The real estate industry is historically rigid and illiquid. However, real estate syndication enables limited partnerships and passive investors to source, purchase, and cultivate actual properties. The group of investors who partake in real estate syndication can pool their skills and resources to access premium investments. In turn, the investor receives steady passive income.
In this article, we will discuss how real estate syndication paves the way for fundraising for both new and existing investors.
What does the term ‘Real Estate Syndication’ refer to?
Real Estate syndication refers to the mechanism where like-minded investors collaborate and combine their capital to jointly invest in real estate opportunities. These investors own fractional shares of an entity. This is contrary to owning the property or buying properties individually where an investor assumes the role of property manager themselves.
In real estate syndicates, the investors combine their skills, resources, and capital to purchase and manage a property. Hence, they can invest in a property that otherwise would not have been individually affordable enough.
Research shows that in 2020, over 60,000 individual investors participated in real estate syndications through real estate crowdfunding platforms. Additionally, independent sponsors raised money directly from investors.
Legal entity structure
The arrangement of a Real Estate Syndicate is similar to that of a legal entity. The majority of such syndications are formed as a Limited Partnership (LP), Limited Liability Company (LLC), Single Purpose Entity (SPE), or Special Purpose Vehicle (SPV) for individual real estate deals.
It is noteworthy that these legal entities provide considerable asset protection to their limited partners. In certain cases, the sponsors or general partners must assume personal accountability for all of the entity’s debts.
Who is a Sponsor or a General Partner (GP)?
In these legal syndicates, the Syndicator or sponsor sources and acquires real estate deals.
The sponsor is also known as the general partner and they are the chief creators of the real estate Syndicate. Therefore, they also arrange finances for the initial capital for any deal. Besides, they conduct proper due diligence before executing the entire investment process.
Furthermore, the sponsors are also responsible for managing a particular real estate asset.
Who is a Limited Partner (LP)?
A Limited Partner is an individual investor to invest in a real estate opportunity alongside the sponsor GP. Therefore, they are a partial or limited owner of the asset in proportion to their investment amount.
Their limited role in an investment allows them to reap the returns from property ownership while retaining their passivity. Unlike the Sponsor GPs, the limited partners are not responsible for property acquisition and management.
The law also obligates the real estate syndicate to exclude the investors from both its debt and legal liability.
How to form a Real Estate syndicate?
Forming a Real Estate syndicate might sound daunting due to its financial and tax liabilities concerning real estate. So, you should start with:
- Finding suitable partners to invest and collaborate with. Hence, sponsors and investors can share a balanced financial equation.
- Mutual agreement with one collective regarding the property strategies, group’s timeframes, and level of financial commitment both are comfortable with.
- Creating a finance strategy to mix into the design of the collective’s property.
- Determining the investment structure that churns maximum tax benefits.
- The final property selection criteria, the number of properties, the time duration and finally placing a legal agreement.
What are the types of Real Estate Syndication Structures?
Novice real estate investors must begin their investment journey with a thorough investment of their own individual real estate investing goals.
Real estate syndication structures are much like fingerprints where each deal is unique.
Some high-risk real estate syndications offer higher potential returns to investors.
However, others are more traditional and subject their investors to calculated and conservative splits.
Such contrasts in the syndicate structure often have to be in line with the personal preferences of a General Partner (GP) and their track record. These differences must also mimic the experience of the general partners, their niche investment markets, the individual property, and their position in the market cycle.
Therefore, before investing, passive investors must analyze the structure of each syndication notwithstanding the market, asset class, and sponsor. Furthermore, this will ensure that each real estate syndication aligns with its investment goals.
Let’s take a look at the two most common real estate syndication structures:
1. Straight Split Structure, and
2. Waterfall Structure
Straight Split Structure:
This is by far the easiest and simplest of real estate syndication structures to understand. As the name suggests, this deal structure uses the same split across the board, for all returns – cash flow. Besides, it also uses any profits from the sale of the asset.
For instance, a deal is using a split of 80/20.
This implies that 80% of all preferred returns are enjoyed by the limited partner investors. The rest 20% goes to the general partners or the deal sponsors. They are the ones who have been syndicating the real estate deals.
This remains the same, regardless of whether there is $1 or $100,000 in returns.
Let’s consider that a real estate syndication deal has an 80/20 split.
In such a case, passive investors get 80% of the returns across the board. On the other hand, the general partners receive 20% for their role in syndicating real estate.
Hence, as per the returns, this deal structure can be especially beneficial to passive investors who want to generate high returns.
Another structure commonly used for Real Estate Syndication is the Waterfall structure. This utilizes a preferred return, which is particularly lucrative for most investors.
Supposing a syndicate deal includes a 7% preferred return.
The first 7% of the preferred returns usually consists of the cash flow or profits from a sale of the property. Such returns go directly to the first person.
The other limited partner investor gets 100% of the first 7% of returns. Furthermore, the general partners only get a piece of the preferred returns if they are above 7%.
Can we determine which Real Estate Syndication Structure Is the most beneficial for real estate investors?
In the end, when it comes to real estate investing, only the entity can determine which syndicate works best for them.
If you want to reap passive income or cash flow, a real estate syndication with a preferred return might work best. This is because they are likely to see greater cash flow distributions during the lifecycle of the project.
However, with the waterfall structure, one may potentially see smaller returns at the project closure.
For instance, someone focuses on the potential appreciation and profits during the sale and is not interested in the ongoing cash flow distributions. They will prefer real estate investments with a straight split. As a result, they can boost their chances of a larger amount of money upon project transit.
Hence, someone investing with a self-directed IRA account will experience a straight split. That might align more with their goals.
But, one investing cash and wanting to boost the salary, might place greater value on the ongoing cash flow distributions.
There are no hard and fast rules regarding the most appropriate structures for real estate syndications. However, when in doubt, you must strive to harness your real estate investments to meet their investing goals.
What are the three phases of Real Estate syndication?
Phase 1: The Origination Phase
This stage of origination planning focuses mainly on the identification of the property and due diligence. It also focuses on raising finance and finally closing the deal successfully. The sponsor fulfills the following, during the origination phase:
- Networking and marketing to search for the right deals and analyze the profit potential of the project.
- Creating a business plan for the property by auditing the financial records
- Seeking a suitable loan plan
- Assembling guarantors and ordering commercial appraisals.
- Creating an entity to engage assets
- Raising the amount for the down payment and renovations
Phase 2: The Operation Phase
At this phase, the sponsor is involved in executing the business plan designed in the origination phase. The Operation phase focus on:
- Wrapping off the pending maintenance
- Executing renovation plans along with repair requirements (if any sent by a lender)
- Carrying out a lease-up on an increase in rent in the plan or even renewal is required
Phase 3: The Liquidation Phase
Marked as a ‘liquidity event’, this phase involves returning capital to the investors through selling the asset or refinancing the loan. The sponsor is responsible for:
- Preparing repairs, upgrades, and financials to make the asset appealing to buyers
- Promoting buyer tours and reviewing offers
- Negotiating the contract of purchase with the winning buyer and closing the escrow
- Distributing loans to the passive investors according to their portions and preparing the final tax returns
The Lilypads bottom line
In recent years, real estate syndication deals have gone mainstream, and are no longer privy to the posh or highly-paid financial domain. The easing of restrictions on general solicitation, the right to marketing, and publicizing gave rise to real estate crowdfunding. A culmination of digital finance, real estate syndication has ushered in a new horizon for real estate investors. Both individual and accredited investors are now able to pool their assets to access quality real estate investment opportunities.