A real estate syndication is simply a group of investors pooling their resources to acquire real estate (such as an apartment community) that is selected and managed by a general partner or operator.
Real estate syndication enables individuals to passively invest in real estate deals that would otherwise be more expensive than any of them could afford on their own.
How Does It Work?
There are two kinds of participants in the syndication:
(i) the Active Partner (generally referred to as the general partner, sponsor or operator) who finds the property, arranges the financing, and oversees improvements and management of the property, and
(ii) the Passive Partners who invest cash and receive a proportionate ownership interest in the real estate.
In a typical scenario, the sponsor will locate a property with “value-add potential,” which might mean that it is being poorly managed or in need of some level of renovation. Very commonly, the value-add proposition is to renovate or make improvements to the property so that the apartments will command a higher rent which increases cash flow and increases the value of the building for future sale.
The sponsor then offers investors the opportunity to become partners in the company. Depending on the type of property and type of loan, the LLC can usually borrow between 65% and 80% of the purchase price. The majority of the remaining purchase price comes from the investors in the LLC. The sponsor will usually contribute a smaller share of the equity.
The company will then acquire for example, an apartment building which is leased to the residents. As apartment units are vacated, the sponsor will renovate the units by replacing the cabinets, countertops, appliances, flooring, and paint, so that the apartment can be re-rented to a new resident at a higher rent. The cash flow from operating the apartment building is distributed to the investors (usually each quarter). When the building is sold, the profits are also distributed to the investors. Note that at the time of sale, a portion of the mortgage on the property will have been paid down, so that will result in an additional return to the investors.
How Do Investors Get Paid?
The investors receive the majority of the profits from the property (generally 70%–80%), and the sponsor receives the other 20–30%. Sponsors also receive fees as part of their compensation for the property acquisition, asset management, and investor communication. Often times, the investors are entitled to a preferred return typically ranging from 6%–-8%. That means that the company will pay every dollar of profit to the investors until they have received the preferred return on their investment. Each dollar after that is split between the investors and the sponsor 70/30 or whatever split was established.
It is common for the profit-sharing ratio to shift to provide a greater share to the sponsor once a specified return is achieved by the investors. For example, the investors might receive 70% of the profit until they have received a return on their investment equal to 14%, and after that, profits will be split 50/50 between the investors and the sponsor. This arrangement incentivizes the sponsor to maximize the return from the investment, and most investors are perfectly happy to incentivize the sponsor so that they can receive returns of 14% or more!
Sometimes the sharing arrangement will just be a straight percentage split such that the investors receive for example 70% and the sponsor receives 30% of all returns. This type of arrangement can be beneficial to the investors for investments with high yield since their percentage share of returns over a specified threshold e.g., 14% continue at 70% and are not reduced to 50%.
What is the Process for Investing in a Syndication?
When an investment becomes available, potential investors that have expressed interest in future opportunities are notified by the sponsor that one is coming up. They will receive an invitation to attend a webinar where the details of the property, the business plan for the property, and the terms of the investment will be provided by the sponsor, and a Q&A period will follow. These webinars are usually recorded so that they are available to interested investors who were not able to attend at the scheduled time.
After that, investors generally will have about a week to:
(i) review the Private Placement Memorandum, which is the legal document that specifies all of the terms of the investment
(ii) decide whether to invest and
(iii) reserve the desired amount of the investment.
Shortly after that, investors sign a subscription agreement, which is the legal agreement by which they purchase their interest in the company. The investor typically will have a week to 10 days to transfer the funds for their investment to the company.
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