This article is an excerpt from our no cost Ultimate Guide To Passive Investing. You can download the full guide here.
How syndication works
What is real estate syndication?
A real estate syndication is just a fancy term for a group investment in a piece of real estate. These syndications include both Active Sponsors (aka Operator, General Partners, GPs), who are responsible for managing the investment, and Passive Investors (aka Limited Partners, LPs), who invest their capital alongside the General Partners. Together they pool their resources to acquire large real estate assets.
Real estate syndication allows you to invest your money in real estate together with a group of passive investors, yet you don’t have to do any of the day-to-day work of managing the property. Your work is done upfront by selecting the sponsor and the deal. After that you get to sit back and collect cashflow checks for your share in the ownership.
Our investors have been using this investing strategy to build wealth for their families and create ongoing passive cashflow without the day-to-day work of managing.
Let’s say the sponsorship team finds an apartment complex and get it under contract for $12 million. To close they need $3 million for down payment and another $1.5 million to renovate and improve the property. All together they need $4.5 million.
The sponsor could put up 100% of the money to buy the apartment on their own, but then that will be the end of their acquisitions until they earn more money in return. Rather, they opt to form a syndication to invite investors into the project – giving everyone access to the investment and allowing the sponsor to spread their capital over multiple deals. This leads to diversification and most importantly economies of scale. Each passive investor invests into the deal, buying a share in the property. You invest $100,000, another investor commits $50,000, and another person puts in $200,000 and so on until we reach the equity mark of $4.5 million.
Depending on the total amount raised, some real estate syndications can include a large group of passive investors. Sometimes it’s just a few people riding large checks. The syndication group creates an entity, often an LLC, and the passive investors are purchasing ownership shares in that entity. The group would engage in syndication attorney to create a private placement memorandum PPM, which is a legal document that outlines things like how investors are tied to the investment, the risks involved, and so on.
The Team Includes:
- General Partners aka the Sponsor
- This includes the loan guarantors / key principle, asset manager, investor relations, acquisitions
- Property Management Team
- Mortgage Broker
- Real Estate Attorney
- Syndication Attorney
The sponsorship team purchases the assets, executes the business plan, and handles all of the active management. At the end of the investment timeline, the sponsorship team sells the asset and the initial investment is returned to investors with a share of the returns.
Why real estate syndication?
Real estate syndication gives passive investors the ability to participate in large institutional quality investments without needing the experience or capital to do it on their own. This allows investors to experience the upsides of commercial property while allowing for diversification.
The other big advantage is you are becoming a direct owner when investing in private real estate syndications. This ownership puts you closer to the Sponsor or Manager, which allows you to have a more personal connection to the deal with access to tax benefits you can only receive as an equity owner. In addition, historically these private syndications perform better than public real estate offerings for private investors, as there are lower fees and less bloated overhead.
Syndications put private investors in the driver’s seat of their investment career, allowing them to build direct relationships with operators and invest alongside them. They get the benefits of direct ownership, without the headache or liability of managing. There’s no 2 am phone call from tenants for private investors in a syndication. There’s no call from your manager to make decisions on what to fix once each tenant moves out.
As I started expanding my rental portfolio I began to realize the incentive alignment with single family property managers. For example my $100,000 investment property charges $1,000 per month for rent. The property manager making their 6% management fee only earns $60 per month to oversee my $100,000 property. I simply couldn’t’ expect them to care about the property as much as I do. Are you starting to see the misalignment of interests?
On the other hand in a syndication, the operator is financially invested in the deal, and further they have taken on the full liability for its success. This leads to an alignment of interests that creates a level of confidence that they are positioned to do what’s right for the property. Earning more money is a driver for some, but the fear of losing money will make most people work twice as hard to reach success.