Most new investors usually begin their real estate investment journey with familiar forms of residential real estate, like flipping houses, Airbnb rentals, or traditional leasing. But, seasoned investors understand that the biggest profits often come from commercial real estate (CRE) – properties like office towers, warehouses, and large apartment communities. The only catch? Getting into commercial real estate requires a lot of capital.
This is where CRE syndication comes in. In syndication, a sponsor raises money from multiple investors to purchase large commercial properties. The sponsor manages the operations, while the investors enjoy passive returns from the property’s income. Thanks to the growth of syndication, even average individuals can now invest in CRE, a sector previously dominated by large institutions and wealthy investors.
This guide breaks down how syndication works. I’ll provide tips for evaluating deals and sponsors, and equip you with best practices to thrive as a sponsor or passive investor.
Whether you want to test CRE or go all in, this guide will help you develop the skills to profit from syndication.
CRE syndication allows investors to pool resources to buy large properties like office towers and warehouses.
CRE Syndication involves a General Partner managing the investment and Limited Partners providing capital. It includes stages of origination (finding and funding properties), operation (managing the property), and liquidation (selling for returns). It’s regulated by the SEC for investor protection.
Syndicates, usually formed as LPs or LLCs, require clear agreements on capital contributions, profit distribution, and exit strategies. Financing combines debt (from lenders like banks) and equity (from GPs and LPs), with mezzanine financing as a hybrid option.
Investors can find syndication opportunities through online clubs, crowdfunding, networking events, and referrals.
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What are Commercial Real Estate Properties
First, let’s identify what properties are considered commercial real estate. CRE properties are buildings or land intended to generate a profit, either from capital gain or rental income. They are typically used for business purposes rather than residential living needs.
Multifamily properties, such as apartments and townhomes, are considered commercial real estate investments when they have more than four units. Other types of CRE are:
Office buildings, ranging from downtown skyscrapers to suburban office parks.
Industrial properties that provide expansive spaces for manufacturing and storage purposes.
Retail spaces, from shopping centers to restaurants, that host consumer-facing businesses.
Hospitality venues such as hotels, resorts, and entertainment complexes that provide short-term lodging.
Apart from buildings, vacant land reserved for potential investment or future development is also considered a part of the CRE asset class. Additionally, custom-built structures for specific uses, such as amusement parks, data centers, or laboratory spaces, also fall within the CRE category.
While diverse in nature, all commercial properties share the core goal of generating income through rents or sales. Each type has its unique operational aspects, risks, returns, and tenant types, influencing its value and income potential.
What is CRE Syndication
CRE Syndication is a process where multiple investors pool their resources together to purchase a commercial property. This method allows individuals to invest in properties or projects that would be too expensive for them to afford on their own.
The syndication process typically involves a General Partner (GP), also known as a sponsor, who is responsible for identifying the asset or opportunity, negotiating a purchase, arranging financing, raising equity, and managing the real estate investment on behalf of the Limited Partners (LP) or passive investors.
Real estate syndication usually occurs in three phases: origination, operation, and liquidation.
In the origination stage, the sponsor looks for a good property to invest in, negotiates the purchase, and gathers the needed funds.
During the operation stage, the sponsor manages the property to make money, usually through rent and the property increasing in value.
Finally, in the liquidation stage, the property is sold, hopefully at a profit, and the money made from the sale is shared among the investors.
It’s also important to note that syndications are governed by the Securities and Exchange Commission (SEC), ensuring that each offer is documented and reported to protect the investors.
Choosing a Role: General Partner vs Limited Partner
When participating in real estate syndication investments, you have to decide if you’ll be taking on the role of the GP or if you’ll be one of the investors or LP. The better fit depends largely on your risk tolerance, desired involvement level, and investment objectives. There are differences in responsibilities, liability, control, and financial benefits, which we’ll unpack here.
As a GP, you are the active lead sponsor in the syndication. In this role you’ll source assets, structure deals, oversee property management, and make executive decisions. Key responsibilities include:
Locating investment opportunities and analyzing deals
Performing due diligence on the asset
Securing financing and closing on the purchase
Overseeing construction, leasing, marketing, etc.
GPs assume significantly more risk and liability in exchange for greater control and higher earning potential. This comes from sponsor fees like acquisition fees, asset management fees, and backend profit shares upon sale.
As an LP, you act as a passive investor simply contributing equity capital to participate in the deal. Your responsibilities are minimal. Beyond your initial capital commitments, LP investors are generally hands-off, earning attractive targeted returns from the asset’s cash flow and back-end profit distributions, proportional to their individual shares, without the need for active management.
The LP role limits your risk exposure to the amount of capital you’ve invested and eliminates personal liability. However, it means ceding control over decision-making to the GP. Therefore, careful vetting of sponsors is crucial to minimize risk. While the role is more passive, LPs benefit from predictable cash flow and wealth growth by leveraging proven real estate strategies, without needing extensive real estate expertise.
Which Role Is Right For You?
As mentioned above, your choice depends on your risk tolerance and goals. If you’re inclined towards an active role and have real estate knowledge, embracing the responsibilities and potential for greater rewards as a GP might be suitable for you. But, if you prefer a more hands-off approach and are comfortable with less control in exchange for simplicity and liability protection, then opting to be an LP could be the right choice for you.
Setting Up a Real Estate Syndication
When a group decides to invest together in real estate, the first important steps are to set up the legal structure of the group and agree on the rules for working together. These elements ensure that all parties have a clear understanding of their rights, responsibilities, and expectations throughout the investment lifecycle.
Choosing a Business Structure
First, the syndicate must legally register as a specific business entity. Most real estate syndications are organized as either a Limited Partnership (LP) or a Limited Liability Company (LLC). Both structures allow pass-through taxation while limiting personal liability. However, LPs more easily accommodate adding passive investors at scale. An experienced real estate lawyer can recommend the optimal structure.
Sometimes, syndication deals involve a joint venture arrangement where the sponsor partners strategically with a third party. This joint venture partner may assist in raising capital, handling tax reporting, or other responsibilities according to their area of expertise.
Crafting the Syndication Agreement
Once legally formed, the syndicate creates an Offering Memorandum outlining the investment strategy, rights, and expectations around the deal. While specifics vary, most agreements address these key areas:
Capital Contributions: Details the amount of money each investor needs to contribute and the timeline for these contributions.
Distribution Schedule: Describes how and when distributions (like rental income or proceeds from a sale) will be made to investors.
Communications Protocol: This includes how often meetings are held, reporting schedules, and how information is shared between the GPs and LPs. This ensures operational transparency.
Voting Rights and Decision Making: This part details how investors can vote on important decisions about the property. It includes how much notice is needed for decisions, what counts as a majority, and other voting procedures.
Profit and Loss Distribution: Defines capital account balances for partners and stipulates precisely how net proceeds, profits, and losses will get allocated among the ownership group based on relative equity shares.
Exit Strategy: Defines the conditions and processes for selling the property, including timelines and decision-making procedures.
Setting up the rules early on makes handling the investment easier later. If you have a good system and clear rules, a real estate syndicate can work efficiently towards its investment goals.
Financing Commercial Real Estate Syndication Deals
In real estate investing, syndications often combine debt and equity to fund the purchase of large commercial properties. It’s essential to strategically structure these elements to successfully secure the deal, enhance returns, and mitigate risks.
In debt financing, most syndicates will fund 20%-35% of the purchase price via an upfront capital contribution from the sponsor and limited partner investors. The remaining 65%-80% gets covered by medium to long-term debt financing from institutional lenders.
Typical lending sources include commercial banks, credit unions, insurance companies, pension funds, private money lenders, and hard money loans. Interest rates, terms, amortization schedules, prepayment penalties and recourse vs non-recourse nature varies widely across loan type and asset category.
For purchases of stabilized, income-producing properties that already have tenants paying reliable rental rates, lenders are willing to offer higher loan-to-value ratios (LTVs) up to 80% of the purchase price.
However, for value-add deals involving older, dysfunctional buildings requiring major upgrades and repairs, lenders perceive greater risks. So they only provide 65% to 75% LTVs on the acquisition cost. This means the syndicate must invest in significant improvements to justify the purchase price by increasing the property’s rental income and value over a period of 1-3 years.
This is where the GP and LPs pool their equity to cover the down payment for the property, which isn’t covered by loans. This equity also helps fund renovations, operating reserves, and other expenses like closing costs and fees.
Typically, syndications target an average 20% preferred return for limited partners, which comes from the profits made by the property.
The GP usually puts in about 5% to 20% of the total equity needed, with the rest coming from limited investors. These investors commit their funds through initial contributions and additional cash calls as needed, as outlined in the operating agreement.
Mezzanine financing is a hybrid form of financing that combines elements of both debt and equity financing.
Mezzanine financing is typically structured as a loan that can be converted into equity if the loan is not repaid in time. This gives the lender the potential upside of equity ownership if the borrower defaults on the loan. On the other hand, if the borrower is able to repay the loan, the lender receives interest payments and the return of the principal.
Sourcing CRE Syndication Deals
Potential investors hoping to diversify into commercial real estate can earn attractive returns through syndication deals. But for novice investors, finding profitable deals led by skilled sponsor-operators is challenging, given the exclusive nature of the syndication space.
So how can individuals with capital effectively find and assess good syndication investment opportunities?
One approach rapidly gaining traction is membership in online CRE co-investing clubs. A club worth checking out is SparkRental. Top-tier sponsors with solid track records source and operate each deal, while members participate as silent LPs. These platforms enable members to diversify across CRE syndicates with lower buy-ins, typically between $5,000 and $10,000, and provide ongoing reporting and education to support commercial real estate evaluation.
Crowdfunding has emerged as another viable option for sourcing CRE syndication deals. Platforms dedicated to real estate crowdfunding allow individual investors to pool their resources and invest in larger commercial projects.
Another way to look for CRE syndication deals is by attending networking events and real estate meetups in your area. You can rub elbows with experienced commercial real estate investors and syndicators who are gathering funds for local projects.
Also, tap into the power of referrals. Chatting with lawyers, accountants, brokers, and other real estate pros can open doors to CRE sponsors in need of limited partners for their next big project.
Real estate syndication presents a strategic approach to real estate investments, striking a balance between market risks and the benefits of collective ownership, leverage, and professional management. This structure maximizes the potential for significant gains while protecting individual investors from excessive market exposure.
It opens the door for a broader range of investors to wisely engage in the lucrative commercial real estate market, historically reserved for the ultra-wealthy. For many, blending these high-yield CRE returns with conventional market investments could be an effective strategy to achieve their portfolio goals.
CRE Syndication FAQs
How Do Investors Decide Which Real Estate Syndication To Get Involved In?
Investors typically decide which real estate syndication deal to get involved in by considering factors like the track record and reputation of the syndicator, the potential returns and risk profile of the project, the location and type of property, and their own investment goals and timeline. They also often conduct thorough due diligence, reviewing financial projections and legal documents, before making a decision.
Who can invest in CRE syndication?
Generally, accredited investors, who meet an annual income of $200,000 (or $300,000 together with a spouse) for the last two years or with $1 million net worth criteria, can invest in CRE syndication. Some syndications may also be open to sophisticated investors with sufficient knowledge and experience in financial and business matters.
What are the risks of CRE syndication?
Market risk is a primary concern, as fluctuations in the real estate market can impact property values and rental incomes. This volatility directly affects the investment’s profitability. Liquidity risk is another factor; CRE investments are typically long-term and not easily liquidated, making it challenging for investors to quickly access their funds.
Additionally, the use of leverage or borrowed funds can magnify losses if the investment underperforms. Investors must also be mindful of regulatory risks, such as changes in zoning or tax laws, and project-specific risks like construction delays or unexpected maintenance issues.