commercial Real Estate (CRE) includes any property that generates income. The following is a breakdown of the various types of commercial real estate:
- Multifamily homes
- Retail buildings
- Office spaces
- Self-storage facilities
- Hotels
- Mobile home parks
- Special purpose buildings
What Is Self-Storage?
Real estate syndication is an asset structure that is often neglected. The reason behind this varies (lack of sufficient knowledge, limited access, high cost of entry, etc.).
As mentioned before, commercial real estate is made up of several property types. We’ll turn our focus to self-storage facilities, a fast-growing sector that has taken advantage of a growing market of people who need to store excess household items.
Self-storage facilities are commercial properties that rent space to tenants either on a monthly or long-term basis. Spaces vary in size (lockers. rooms, containers, outdoor space, etc.). From an investment perspective, even as self-storage experiences an upturn in pricing/demand, the market continues to grow/expand, and capitalization rates remain attractive.
Self-storage units are a small storage space that can be rented out to a person, company, etc. These units are usually split up into small spaces. There are also large storage units that are built with the exact company needs in view. Self-storage businesses offer space-strapped customers a secure place to store items they do not immediately need but cannot bring themselves to throw away. Investing in self-storage facilities is a lucrative business project for real estate investors looking to branch out their portfolio into multiple asset classes. The self-storage industry has achieved exponential growth over the last twenty-five years as demand for this sector has increased.
Self-Storage Sizes
Self-storage companies lease a variety of unit sizes to civilian/business customers. Each storage facility has a unique mixture of sizes to fit their customers’ needs. Popular unit sizes include:
- 5 ft. × 10 ft. (the size of a large walk-in closet)
- 10 ft. × 10 ft. (the size of a child’s bedroom)
- 10 ft. × 20 ft. (the size of a one-car garage)
- 15 ft. × 20 ft. (the size of a large master bedroom)
- 20 ft. × 20 ft. (the size of a two-car garage)
What Is Indoor Self-Storage?
Indoor storage units, offering additional protection against the weather, are generally located inside a single or multi-story building. These units and lockers provide customers with other benefits to keep their belongings dry, safe, and secure. Recommended items to store there include furniture, electronics/appliances, books, paintings, photos, documents, etc.
What Is Outdoor Self-Storage?
Outdoor storage units are essentially extra garage spaces. They make it possible for tenants to quickly load/unload their belongings. Although they are affected by weather/humidity, they offer the most convenience and accessibility to frequent visitors. Generally, they are the most affordable self-storage option. Recommended items to store there include tools, outdoor or seasonal furniture, sporting equipment, holiday decorations, etc.
Pros of Self-Storage Investing
Storage facilities have quite a few striking advantages for an investor. Below is a summary of the most interesting features.
Minimal Infrastructure
First and foremost, self-storage requires minimal infrastructure. In other words, storage units are much cheaper to construct than other building types.
Growing Demand
Self-storage facilities have become big business. One in ten U.S. families now rents one self-storage unit. There is a high demand for self-storage, and construction cannot keep up with demand. Therefore, occupancy rates are high, rents are increasing, and there is a possibility for expansion. The growing demand for self-storage in the U.S. is created by people moving and various lifestyle transitions, such as retirement, marriage, divorce, a death in the family, etc.
Lower Expense Ratio
Self-storage has fewer unexpected expenses. These more straightforward facilities have fewer things that can break, resulting in fewer occasional emergencies and lower maintenance costs.
Month-to-Month Rent
When someone rents a unit, they sign a rental agreement that expires monthly, not a long-term lease. If rents are increasing in the market, you can raise rents to capture that potential revenue.
Good Performance in Recessions
Self-storage is uniquely positioned in the market to flourish in both downturns and upturns in the economy. During an upturn, residential sale increases as homeowners move into new homes creating greater demand for temporary storage during the transition. During a downturn, self-storage typically becomes an urgent need since many families choose to downsize or rent.
Flexible Business Model
There are several quality levels for storage units. An investor can choose to focus on a specific one or offer various types and sizes according to market demand.
Tenant Rights
People store all kinds of goods, from furniture to vehicles to seasonal decorations. Hence, the owner of a self-storage facility is dealing with belongings and not people. A traditional landlord must obey local tenant regulations. Storage landlords do not. In fact, by law, the storage facility owner has a lien (the right to keep somebody’s property until a debt is paid) against all personal property stored in their space.
When tenants fail to pay their debt, the owner can sell, move, or dispose of a tenant’s property, and their items can be auctioned off. This legal protection leads to a lower risk environment for a self-storage landlord.
Cons of Self-Storage Investing
Below is a summary of the disadvantages of investing in self-storage:
Rental Rate Decrease
Just as the month-to-month nature of storage makes it possible for rental rates to increase, the opposite is also true. If market rents are declining, then a facility is likely to be influenced by the price shifts.
Market Positioning
Self-storage facilities must be located in areas with heavy car traffic where there is no competition. It is also essential to offer a suitable mix of units to meet the local community’s needs.
Management
Despite low maintenance and operating costs, self-storage owners sometimes face significant challenges in finding and recruiting good managers to run their business.
Tenant Demographic
Tenants in a normal self-storage facility can be temporary. They are often undergoing/experiencing some level of stress in their life. Sometimes these tenants have trouble paying their monthly rental fees. Hence, the manager should be aware of this phenomenon and accommodate the tenants as much as possible to keep the business running.
Month-to-Month Tenancy
The self-storage business model’s temporary nature causes constant moves in and out of the facility by tenants. This repetitive turnover requires active management to minimize vacancy rates.
Lower Net Operating Income
The overall net operating income (NOI) for self-storage is usually lower than for multifamily development. However, the income generated versus expenses incurred is much higher.
Are Self-Storage Units a Good Investment?
When one owns a self-storage unit, you have to keep in mind that it is a piece of real estate, which by nature, will have two components: capital growth and yield. The cost of owning one self-storage unit is low, making the return on investment (ROI) high. Even though the initial advertised price for buying a storage unit is low, you need to hire a consultant capable of understanding supply/demand for the area in order to do it properly.
When the economy is doing well and disposable income is increasing, people buy more stuff. So, they need a place to store it. When the economy is in deep recession and homeowners are unable to pay their mortgages, losing their homes, downsizing their apartments, etc., they have no choice but to place their belongings in self-storage units.
Therefore, without doing any further analysis, it is clear that self-storage is the best real-estate deal one can enter into. With lower operating costs, fewer headaches, and alternative financing options, there is little doubt demand for self-storage investment will persist.
One should ponder the fact that unlike residential properties, investment doesn’t have significant capital growth; therefore, one needs to be confident of a low vacancy rate to make this a profitable deal.
Conclusion
Syndication is an unbelievably effective method to raise large amounts of capital. Real estate syndication occurs when you commit your limited investment and agree to terms and conditions set by the project manager.
Real estate syndication deals include self-storage, multifamily properties, manufactured home parks, land development, hotels, student housing, warehouses, etc. Some real estate syndications focus on ground-up construction, while others are buy-and-hold properties (i.e., buying an already-stabilized asset and holding on to it for a few years).
Each investment will always have its unique pros and cons; consequently, it is essential to understand the options available, the terminology, and the risks to find a deal that best fits your goals and investing style.
You should also be able to determine what the most critical aspect of the agreement that attracts you is. Does it outweigh the cons for you? If affirmative, then don’t delay taking action. You should also bear in mind that sound investment decision-making will develop as you gather ever more reliable data/advice. If you’re considering investing in real-estate syndication and want to get started, our support team would be more than happy to help.
