As an investor, there may come a time when your resources are tapped and you’ve reached the limit of how much you can grow on your own. Real estate syndication may be the answer.
What is real estate syndication?
Real estate syndication (or property syndication) is a partnership between several investors. They combine their skills, resources, and capital to purchase and manage a property they otherwise couldn't afford.
There are usually two roles in property syndication: syndicator and investor. The syndicator is also known as the sponsor.
Your skills, abilities, wherewithal, and amount of available capital determine which you’re best suited for.
Choose your role carefully
If you're great at scouting and managing properties but have little capital, a role as syndicator may work best. The sponsor scouts and secures the property with a contract and usually manages the investment as well. Sometimes the sponsor will put in a little bit of money (maybe 5%–10%) while other times their contribution is purely in the form of time and effort.
It’s normal for the syndicator to earn an acquisition fee, which is essentially a commission, for bringing in the deal. This fee varies but averages around 1%.
Other members of the deal provide the money to buy, renovate, or operate the property. Once it's stabilized or sold in a predetermined exit strategy, the syndication is complete. Those members expect to have a passive role in which they invest their cash and receive a monthly or quarterly return.
Whether the sponsor put in money or not, he or she also gets a piece of the deal. But before getting paid, the sponsors give the other investors an annual "preferred return" as high as 10%.
There are many ways to split the profits
Let's look at an example. You're a sponsor who secured an apartment building for $1 million. There are four investors who each put in $250,000, but all five of you have agreed to own 20% of the deal.
The group has agreed to pay you a 1% acquisition fee of $10,000. The building’s annual net operating income is $80,000. You pay a preferred return of 5% to each of the investors who put in cash, which is $12,500 each, or $50,000 total. You split the remaining $30,000 five ways, which is $6,000 each.
For the investors, this is a 7.4% annual return on their money. That’s on top of any appreciation of the property they could cash in on when it's sold. As the sponsor, you’ve made $16,000 without putting in any of your own cash.
This scenario assumes you pay for third-party property management. If you, the sponsor, manage the property, you could collect a management fee based on rents.
Let’s say the group agrees to pay you to collect rents, conduct building maintenance, pay the bills, and keep the building in good shape. They'll give you a 10% management fee on $120,000 gross income. That’s $12,000 in addition to the $6,000 you’ve earned as a return.
Now imagine that, in five years, the group agrees to sell the property for $1.5 million. You and the investors share the $500,000 gain five ways, each making $100,000 in addition to their cash flows for the last five years.
Of course, you don’t have to split returns equally. You might do a 70% share to the passive investors and a 30% split to you as the sponsor. Or 80/20. Or 50/50. It’s up to the syndicator and investors to negotiate. It may be related to how much work you did to acquire and manage the investment.
If the property needs a lot of work when you buy it, and you'll manage it yourself, you should take a bigger share of the profits. You might need to evict tenants, take care of overdue maintenance, or spruce up units to make them more attractive to potential tenants. That's definitely worth more income.
Choose a structure
Syndications are usually structured either as a limited liability company or a limited partnership. In these cases, the sponsor is called either the managing member or the general partner. The investors are limited partners or simply members.
The sky’s the limit on the terms of a syndication agreement. Seek the guidance of an experienced real estate attorney to help you put together a contract that protects everyone. It's best to work with someone who has experience in syndication.
Clearly lay out voting rights and communications requirements so everyone is on the same page at all times. You may even want to schedule quarterly lunches or meetings to discuss the property's progress and next steps.
While it may seem like a great situation to be a sponsor, you have a lot of responsibility to your investors. They're relying on you for expertise and diligence -- and for fiduciary stewardship of their money. You need to be good at active management of the asset, but you're also responsible for reporting and accounting. So you need a talent for paperwork as well.
When you're taking on a project for which you’re seeking investor capital, make sure you can execute it well. The sponsor’s role is usually to fix problems that arise -- your passive investors are passive for a reason. They don't want to deal with the day-to-day headaches of owning an income property. That’s why they pay you a premium for it.
Be prepared to head off risks as they come along. And to advise your investors on the exit strategy and opportune times to sell the property.
Despite the complexities, real estate syndication can be a win-win for real estate investors. Just make sure you put in the work and trust your partners.