Guide to Real Estate Syndication
This piece is for informational and educational purposes only. It is not intended to be investing advice and should not be used to form the basis of an investment decision.
According to Financial Samurai, over 300,000 investors participated in syndications in 2021. However, you may have never heard of a real estate syndication or considered how they work. Below, we answer some of the fundamental questions people might want to know about real estate syndications.
What is Real Estate Syndication?
A real estate syndication is an investment structure where a group of investors pool their capital together in order to purchase a real estate property. Such an arrangement has the potential to be favorable for certain real estate investors for a variety of reasons.
First, this structure enables investors to get access to deal flow that they might not otherwise be able to. Similarly, through syndication, investors can have greater flexibility in the types of real estate transactions that they can participate in, particularly when it comes to commercial real estate and other multi-million dollar ventures. Lastly, the actual “work” that investors have to do, outside of finding a trustworthy syndicator, is very limited. It is the job of the sponsor to deal with property management and day-to-day operations.
The two primary parties in a real estate syndication deal are the syndicator (or sponsor) and the passive investors. Depending on how the deal is structured, the terms for these can vary – in a limited partnership arrangement syndicators are referred to as general partners whereas investors are referred to as limited partners – but the basic roles are the same.
A syndicator can be thought of as the “active manager” in the deal, and has much more responsibility than the passive investors. These individuals will typically lay the groundwork by first finding the property and getting it under contract via negotiation with the sellers. Sponsors usually have many years of real estate experience and the necessary knowledge to perform due diligence on the acquisition.
Once the target is located, sponsors are also responsible for financing the deal by finding investors and determining how it will be structured. Besides time and effort, syndicators may also contribute a small amount of capital towards the initial purchase of between 5% to 20% for some deals. Sponsors will typically be paid an upfront acquisition fee at the start of the deal, which can be between 1%-3% of the purchase price.
When the groundwork has been laid and the deal is in place, the job of the sponsor is not done. That is because one of the primary responsibilities of the syndicator is to actually execute on the business plan. To manage the property, the sponsor may contract with a third-party property management company, or do the work themselves. Either way, the goal at this stage is to create revenue from the asset in order to generate passive income for the investors. Eventually the sponsor may sell the property, thereby providing potential appreciation for investors.
The role of the passive investor in a real estate syndication is far simpler than that of the sponsor. Essentially, these individuals provide the capital in exchange for ownership of a percentage of the asset. Although payments can vary depending on how the deal is structured, they will generally receive income from the asset on a quarterly or monthly basis, and potential appreciation when the property is sold.
One of the more challenging decisions for an investor in a syndication deal is to determine who to invest with. Afterall, the sponsor of the deal will ultimately determine the outcome of the investment depending on their ability to execute on the business plan.
Joint Venture/Equity Partner
Sometimes a Joint Venture/Equity partner is also involved in the deal. This party is responsible for serving as a conduit between the sponsor and investors in the deal. It is important that the JV partner has easy access to the investors in order to facilitate things like reporting, investor communications, and taxes.
What is the Preferred Return?
Before the sponsor participates in the profit, investors must typically receive the preferred return. The amount of the preferred return can vary depending on what has been decided upon in the operating/partnership agreement, but could be anywhere from 5-10% of initial capital outlay. Once the preferred return has been paid, future profits are split according to the agreed upon structure.
The LLC operating agreement or LP partnership agreement will typically include rights to distributions, voting rights, and Sponsor’s rights to fees.
Criteria for Investing To be eligible to participate as an investor in a real estate syndication, you must be an accredited investor. This includes anyone with earned income greater than $200,000 (or $300,000 with a spouse) in each of the prior two years and expectations of the same for the current year. Also included in the definition is anyone with a net worth greater than $1 million, excluding the value of the primary residence.