Real estate investing presents plenty of opportunities to reap huge returns, even if you’re not a big-time investor. Depending on your investment goals, putting money into syndicated real estate projects can be a good option.
Real estate syndication allows you to pool funds with other investors, so you can all participate in high-value property deals that would’ve otherwise been unaffordable individually. When done right, the returns can be lucrative.
In this client education guide, InvestmentNews explains how real estate syndicates work. We’ll delve deeper into the pros and cons. We’ll also discuss the factors you need to consider before choosing a syndication to join in.
If you’re working out whether syndicated real estate investments are a viable option, then this guide can help you make an informed decision. Read on and find out if this investment opportunity suits your financial goals.
Real estate syndication is an investment model where several investors pool capital to acquire a property investment. It is designed to allow you and other investors to invest in real estate projects that are significantly larger than what you could afford individually.
There are two main players involved a syndicated real estate deal:
Popularly known as the sponsor, general partners (GP) act as the leaders of a real estate syndicate. They oversee the financing, acquisition, and management of an investment property on behalf of the investors. Some of the primary responsibilities of a GP include:
The success of a syndicated real estate investment relies heavily on how competent the deal sponsors are. That’s why when choosing a syndicate, you need to ensure that the GPs have a firm grasp of how the real estate market works.
Also known as the investors, limited partners (LP) provide much-needed funding to acquire a real estate project or property. As an LP, your returns depend on how much money you put in, apart from, of course, the project’s success.
Investors aren’t involved in property management. This makes real estate syndicates an appealing way to earn passive income.
The Securities and Exchange Commission (SEC), however, restricts participation in syndicates to accredited investors. To be considered one, you must either have:
This requirement is aimed at limiting participation to investors who can absorb a loss if the investment fails.
An emerging option, real estate crowdfunding, however, opens the door for non-accredited investors. In this investment model, GPs use crowdfunding platforms to find deals, raise capital, and manage regulatory tasks.
Real estate crowdfunding may even generate higher returns, but there’s additional risks. Some projects might be run by less experienced sponsors. Others might not have been able to secure funding from traditional lenders.
You can learn more about the different ways to invest in real estate in this guide.
Syndicated real estate investments have a lot of moving parts. If you’re looking to invest in one, there are several elements that you need to understand:
A real estate syndicate can be structured as a:
Each business structure offers varying levels of protection for participating investors. But just like in other real estate deals, most syndicates are structured as an LLC – and for good reason.
This type of business structure protects investors from personal liability for the syndication’s debts and claims. This means that if the real estate syndicate fails, the investors' personal possessions can’t be legally pursued.
Real estate syndication deal structure
Syndicated real estate deals come in different structures meant to suit varying investment goals and risk tolerance. Here are the three main structures of a syndication deal:
In an equity syndication, investors pool capital to buy a property, which is how most real estate syndications work. As an investor, you become a fractional property owner and get a share of the rental income and any capital from the sale of the property.
If you choose to join a debt syndication, you’re essentially lending money to a real estate project. In this deal structure, the funds pooled from investors are used as a loan to the property owner or developer. As an investor, you earn income from the interest of the loan.
Debt syndications are considered less risky than equity syndications because investors are on top of the capital structuring. However, this also means that the underlying returns are smaller.
As the name suggests, this deal structure combines elements of debt and equity syndications. You may receive interest payments due on a loan. At the same time, you can get a share of the profits from the operation and sale of the rental property. Hybrid syndications are designed to balance possible risks with the potential rewards.
Syndicated real estate investment deals occur in three stages:
This is the phase before the investments officially start. In this stage, the sponsors:
Origination ends when the real estate deal is closed, and all investors have committed capital.
This is when the sponsor carries out the business plan. This phase can involve:
This is the stage when the property is refinanced or sold. If the deal is successful, this is the phase where you and the other investors cash out with a profit.
Syndicated real estate deals often have a holding period of five to seven years, sometimes longer. This makes real estate syndication more suited for long-term investments.
If you find real estate syndication a bit complex and prefer to own property instead, this guide on purchasing an investment property can help.
There are two main ways real estate syndications distribute returns between sponsors and investors:
The simpler of the two models, this structure issues the same split across the board for all returns. Let's say a real estate deal uses an 80/20 split. This means that the limited partners receive 80 percent of all returns, while the rest go to the general partners. The split remains the same regardless of whether the syndication earns $1 or $100,000.
This deal structure especially benefits investors in high-return deals.
Here’s an illustration:
In this model, the returns must hit a certain threshold – called the hurdle rate – before these are distributed between the sponsors and the investors. It’s more popularly known as the waterfall structure as it resembles water flowing over a ridge and pouring into a new body of water.
Let’s say that a real estate syndication agrees on a 7 percent preferred return. This means that you and the other investors get 100 percent of the first 7 percent of returns. The sponsors only get their share if the returns exceed 7 percent.
Once the hurdle rate is hit, however, a different split is activated. For instance, returns between 7 percent and 14 percent can have a 70/30 split between investors and general partners. After reaching the 14 percent threshold, the split can change to 50/50.
Here’s an illustration:
The waterfall structure often serves as a win-win for the investors and sponsors. It also serves to align interests. This is because the model prevents sponsors from taking on syndicated real estate deals that they aren’t confident will reap returns beyond the hurdle rate. It also incentivizes them to work hard to make the asset perform well.
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Just like other types of investments, investing in syndicated real estate deals comes with its share of benefits and drawbacks. Let’s go through some of them:
The biggest benefit of investing in syndications is that it allows you to participate in larger and potentially more profitable real estate deals that you won’t have otherwise afford. But there are other advantages, including:
Although the returns vary depending on the deal, real estate syndications often provide higher returns compared to other types of passive investments. These include investing in stocks or bonds. In a syndication deal, you can receive regular cash flow distributions from rental income and a share of profit upon sale.
Real estate syndicates can be a great way to diversify your investment portfolio. If you have enough capital, you can spread it across multiple syndications handling different property types. This way, you can reduce your overall risk.
You, as an investor, can reduce your taxable income through depreciation and other tax deductions associated with real estate. Income from real estate syndications is also often taxed lower than those from other investments. This makes investing in syndicated real estate deals a tax-efficient way to build wealth.
In a real estate syndication, sponsors handle all aspects of your investment, from the purchase of the property and day-to-day management to its eventual sale. This hands-off approach can be appealing if you want to invest in real estate but don’t want to deal with the headaches of property management.
Here are some of the drawbacks of putting your money into real estate syndications:
Real estate syndications are considered illiquid investments. This is because they have a set holding period, usually five to seven years, even longer. During this period, you won’t be able to access your capital. This could be an issue if you need liquid cash asap.
The success of a real estate syndicate is tied to the skills and expertise of the sponsor. If the sponsor makes poor investment decisions, you can suffer losses. This is why conducting due diligence also applies to investors when choosing a syndicate.
Once made, you have limited control over the investment. The general partners make the key decisions regarding all aspects of the project, including property management, leasing, and sale.
While syndicated real estate deals follow a distribution structure, there’s no guarantee that the threshold will be met. There are times when a project doesn’t earn income right away, especially for development and renovation projects. Market conditions and economic factors can also impact potential returns.
If you want to know the difference between REITs and real estate syndicates, this guide on real estate investment trusts can provide answers.
The first and most important step if you want to participate in a syndicated real estate deal is to practice due diligence. Some factors to consider include:
Track record of sponsors: Check to see if they have vast industry experience, the right connections, and a record of successful performances. Seasoned sponsors perform well through good and bad market cycles.
Financial projections: Review the syndicate’s business plan and financial projections. Be wary of sponsors making unrealistic projections. Experienced sponsors often have conservative growth estimates. They also focus more on downside protection than maximizing potential returns.
Investment property: Research the target real estate property or development. Make sure all aspects tick the boxes of your investment goals.
Fees: Syndication may charge fees for certain services. Carefully evaluate the fee structure to determine if the costs fit your financial goals.
After completing due diligence, you can invest in real estate syndication by following these steps:
Sign up with your chosen sponsor. It’s best to speak with a member of the sponsor team first, so they can understand what your investment goals are.
Choose a real estate syndication to participate in. Once you’ve signed up, you will gain access to the syndicate’s current and upcoming real estate offerings.
Complete the paperwork. Once you’ve settled on a project, you will need to sign the necessary paperwork and wire your funds to escrow.
Close the deal. Your capital will be in escrow until the deal closes. After this, you become a co-owner, along with the sponsors and the other investors. You can then receive returns for the property’s income, sent directly to your bank account.
Investing in syndicated real estate deals can be complicated, especially if you’re new to the market. An experienced financial advisor can guide you through your investment journey.
If you’re looking for one, our Best in Wealth Special Reports page is the place to go. The firms and industry professionals featured in our special reports have been vetted by our panel of experts as respected and reliable market leaders. By partnering with these professionals, you can be sure that your best interests are prioritized.
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