Syndication 101: A Simple Starter Guide
Understanding Real Estate Syndication:
What is Real Estate Syndication?
“Syndicate” is one of those unusual, perhaps slightly sinister-sounding words. The Syndicate sounds like a cheesy, nefarious organization in a bad video game which it actually is.
But in real life, the word syndicate simply means a group of individuals or organizations combined to promote a common interest. In practical terms, real estate syndication is the act of pooling resources in order to make an investment. The resource which is pooled is usually capital, of course, but also includes management skills, market research, etc.
Real estate syndication usually involves two classes of people: sponsors (or general partners) and investors (the limited partners). Sponsors contribute more to the project than just capital, if they contribute capital at all – they are the ones who find the property, negotiate the purchase, manage it, and otherwise handle the details of the investment. Investors contribute the necessary finances to cover the costs of the investment.
These categories aren’t hard-and-fast; sponsors sometimes do contribute some of their own money to the investment, and some investors may also share some of the duties of sponsoring. Another way to look at the situation might be as active and passive investors. If two people decide to purchase an old warehouse on the edge of a revitalising sector of town and turn it into a wedding venue, one person (the sponsor or active investor) might have experience operating such a venue. She decides which property is ideally located, oversees the necessary renovations, and operates the venue. The other investor might be a friend of hers or someone she met through networking, who funds the project but doesn’t have a hand in day-to-day activities.
Of course, things aren’t always so simple, and there may be far more than two people involved in such a transaction.
How to Profit from Real Estate Syndication
How do you profit from real estate syndication? Well, it depends on which category you’re in – a sponsor or a passive investor.
For passive investors, there are two primary ways of profiting from real estate syndication. First, you will receive a preferred return on your investment. The rate of the preferred return is negotiated at the beginning of the investment, say 10%. That means that after the property becomes profitable, you should receive 10% of your initial investment as an annual return. If your investment is $100,000, you’d be looking at $10,000 per year.
Of course, passive investors also benefit from appreciation, as rents and property values increase over the life of the investment.
Sponsors receive slightly different incentives in return for the sweat equity they invest in finding and arranging the investment. Sponsors typically receive an acquisition fee, somewhere between 0.5% and 2% of the purchase price.
Both sponsors and passive investors will have agreed to a profit split when arranging the investment. After the investment matures and regular profit is being made, and after the passive investors receive their preferred returns, any remaining money is split between the investors as a group and the sponsor. If a particular investment brings in $2 million, and $1.5 million goes to the preferred returns, the remaining $500,000 gets divided according to the profit split. If that split is 80% / 20%, then $400,000 would be split between the passive investors; the last $100,000 belongs to the sponsor. This type of profit splitting is known as a promote or waterfall.
When it comes time to sell off the property and lock in all of the profits (assuming there were profits), passive investors receive their principal back, as well as the remaining distribution of capital, some of which come from the appreciation.
Some sponsors also charge property management fees, often ranging between 2-9%, among other sponsor fees they build into the deal.
Getting Established in Real Estate Syndication
The Old-Fashioned Method
In the ancient days of yore, real estate syndication was for monied, well-connected people. You needed to have the right connections, be in the right places at the right times, and have sufficient funds to take advantage of multi-million-dollar syndicated investments.
Because syndication relies heavily on sponsors who do the hard work of researching and arranging investment deals, even being wealthy was no guarantee. You needed to know someone who specialized in private real estate deals; without that “in,” it was nearly impossible to break into real estate syndication as a passive investor. Thankfully, technology and regulatory advances have changed much of that old arrangement and made it possible for sponsors to work with a wider group of passive investors.
Crowdfunding!
Crowdfunding has transformed the world of real estate syndication. With multiple platforms offering syndicated deals, private investors can get started in syndicated deals fairly easily, with surprisingly small amounts of money. The various platforms – Fundrise and RealtyMogul are two of the biggest – serve as an extra layer, vetting the different sponsors who advertise syndication opportunities on their sites. In return, sponsors gain access to a far larger pool of potential investors, and passive investors can enter the world of syndication without needing to have an extensive network of wealthy, well-connected real estate moguls.
One caveat sponsors grapple with, in this option for syndicating a deal, is that the crowdfunding platforms have significantly larger demand from sponsors than they can fill with their base of passive investors. This leads to a competitive market, where only some sponsors are able to get their deals approved onto these platforms. If using technology for improving your ability to syndicate to a growing number of passive investors is your need, there are a number of technology providers offering real estate sponsors white-labeled platforms.
If taking the route of a sponsor, networking is never a bad thing, even for smaller sponsors who choose to take advantage of crowdfunding platforms. Talk to other real estate syndicators, and of course, read all you can find about real estate syndication: you’ve already made a great start with this article!
For more information about Real Estate Syndication and tools to help you get started, check out Groundbreaker.co.