Property syndications or real estate syndications aren’t exactly a common concept, even for seasoned real estate investors. Or for those who do come across it, the idea might seem too complicated, too many people involved or just too much of a hassle. Well, it’s a common initial reaction.
As a seasoned real estate investor myself, I get it. Despite my extensive experience in the industry, it took me 20 years to structure my first syndication. At first, it seemed like a big, complicated leap from what I was used to. But when I really got into it, I realized that syndications could open doors to new kinds of real estate investing opportunities.
The leap from traditional real estate investments to real estate syndication isn’t a small one – it’s like learning a new language in the world of real estate investments. But once you get the hang of it, you might see how syndications can actually make some parts of real estate investing easier – especially as a passive investor.
If you’re new to property syndications, or if the thought of it leaves you with more questions than answers, this blog post is here to help. I’ll cover what it is, who can invest, the potential returns and risks, and how you can start your investing right away.
Property syndications allow groups of investors to acquire large real estate assets jointly. A sponsor structures the deal and manages the asset on behalf of limited passive investors.
Returns come from rental income, property appreciation when sold, and value-add improvements. Partners split profits and losses according to agreed-upon terms.
Risks include market shifts, illiquidity, management issues, and leverage exposure. Perform thorough due diligence before investing in any syndicated opportunity.
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What is Property Syndication?
Property syndication is a method where multiple investors pool their resources to jointly invest in a big real estate property, like commercial real estate.
The process typically involves a sponsor who is responsible for organizing the deal and purchasing a property on behalf of a larger group of passive investors. The syndicate becomes the property owner and divides any profits or losses among its members.
Who Are the Parties Involved in a Property Syndication?
Sponsor, GP, LP – what do these terms mean? Let’s break it down and understand who the key players are in this investment strategy.
The General Partner or GP (also known as sponsor or syndicator) is usually the heavy lifter in this arrangement. They’re typically individuals or a company specializing in real estate syndication.
Their role? It’s multifaceted. They identify and secure the investment property, conduct due diligence, raise capital from passive investors, structure the terms of the deal, and manage the asset.
Sounds like a lot, right? Well, being a sponsor has a lot of perks that make the workload worthwhile. Typically, the sponsor will only contribute around 5-20% of the total equity needed for the deal, with their investors making up the rest. They usually have control over the investment and, naturally, reap the most rewards. The overall sponsor fee includes acquisition fees, asset management fees, refinancing fees, and most lucratively – a share of profits upon the eventual sale, which can exceed 20% of total investor gains.
But with the high reward comes high risk and responsibility for the GP. GPs are often personally liable for the debts of the syndication, meaning if things go awry, they’re the first in line.
Then there are the Limited Partners, or LPs, or the investors. Think of them as the financial backbone of the syndication. They provide the necessary capital for purchasing and improving the property.
Their role is more hands-off or ‘passive.’ This passivity comes with a perk—limited liability, which means that their risk is limited at the amount they invest. If the syndication incurs debts beyond their investment, their personal assets remain untouched.
Other Key Players
Beyond GPs and LPs, real estate syndications often involve other key participants. Many sponsors work with an outside property management company that handles the day-to-day management of the syndicated real estate asset. They deal with things like screening tenants, handling maintenance, etc. This allows the sponsor group to focus on higher-level strategic oversight.
Other parties can include lenders who provide financing, brokers who help close deals, attorneys who handle legal paperwork, accountants who handle tax filings, and consultants who provide specialized advice. While these roles are important, the core of a real estate syndication revolves around the dynamic between GPs and LPs.
Who Can Be a Property Syndication Sponsor?
When it comes to sponsoring a syndication deal, you might be surprised to learn that there are no exclusive clubs or specific legal certifications required. People from all sorts of backgrounds, like lawyers, doctors, or entrepreneurs, can become sponsors in real estate syndications.
But here’s the catch: while the entry barriers might seem low, the real challenge is in the skills and knowledge you bring to the table. The success of a real estate syndication often depends a lot on how skilled and experienced the sponsor is. Investors looking to put their money into these deals will definitely want to see that you’ve got a good track record, especially in dealing with the kind of property you’re pitching.
Your reputation, experience, and ability to successfully manage real estate projects will play a big role in attracting investors, especially the more experienced ones.
How to Structure a Property Syndication
When structured thoughtfully, syndications can be hugely profitable for both general partners and their limited partner investors. But not all syndication structures are created equal. The way you set it up – like the legal structure, who’s investing, the fees, and how you split the profits – can make a big difference.
Here’s what you need to think about:
Choose a Legal Entity: The most common entities are Limited Partnership (LP) and Limited Liability Company (LLC). LPs are great if you want a clear line between the sponsors and the investors, with the sponsors having more control and the investors enjoying limited liability. LLCs, on the other hand, offer all members limited liability and provide more flexibility in terms of management and profit distribution.
Pick Your Investors: Determine if you will accept accredited investors only or also include sophisticated but non-accredited investors. This choice affects the legal stuff you have to deal with.
Establish Reasonable Fees: Fees should fairly compensate general partners for their time while avoiding misalignment with investors.
Create a Balanced Split Structure: Straight equity splits, preferred returns to investors, or tiered distribution waterfalls are common. Focus more on shared upside versus excessive general partner guarantees.
Consider Syndication Software: With multiple limited partners across an illiquid, long-term investment, using real estate syndication software can systematize communications, track investor details, collect funds securely, and report on performance. Streamlining back-office tasks allows sponsors to focus on driving returns.
In the end, it’s all about creating a deal that’s fair and transparent. You want everyone involved to trust each other and feel like they’re getting a good deal. Keep it clear, keep it fair, and you’ll set up your syndication for success.
Who is eligible to invest in a property syndication
The laws about who can invest in private real estate syndications have changed over time.
Let’s start with a bit of history. After the stock market crash in 1929, the U.S. government stepped in with the Securities Act of 1933. Their main goal is to make investing safer by requiring companies to share important financial details.
Then, in 2012, a new bipartisan law called the JOBS Act was passed. Before this law, only people worth over $5 million could invest in these types of businesses. The JOBS Act expanded investment opportunities to more people. Now, “accredited investors” who meet certain income or net worth levels can invest in private real estate syndications. A smaller number of “non-accredited” but still sophisticated investors can also participate.
So today, there are two types of investors who can invest:
Accredited Investor: This is someone with a net worth of at least $1,000,000 (not including their primary home) or has earned $200k ($300k for couples) a year for the past two years.
Non-Accredited Sophisticated Investor: This type of investor may not meet the net worth or income qualifications of an accredited investor but has a certain level of investment knowledge and experience. They are considered “sophisticated” because they understand the risks involved in investing.
How to Invest in Real Estate Syndication Deals
Investing in syndications requires more attention and thoroughness compared to purchasing individual rental properties or investing in real estate investment trusts (REITs).
Here are the steps to consider when looking into a syndicated real estate deal:
Research and Due Diligence: Start by digging into potential syndication deals. Focus on the reputation and past performance of the sponsor. Dig into their background, evaluate past project track records, and understand their area of expertise.
Understand the Setup: Get familiar with the syndication’s structure, whether it’s LLC or LP. This tells you what your rights and duties will be as an investor.
Look at the Numbers: Go over the financial plans and projections for the property. This includes looking at expected income, costs, and the strategy for making money.
Evaluate the Market: Look into the area where the property is located. Things like economic growth, job rates, and local real estate trends are important.
Know the Deal Terms: Understand details like the minimum amount you need to invest, how long they plan to keep the property, when and how you’ll get any profits, and their plan for selling the property down the line.
Review Legal Documents: Go through all the legal paperwork, like the Private Placement Memorandum (PPM) or Offering Memorandum (OM), Subscription Agreement, and Operating Agreement. These documents spell out the real estate syndication investment terms, risks, and your rights.
Stay Informed: Keep up with how your investment is doing. The sponsor should send regular updates, and you’ll get annual tax documents for your records. It’s also helpful if the sponsor uses an investor portal where you can see information and updates in one place.
Keep in mind that real estate syndications are typically long-term investments and aren’t as quick to sell as stocks or bonds. It’s also smart to diversify your real estate portfolio to lower your risk.
Property Syndication Profits
Property syndications can lead to significant profits, but it’s important to understand how these profits are generated and distributed.
Sources of Profit
Property syndications make money in a few ways. First, rental income. Real estate syndicates typically buy properties to rent out. Investors earn rental cash flow based on occupancy rates and rental prices.
Second, appreciation. Over time, the property itself gains value. When the syndicate eventually sells the asset, investors profit from the increased market value.
Third, value-add opportunities. Many syndicates buy properties with room for improvement. Upgrades to the physical buildings or better management can boost property value. This growth translates to higher returns for syndicate investors when the asset sells.
The distribution of profits in real estate syndication depends on the structure of the deal. This distribution is often outlined in the real estate syndication agreement and can take various forms:
Preferred Returns: Investors may receive a preferred return, which is a predetermined percentage paid out before the sponsors receive their share.
Profit Splits: After preferred returns, profits are typically split between sponsors and investors. The split ratio can vary widely depending on the agreement.
Waterfall Structures: Some syndications use a tiered structure where the profit split changes once certain return benchmarks are reached.
Factors Influencing Profits
A few key things influence how much money syndications make.
First, the overall real estate market matters a lot. The economy, interest rates, and local area conditions impact property values and rents. When the market is strong, syndications tend to do better.
Second, good property management can make a big difference. Good management can lead to higher profitability by ensuring efficient operations, keeping the property fully occupied, and setting rental prices appropriately.
Finally, the specific terms of the syndication deal itself, such as the length of the investment, any fees involved, and how profits are split among investors, also have a direct impact on the returns that individual investors can expect.
Where to Find Real Estate Syndication Deals
Now, let’s look at some ways on how to find real estate syndication deals:
Real Estate Crowdfunding Platforms: These crowdfunding websites do some of the legwork for you by pre-vetting deals. They offer a variety of syndication opportunities that you can browse and invest in.
Online Investment Platforms: These online platforms provide a convenient and accessible way for investors to explore and participate in real estate deals from anywhere.
Networking: Get to know other investors. Attend real estate conferences and join local real estate investment groups.
Social Media and Online Forums: Dive into real estate-focused social media groups and forums like BiggerPockets. These online communities can be rich sources of information and leads on syndication deals.
Direct Contact with Sponsors: Reach out to experienced syndicators or sponsors directly. This can give you access to their upcoming deals. Just make sure to do your homework on their track record and reputation.
Real Estate Investment Club: Online real estate investment clubs, like SparkRental’s Co-Investing Club, offer a modern approach to investing in real estate syndications. In this club, members pool funds between $5,000 to $10,000 to invest in a variety of pre-vetted real estate assets, including multifamily units, self-storage, and mobile home parks.
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SparkRental sources and analyzes these deals each month. The club also fosters a supportive community through monthly video calls, where members can review upcoming investments, ask questions, and find accountability partners.
Understanding Property Syndication Returns and Risks
The most lucrative syndication deals balance high potential returns with risks that are clearly communicated and carefully managed.
Key metrics for measuring returns
Cash on Cash Return: Cash on Cash return measures the cash income earned on the cash invested in a property. It is calculated by dividing the annual pre-tax cash flow by the total cash invested.
Internal Rate of Return (IRR): IRR is a comprehensive measure that takes into account the time value of money by calculating the annualized effective compounded return rate that can be earned on the invested capital.
Equity Multiple: This is a simple measure that shows how much an investor will get back from an investment. It is calculated by dividing the total distributions received from an investment by the total equity invested.
Capitalization Rate (Cap Rate): Often used to estimate the investor’s potential return on an investment, the cap rate is the ratio of a property’s net operating income (NOI) to its property asset value.
Understanding the Risks
One significant risk is market risk, where fluctuations in the real estate market can affect property values and rental incomes.
Another important consideration is liquidity risk. Real estate is inherently not a liquid asset, meaning that converting your investment into cash quickly could result in substantial losses.
Management risk also plays a vital role, as poor management of the property can lead to decreased returns, irrespective of the property’s inherent potential.
Lastly, there’s leverage risk to consider. While using borrowed capital can increase returns, it also raises the stakes, potentially leading to significant losses if not managed carefully.
Property syndications let everyday investors team up to buy bigger properties. In this article, we covered the basics – the potential rewards of syndications as well as the risks. We looked at how to structure a fair deal, assess the numbers, find opportunities, and more.
But of course, this just scratches the surface when diving into your first syndicated deal. Before joining any syndicate, you still need to dig deeper yourself. Perform your own due diligence, seek counsel from legal and tax advisors, and thoughtfully weigh if the projected returns justify the risks.
Property Syndications: FAQs
What are the common types of properties for syndication?
Common types of properties for real estate syndication include multifamily apartments, commercial real estate (like office buildings and retail centers), industrial properties (such as warehouses), self-storage units, mobile home parks, hospitality properties (hotels and resorts), senior living facilities, and student housing near universities. Each type offers different investment opportunities and risks.
Can you give an example of real estate syndication?
To give you an example, let’s imagine Joan, a busy professional with $75,000 to invest. She wants to earn from real estate but can’t manage the demands of being a landlord.
She opts to invest her money in a real estate syndication run by a group of professionals. Her investment, pooled with funds from 39 others, raises $3 million, used to buy a 50-unit apartment complex.
The sponsors manage the property while Joan and the other investors earn from rental profits and, eventually, the sale of the property. This way, Joan invests in a significant real estate asset without the usual responsibilities of a landlord.
What are the tax benefits of real estate syndication?
Real estate syndication offers several tax benefits. Real estate syndication allows for depreciation, which is a non-cash expense that can offset income and reduce tax liability.
Additionally, through a 1031 exchange, capital gains taxes can be deferred by reinvesting the sale proceeds from one property into another. Moreover, as many syndications are structured as pass-through entities, investors may qualify for pass-through tax deductions that can further reduce their tax burden.