Do you dream of passively earning a salary’s worth of cash flow through real estate investing — but without the hassle that comes with managing one? Through real estate syndications, you can!
A real estate syndication is a great opportunity for multiple real estate investors to fund a large asset and achieve the benefits of owning commercial properties like hotels – but without the responsibilities of owning one.
This guide will teach you what a real estate syndication is, how it usually plays out, its benefits, drawbacks, challenges, and who it is for so you can sit back, relax, and truly make passive income.
- Real estate syndication: Group of investors pooling capital for larger commercial property purchases.
- Syndicate structure: Limited partners (LPs) and general partners (GPs) managing investments.
- Legal entities: Typically formed as Limited Liability Company (LLC) or Limited Partnership.
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What is Real Estate Syndication?
A real estate investment syndicate refers to a group of investors teaming up to pool capital toward purchasing a property. Typically, each individual investor would be unable to acquire such a large asset on their own.
Syndicates consist of limited partner (LP) investors led by general partners (GPs) who source deals, organize legal entities, and manage the investment. Understanding the difference between GP vs LP is key.
GPs demonstrate extensive real estate expertise and leadership experience to earn investors’ trust in forming a syndicated partnership, while LPs contribute capital in exchange for more passive ownership. These GP sponsors need to demonstrate extensive real estate expertise and leadership experience to earn investors’ trust in forming a syndicated partnership.
By bringing together professionals and funding under cooperative entities, real estate syndicates allow investors to benefit from owning substantial income-generating assets that would normally be out of reach.
Who is Real Estate Syndication For?
Real estate syndications are geared toward investors who want passive investments and don’t have all of the capital needed to buy commercial real estate like multifamily properties, trailer parks, self-storage, retail, and office spaces.
They are also for people who want the benefits of investing in a real estate property – equity, appreciation, tax breaks, and monthly rental income/cash flow – without having to deal with the responsibilities of successfully maintaining one.
If this sounds like you, consider joining SparkRental’s Passive Co-Invest Club. It’s a unique opportunity for investors like you to participate in carefully vetted real estate deals with minimal effort.
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Common Real Estate Syndications Structures
There are several types of real estate syndication structures, each with its own characteristics and benefits. Here are three of the most common types:
Equity Syndications – Equity syndications work by having investors pool their capital together to acquire ownership or profit share of a property and look for a sponsor to spearhead their investment.
They share in the property’s cash flow, appreciation, and profits from the eventual sale of the property.
Debt Syndication – Real estate debt syndication involves pooling funds from multiple investors to provide loans for a real estate project. Investors earn returns through interest and principal repayments from the borrower.
Debt syndications are used in large-scale commercial real estate deals due to their ability to leverage both equity and debt to access a larger pool of capital, spreading risk and potentially increasing returns on equity.
Preferred Equity Syndication – Preferred equity investors receive a fixed return on their investment before the common equity investors receive any profits.
They have a higher claim on the property’s cash flow and proceeds, similar to debt investors, but they also have some potential for upside beyond their fixed return.
Real Estate Crowdfunding – In real estate crowdfunding, an online platform is used for marketing investment opportunities to a large pool of investors. Investors collectively provide the funding for real estate assets through the crowdfunding portal rather than the sponsor raising funds independently.
Real estate crowdfunding makes syndicate investments more accessible to everyday investors by providing an easy-to-use online interface.
To form a syndication, all the participating investors must decide how to structure the company into a legal entity to establish profit distribution, voting rights, and sponsor fees – and protect both the sponsor and the Limited Partners.
Syndications are usually structured as a Limited Liability Company (LLC) or a Limited Partnership with the following three members involved:
- Syndicators – also known as sponsors or general partners, syndicators are either real estate developers or possess significant experience in operating and managing a property with a solid track record (like me)
A general partner is responsible for all aspects of the investment, whether it’s looking for real estate assets and securing financing for it, property management and renovations, and strategizing the next steps.
- Limited Partners – Also known as passive investors, limited partners provide the capital needed by a syndicator to purchase a property while playing a mostly passive role in the transaction, hence their name.
In return for their invested capital and sponsor fees, a passive investor can gain an ownership stake in the real estate asset and receive a small share of the profit based on the invested amount.
However, they are not interested in running the day-to-day operations of the property, so they delegate that task to a sponsor who has direct experience in running one.
How Real Estate Syndications Work
The process of investing in a real estate syndication can vary slightly from one sponsor’s structure to another, but here are the most common steps:
First, you will have to find a sponsor that you’re comfortable investing with.
This sponsor will either allow you to participate in their current and upcoming syndications or hop on a call with them to assess you and your investing goals – plus give you a chance to ask questions before moving forward with the syndication.
Next, you will choose which property syndication you would like to participate in.
Once you do this, you’ll enter what’s called a “due diligence” process wherein you will evaluate your investment opportunity by reviewing the Offering Memorandum, the property’s financial documents, the sponsor team’s background and track record, and anything else that will help you make a decision.
If everything passes with flying colors, you can now begin to move forward with your investment by signing the paperwork and transferring your capital to an escrow. Your funds will be held there until the deal closes.
You can fund your participation in various ways – whether via cash savings or self-directed IRA retirement accounts. Assess which approach aligns best with your financial situation during the due diligence process.
By the time the deal closes, you will have an ownership stake in the investment property and become “co-owners” alongside other limited partners.
At this time, you should also hear from the sponsor team and receive guidance on the next steps as well as what to expect during the duration of your investment.
Additionally, you may also engage with the sponsor in the following ways:
- Attend investor meetings and receive business plan progress alongside other members.
- Monthly updates on occupancy rates, property performance, and financial reports.
Qualifications to Become a Limited Partner
Real estate syndications are governed by the Securities Exchange Commission (SEC). Many real estate syndications are open to accredited investors only.
An accredited investor is an individual or entity that meets the criteria imposed by the SEC, allowing them to participate in riskier or more complex investment types without the same level of regulatory protection as non-accredited investors.
There are multiple ways to qualify as an accredited investor with the most common based on net worth or income.
To qualify via your net worth, you must either have:
- Over $1,000,000 in net worth, excluding your primary residence
- An annual income of $200,000 or more ($300,000 or more if combined with your spouse) for the last two years
If you do not meet either one of those qualifications, you are considered a non-accredited investor. However, you still have a chance to join real estate syndications since the definition of accredited investors can also apply to corporate entities.
- Through Rule 506(b) offerings, which allow non-accredited investor participation with certain restrictions.
- Through Regulation Crowdfunding (Reg CF) offerings, which permit non-accredited investors up to certain individual investment limits.
In contrast, Rule 506(c) offerings only allow verified accredited investors to participate but enable the offering to be openly advertised.
Rule 506 (b)
Thanks to Rule 506 (b), non-accredited investors are also allowed to invest in real estate syndications, although there are strict investment restrictions to filter those who are allowed to participate.
In 506 (b), the sponsor for the syndication will be referred to as an “Issuer”. When raising funds from a non-accredited investor, the issuer must follow strict guidelines:
- While they can receive investments from an unlimited number of accredited investors, they can only allow up to 35 non-accredited investors to participate in the deal.
- Participating non-accredited investors must be “sophisticated investors”, meaning they are required to have sufficient knowledge and experience in financial and business aspects of the investment transaction.
- The issuer must provide non-accredited investors with disclosure documents, which contain the registered offering and financial statement information.
- Should any non-accredited investor have any questions, the issuer must also be available to answer them.
Note: While Rule 506 (b) allows non-accredited investors to participate in real estate syndicates, these deals cannot be publicly advertised or solicited and are only known by investor networks. Plus, they must wait for a deal to become available.
Additionally, they can also invest in Regulation Crowdfunding (Reg CF) Offerings. However, the amount you can invest might be limited by your income and/or net worth.
Rule 506 (c)
Thanks to the Jumpstart Our Business Startups Act (Jobs Act) of 2012, Rule 506 (c) permitted issuers to actively solicit and advertise syndications and still be considered compliant with the exemption’s requirements as long as
- All purchasers are considered to be accredited investors.
- The issuer verifies the prospective investors’ Accredited Investor Status
- The issuer reviews their documentation, such as W-2s, tax returns, bank and brokerage statements, and credit reports.
506 (b) vs. 506 (c)
While both sub-regulations allow smaller companies to attract investors with minimal SEC regulations, they have a distinct difference.
Rule 506 (b) allows non-accredited investors to participate in syndications, while Rule 506 (c) makes it easier for them to look and invest in one.
Benefits of Real Estate Syndication
Benefits of Real Estate Syndication
In order to make a well-rounded decision if a real estate syndication investment strategy is for you, it is important to understand the benefits and drawbacks and then compare them to your needs. Key benefits of real estate syndication for investors include:
The biggest benefit of real estate syndications for limited partners is the opportunity to make a return on investment — without the work. Instead of shouldering the capital and managing the property on their own, investors can participate in syndications and buy the same property and let someone do the work for them instead — for a fraction of the price.
Real estate syndications also provide tax advantages since you are essentially purchasing shares of an LLC, which owns the real estate asset.
- Pass-Through Taxation – With a syndicated investment held in an LLC or LP structure, the entity itself does not pay taxes. Instead, any tax liability “passes through” the entity to be paid by the individual investors. This allows investors to account for property income, expenses, deductions, and losses on their personal tax returns.
- Depreciation – Commercial real estate held by a syndicate can be depreciated for tax purposes over a 39-year schedule. This depreciation deduction is also passed through to investors to use as non-cash tax deductions each year they own a portion of the property. This reduces investors’ taxable rental income from the property.
A strategy I’ve used here is cost segregation and bonus depreciation to maximize deductions.
- Tax-Deferred Exchanges – Known as 1031 exchanges, this allows the proceeds from selling a property to be reinvested into another property while deferring capital gains taxes. Investors can benefit from sponsors utilizing 1031 exchanges opportunistically within the syndicated portfolio over time.
- Lower Tax Rates – The tax rates on real estate income are generally more favorable compared to ordinary income or short-term capital gains. By investing passively in commercial real estate syndicates, investors can realize these tax advantages.
One of the biggest risks in real estate investing is not diversifying your investment. Meaning, one bad deal can wipe your entire portfolio.
Luckily, real estate syndications can mitigate this risk. With many syndications only requiring investors to front a minimum investment as low as $5,000, investors are able to spread the risk of their real estate portfolio. It’s a way to invest in real estate with a little money versus a large capital investment.
Since investors are participating through an LLC, they avoid the brunt of the risk that the sponsor will assume when going through a real estate deal.
While real estate syndications offer so many benefits, unfortunately, it’s not for everyone.
In order for you to make an unbiased decision, here are the drawbacks of participating in a real estate syndication:
Sponsors can profit even if partners don’t
Sponsors can still profit from a bad deal even if investors do not since they will charge a sponsor fee, acquisition fee, and property management fee.
However, this risk can be brought down to a minimum if you conduct due diligence on the opportunity and the sponsor.
Investors lose control
Since the sponsor is effectively steering the wheel with the investor riding in the passenger seat, investors gain the ability to generate passive income and take on less liability at the cost of relinquishing control to the sponsor over their investment property.
Like most real estate investments, real estate syndication investment portfolios are illiquid. Meaning, it’ll take a lot of time and money before any members see returns on their investment.
Is Real Estate Syndication For You?
While real estate syndications offer so many benefits in exchange for minimal risks, it’s not for everyone.
Why? If you do not tolerate risk well, want to have full control over your investment, or are uncomfortable with the idea of investing alongside tens and even hundreds of other investors, participating in real estate syndication deals might not be for you.
If you are, great!
However, before blindly jumping into investment opportunities and participating in a real estate syndication offering, you should first reflect on your own investing goals.
Are you in it for the tax benefits, the potential returns, or both? After assessing, paying a visit to an experienced real estate attorney would help clear out any other questions you’ll have.
Real estate syndications can tie up your capital for a long time in exchange for attractive returns.
My advice as a sponsor? Vet your sponsor team before jumping into one and looking at their offerings – since you’re essentially taking a risk, it’s a no-brainer that everyone wants someone who knows what they’re doing.
You would want to make sure your sponsor team has a stellar track record of success and has plenty of experience in acquiring and managing a property.
Once you’re comfortable with the risk and the idea of passively earning with other investors, real estate syndications are a GREAT way to grow your investment portfolio.
Real Estate Syndication: FAQs
What is an example of syndication in real estate?
Here is a good real estate syndication example. Imagine you are a passive investor investing $100k in a commercial real estate syndication deal with a 10% return.
You could take home $5k each year once the property earns enough money to make payouts possible.
After each investor gets paid, the remaining money is distributed between the investors and the sponsor based on the agreed profit share structure.
Let’s say that there is $1,000,000 remaining. If the structure is based on an 80/20 split, the investors will take home $800,000 while the sponsor will get $200,000.
Who owns the property in a syndication?
In a real estate syndication deal, the property is owned by a legal entity (typically a company) specifically created for the deal. The company is either a Limited Liability Company (LLC) or a Limited Partnership (LP).
While the company owns the property, investors own the legal entity– therefore own a share of the property.
How do real estate syndications differ from REITs?
While real estate syndications and Real Estate Investment Trusts (REITs) are both investment vehicles, they have differing characteristics such as:
- Property Possession: Real estate syndications involve direct ownership of a property, while REITs allow investors to possess shares in a portfolio of properties.
- Property Management: Certain investors in real estate syndications have more active participation in property management, while it is handled by a specific REIT company in REITs.
- Liquidity: Real estate syndication investment portfolios are illiquid, while REIT shares can be bought and sold on a public exchange.
- Regulations: Real estate syndications are subject to securities laws and typically require a private placement memorandum, while REITs are regulated by the SEC and must file periodic reports.