What is real estate syndication? Have you heard of it? If not, let’s take a look.
The Merriam Webster Dictionary defines a syndicate as a group of persons who combine to carry out a particular transaction or project. And when it comes to real estate syndication, people come together to acquire, operate, and eventually dispose of investment properties for profit.
So who are these people and how does this all work?
The Sponsor or Syndicator
There are a lot of components that go into profitable real estate syndication. Two of the biggest are capital and expertise. You have to have the money to buy a property and you have to know which properties to buy and which ones to stay away from.
Once you’ve acquired a property, you also have to know how to manage it to extract cash flow and force appreciation. That’s where the sponsor or syndicator comes in. Ideally, the sponsor is a company composed of industry experts with years of commercial real estate asset management experience and a track record of success.
With that said, some syndicators are better than others. So due diligence prior to investing is of utmost importance. Once you’ve found an impeccable syndicator that aligns with your investment goals and risk tolerance, what can you expect them to bring to the table?
During The Acquisition Phase:
- Market Analysis
- Submarket Analysis
- Property Screening
- Property Underwriting and Financial Analysis
- Rent Survey
- Rent Roll Confirmation
- Letter of Intent Drafting
- Purchase and Sale Agreement Negotiations
- Physical Condition and Deferred Maintenance Verification
- Environmental Review
- Arrange for Legal
- Organize Property Management
- Organize Lending
- Create Business Plan
- Entity Formation
- Drafting Articles of Organization
- Operating Agreement Formation
- Private Placement Memorandum Creation
- Organize and Raise Investment Capital
- Ensure Regulatory Compliance
- Set Up Banking Accounts
- Purchase Insurance
- Close on Property
During The Operations Phase:
- Clear Any Backlogs of Deferred Maintenance
- Install New Property Management
- Communicate New Ownership To Residents
- Execute on Business Plan
- Regular Meeting with Property Manager
- Review Property Manager Reports
- Oversee Operations
- Property Tax Protesting
- Perform Cost Segregation Survey
- Investor Communications and Reporting
- Investor Distributions
- Perform Regular Physical Inspections
- Pay Debt Service
- Pay Expenses
- Perform Expense Management
During The Disposition Phase:
- Organize and Produce Rent Roll
- Organize and Produce Property Financials
- Interview and Hire Broker
- Engage Legal
- Entertain Offers
- Negotiate Purchase and Sales Agreement
- Respond to New Buyer’s Requests
- Pay Final Expenses
- Settle Debt Service
- Make Final Distributions to Investors
- Final Reporting to Investors
- Close Final Accounts and Recurrent Expenditures
As you can see, the experience and expertise necessary to be an effective real estate syndication sponsor is critical. And that wasn’t even a comprehensive list. Nevertheless, their responsibilities are extensive.
But as an investor, what you care about most is that the sponsor makes you as much money as possible without you having to get personally involved. You want a return on your investment without having to become a landlord. You’re bringing money to the table to buy an investment and expertise. That’s called passive investing.
Capital Partners of a Real Estate Syndication
As I said earlier, successful real estate syndication requires expertise (the syndicator) and capital. It’s the capital that actually purchases the property. And when you’re purchasing multimillion-dollar buildings, the down payment is extensive.
With that said, the largest investor in these deals typically is the lender. Whether it’s GSE, insurance company, local banks, or CMBS debt, it’s not uncommon for them to finance 60% – 85% of the debt. The sponsor must raise the remaining amount.
Sources of capital can come from institutional investors like pension funds, endowments funds, or hedge funds (just to name a few). However, individual, accredited, retail investors make up a significant amount of investment capital in the real estate syndication world.
What are those individual investors looking for?
- Access to Markets
- Access to Deal Flow
- Portfolio Diversification
- Tax Advantages
- Recession Resistance
- Hedge Against Inflation
- Principal Preservation
- Passive Income
- Equity Growth
These investments typically fall under Regulation D of securities law. So with few exceptions, people who invest must be considered an accredited investor. To be an accredited investor, one must meet one of the following three criteria.
- Have an individual annual gross income of at least $200,000 for the last two years with a reasonable expectation of earning that minimum in the current calendar year
- Make a combined income with your spouse of at least $300,000 for the last two years with a reasonable expectation of earning that minimum in the current calendar year
- Have a minimum net worth of $1 million, not including the value of your primary residence
If you meet one of those criteria, you can invest.
Assuming that the property is profitable, the capital partners can expect regular distributions as outlined by the waterfall in the operating agreement. The waterfall, ultimately spells out how profits are shared and distributed between the capital partners and the real estate syndicator.
Real Estate Syndication Due Diligence
Real estate syndication is a way in which capital partners and industry experts can come together to purchase and manage properties for profit.
Of course, like all investments, profits are not guaranteed. And unfortunately, all syndicators are not equal. There is a range of quality in syndicators that can make a material difference in whether a property is profitable or not. Never has that statement been truer than now (the years after 2012).
In 2012, the Jumpstart Our Business Act was passed. The JOBs Act, as it is known, deregulated the syndicated real estate industry and fueled the growth of the crowdfunding real estate industry. The rise of crowdfunding has introduced heightened levels of risk to investors.
So now more than ever it is critically important to vet the syndicator before investing. This due diligence is the key to finding a top notch real estate syndicator that matches your investment goals and risk tolerance.
In my next article, I’ll discuss some tips on how to evaluate a real estate syndicator.