Real Estate Syndication Explained for Potential Investors

Real estate syndication is a powerful investment strategy that allows individuals to pool their resources and invest in larger and potentially more lucrative properties than they could on their own. Syndications involve the pooling of funds from multiple investors to acquire, develop, or manage a real estate investment. Typically, a syndicator, a professional real estate operator or sponsor, sometimes referred to as the general partner or “GP” identifies and manages the investment opportunity, while passive investors, sometimes referred to as “limited partners” or “LPs” contribute capital and share in the profits.

Structure of a Syndication Deal

In a typical syndication deal, the syndicator identifies a real estate opportunity, conducts due diligence, and structures the investment. The syndicator then creates an entity—often a limited liability company (“LLC”)—to serve as the vehicle for the investment. Investors contribute capital to the LLC in exchange for a membership interest in the LLC. The syndicator manages the investment on behalf of the investors, handling the property acquisition, financing, management, and eventual disposition.

Benefits of Real Estate Syndication

Access to Institutional-Quality Deals

Real estate syndication allows individual investors to access institutional-quality real estate deals that might otherwise be out of reach. By pooling resources, investors can in large high quality-assets with strong income-generating potential and high quality tenants.

Passive Investment Opportunities

For investors seeking passive income and wealth accumulation, real estate syndication offers an attractive alternative to direct property ownership. Syndicators handle day-to-day property management and decision-making, allowing investors to enjoy the benefits of real estate ownership without the hassle of hands-on involvement.

Risk Mitigation

Syndication allows investors to make smaller investments into a particular deal and thereby spread their investable capital across multiple deals, this helps spreads their risk and can help reduce an investor’s exposure to property-specific risks, market fluctuations in a particular geography, and operational challenges incurred with respect to a specific property. Additionally, investing in a syndication can allow a passive investor to benefit from the professional management of an experienced real estate investor.

How a Typical “Waterfall” Works for Investors

In real estate syndication, a “waterfall” distribution structure determines how profits are distributed among investors and the syndicator. This hierarchical distribution model ensures that each party receives its share of the investment returns in a predetermined sequence. Here’s how a typical waterfall works:

1. Return of Capital: After investors have received their preferred return, any remaining profits are distributed to investors until they have recouped their initial capital contributions. This step ensures that investors receive a full return of their investment before the syndicator participates in profit sharing.

2. Preferred Return: Investors typically receive a preferred return, often expressed as a percentage of their initial capital contribution. This preferred return is distributed before any profits are allocated to the syndicator.

3. Profit Split: Once investors have received their preferred return and return of capital, any remaining profits are typically split between investors and the syndicator according to a predetermined ratio. Common profit-sharing ratios range from 80/20 to 50/50, with investors receiving the larger share.  The portion of proceeds allocated to the syndicator at this stage of the waterfall is often referred to as a “promoted interest” or “promote”. This incentivizes the syndicator to maximize returns for investors and aligns the syndicator’s interests with those of the passive investors by ensuring that investors are prioritized in profit distributions, receiving the return of their invested capital and their preferred return before the syndicator receives a promote.

Typical Fees Taken by a Syndicator

Syndicators typically charge various fees for their services and expertise in managing real estate syndication deals. These fees are outlined in the syndication offering documents and may include some combination of the following, although it would be unusual for a specific deal to include all of these fees:

1. Acquisition Fee: A one-time fee paid to the syndicator upon the acquisition of the investment property. This fee typically ranges from 1% to 3% of the purchase price and compensates the syndicator for sourcing and securing the investment opportunity.

2. Disposition Fee: A fee paid to the syndicator upon the sale of the investment property. This fee generally ranges from 1% to 2% of the sale price and compensates the syndicator for managing the disposition process and realizing the investment returns.

3. Asset Management Fee: An ongoing fee paid to the syndicator for managing the day-to-day operations of the investment property. This fee is usually between 1% and 2% of the gross revenue or total capital under management, covering tasks such as leasing, maintenance, and financial reporting.

4. Property Management Fee: In addition to the asset management fee, investors may also pay a separate property management fee to cover the costs of onsite property management services, such as leasing, maintenance, and tenant relations. This fee typically ranges from 3% to 5% of the gross rental income.

5. Loan Fee: A fee charged for arranging and securing financing for the property, which may include negotiating loan terms and working with lenders. This fee usually ranges from 0.5% to 1% of the loan amount.

6. Guaranty Fee: A fee paid to the syndicator for personally guaranteeing the loan on the investment property. This fee compensates the syndicator for taking on the financial risk and typically ranges from 1% to 2% of the loan amount.

7. Construction Management Fee: If the investment involves significant renovation or development, the syndicator may charge a construction management fee. This fee compensates the syndicator for overseeing the construction process and typically ranges from 5% to 15% of the construction costs.

8. Other Expenses: Syndicators typically also pass through other expenses related to the investment, such as legal fees, accounting fees, and property operating expenses. These expenses are typically outlined in the offering documents and deducted from investment returns.

Investors should carefully review the fee structure outlined in the syndication offering documents to understand the total costs associated with the investment. While fees are a necessary component of real estate syndication, investors should ensure that they are reasonable and transparent, aligning with the syndicator’s responsibilities and the overall investment objectives.

Conclusion

Real estate syndication can offer investors an opportunity to participate in high quality real estate investments with reduced barriers to entry and diversified risk. However, investors should conduct thorough due diligence, evaluate syndicators carefully, and review investment terms before committing capital to a syndication deal.