Real Estate Syndication: A Powerful Tool for Investors
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Raising enough money to make a down payment on a good rental property is becoming harder and harder, especially with the way that real estate prices keep rising. Prices are hitting record highs, meaning the downpayment required continues to increase. Meanwhile, competition is increasing due to low supply, meaning investors need to more quickly find leads, analyze them, and place offers on deals.
Real estate syndication offers investors a tool to help alleviate some of the financial burdens that the current market environment is exacerbating. Investing in a real estate syndication can tie up less of your cash, and could be a great way to scale up and grow a real estate investment portfolio faster. Let’s take a closer look.
What is Real Estate Syndication?
A real estate syndication is when investors team up and pool their capital to purchase, develop, own, and manage a large real estate project that would normally be out of reach for an individual investor.
Examples of real estate syndication opportunities include new home developments, small and large apartment buildings, agricultural land, and commercial real estate. Real estate syndication investing can apply to any real estate asset class.
How Real Estate Syndication Works
A real estate syndication has two main parties: Syndicator and passive investors.
Real Estate Syndicator
Also known as the general partner (GP) or sponsor, a syndicator is responsible for locating, purchasing, developing, and managing the real estate syndication. The main responsibilities of a syndicator include:
- Identifying the real estate asset to acquire.
- Performing pre-offer analysis and creating a business plan.
- Negotiating a purchase agreement with a seller.
- Conducting due diligence on the property.
- Finding investors, raising capital, and arranging financing for the acquisition.
- Closing escrow and working with the development and property management teams.
- Supervising the asset to meet the goals and objectives of the business plan.
- Overseeing periodic income distributions to passive investors.
- Selling the property and distributing a pro-rata share of any profits to passive investors.
- Managing investor relations throughout the entire holding period of the real estate syndication.
The GP or syndicator is responsible for ensuring that a real estate syndication meets or exceeds the objectives outlined in the business plan. In a real estate syndication, the buck stops with the syndicator.
A passive investor places capital in a real estate syndication, similar to investing in a crowdfund, or as a silent partner in a limited liability company (LLC) or limited partnership (LP). In exchange for investment capital, a silent investor:
- Owns a pro-rata share of the property.
- Receives recurring profit distributions, normally monthly or quarterly.
- Earns a pro-rata share of the profits when the property is sold.
Provided that the project goes according to plan, a passive investor in a real estate syndication will receive the same benefits of owning property directly, including appreciation, net cash flow, additional equity as any mortgage is paid down, and the tax benefits of owning investment real estate.
Profit Splits in a Real Estate Syndication
Sharing of the recurring cash flow and profit when a property is sold in a real estate syndication can be structured a variety of different ways, depending on what the syndicator and passive investors agree to. There are two general ways that profits are split in a real estate syndication:
Also known as a percentage split, examples of a straight split of cash flow and profits in a real estate syndication could be 90% passive investors/10% syndicator, or 80%/20%, 70%/30%, or 60%/40%.
With a 90%/10% split, if a real estate syndication generated $50,000 per year in net cash flow and a profit of $500,000 when sold, the passive investors would receive $45,000 of the annual cash flow and $450,000 of the sale profits, to be shared on a pro-rata basis based on the amount of capital invested.
A preferred return is a guaranteed distribution percentage (assuming syndication is profitable) that passive investors receive before a syndicator gets paid. For example, if passive investors are promised a 10% return, syndication must generate returns of more than 10% before the syndicator receives a cent.
Oftentimes, preferred returns are accrued. In other words, if passive investors did not receive their full promised return in one year, the difference is carried over into the following year, in addition to that year’s promised return, before the syndicator is paid.
Who Can Invest in a Real Estate Syndication?
In most cases, investing in a real estate syndication is only available to accredited or sophisticated investors. According to the Investor.gov website from the U.S. Securities and Exchange Commission (SEC), an accredited investor is a natural person who:
- Earned income of more than $200,000 in each of the two prior years, or $300,000 with a spouse), or
- Has a net worth over $1 million, either individually or with a spouse, or
- Licensed as a financial professional with a Series 7, 65, or 83 license in good standing.
Other categories of accredited or sophisticated investors include an entity in which all equity owners are accredited investors, or an entity or trust with assets in excess of $5 million, such as a family office.
An exception to the accredited investor rule is a 506(b) real estate syndication, also known as a “friends and family” syndication. Rule 506(b) allows a syndicator to raise capital from up to 35 non-accredited investors and an unlimited number of accredited investors, provided there is a pre-existing relationship and the opportunity is not advertised to the general public.
Pros of Real Estate Syndication
Placing capital in a real estate syndication with other investors creates more buying power, increased opportunities, and potentially more lucrative deals:
- Earn passive recurring income with regular distributions and a pro-rata share of the profits when the property is sold.
- Appreciation in property value over time.
- Forced appreciation or equity increase from new or re-development or value adds.
- Tax benefits such as a pro-rata share of annual depreciation expense.
- Hands-off investment with a syndicator responsible for the project from start to finish.
- Complete control over the specific property invested in, unlike more opaque investments in a REIT or crowdfund.
- Diversify capital across multiple real estate syndications versus directly owning one or two properties.
Cons of Real Estate Syndication
As with any other type of investment, there are some potential drawbacks to a real estate syndication to consider:
- Capital invested in a real estate syndication is illiquid and may be tied up for several years until the project runs its course.
- Passive investors generally have limited control over how a syndication project is developed and managed.
- Vetting is required to learn if a real estate syndicator is trustworthy and has a track record of success.
- Syndicators may make money through acquisition and sales fees, property management and asset fees, and finding fees even if a project performs poorly.
- Zero or minimal cash investment by a syndicator means a syndicator may have less “skin in the game” versus passive investors who have contributed cash capital.
How to Invest in a Real Estate Syndication
While there are plenty of potential advantages to syndication, finding the right real estate syndication to invest in is sometimes easier said than done. Some ways to find the best real estate syndication opportunities include:
- Ask lenders, escrow officers, and fellow real estate investors in your network of contacts for recommendations.
- Networking with accredited and sophisticated investors who “know someone who knows someone.”
- Real estate investor forums such as REI or BiggerPockets.
- Online crowdfunding platforms such as Fundrise or CrowdStreet.
The job of a real estate investor is to find a trusted syndicator with a proven track record of success to place capital with. Once the right real estate syndication is located, the syndicator will do all of the work to make the project a success while sharing any profits with passive investors.
That said, investors who want to leverage other people’s money (OPM) can syndicate funds from other investors for their deals to help build out their real estate portfolio faster and use less of their own capital. Explore how to scale your real estate investing business, or learn what to do after you master real estate wholesaling!