The concept of a real estate syndication is not difficult to grasp especially if you’ve ever played poker.
In a syndication, you’re throwing money into a “pot” with others with the difference being in poker, you’re trying to win the entire pot.
In a syndication, you’re able to split the pot with the other players (investors) in a deal including the dealer (syndicator).
This “pot” of money is used to purchase property (apartment buildings, hotels, self-storage facilities, etc.) and hold for an extended period of time.
By “joining forces” with other investors, this type of investing becomes a team sport where everyone wins.
Basics of Real Estate Syndication
So when I get the question, “James, how does a real estate syndication work?”, I typically will compare it to traveling on an airplane.
There are several groups of people involved such as:
- pilots
- passengers
- flight attendants
- mechanics
- luggage and ground crew
Using this analogy, the deal sponsor of a syndication are the pilots and you and I (passive investors) represent the passengers.
Even though both groups are traveling to the same destination, each have considerably different roles during the process.
If surprises occur such as unexpected weather conditions or engine problems, it’s the pilots who are responsible for the flight.
They’re the ones who will monitor and update the passengers during the flight:
(“Good afternoon, this is your captain speaking. We’ve hit an area of turbulence but should be through it shortly….”).
And it’s the passengers job to sit back and allow the pilots to make the decisions on what’s best to flying the plane.
Make Sense?
“90% of millionaires become so through owning real estate.” – Andrew Carnegie
Hopefully you now get a gist of what’s involved during this process as real estate syndication deals works much the same way.
There’s several groups of people that all share a vision and want to improve a particular asset such as:
- Sponsor (general partner)
- Passive investors (limited partners)
- Brokers
- Property management
However, each person’s role within the project is different.
Let’s take a look at the two main groups involved:
#1 General Partner (GPs)
They’re also known as the sponsor group and typically:
- find the deal(s)
- get it under contract
- arrange inspections
- evaluate the numbers
- obtain financing
- keep it leased
- manage the property
#2 Limited Partner (LPs)
This group is made up of those that choose to invest passively with limited risk.
Remember, they have no active responsibilities in managing the asset.
How can you profit from a Real Estate Syndication?
Now that you understand the basic operation of how a syndication works, let’s discuss how you can profit from investing in this type of deal.
Profit in any type of real estate opportunities, regardless of a syndication or not, comes from:
- rental income
- appreciation
Profit is generated when the operating costs of the property are LESS than the rents collected.
This is known as the NOI or net operating income which represents the cash flow distributed to the limited partners via distributions (monthly or quarterly).
Investors will receive an additional benefit as typically a property’s value usually appreciates over time. Because of this, the investors can net higher rents and earn larger profits when the property is sold.
Syndication example
In order to drive this concept home, let’s use an example.
Let’s say that you’ve been researching about the syndication process via blogs and other forums and decide to jump in and invest.
A group buys a 350-unit apartment complex in Charlotte, NC for the purchase price of $50 million.
Everything you need to know is outlined in the Private Placement Memorandum (PPM) which you read BEFORE investing.
You learn that the bank financing the deal requires a 30% down payment ($15M). Of this amount, the sponsors cover $1.5M and then they raise money from limited partners (LPs) for the remaining $13.5 million of the required equity.
A syndication is now formed (Limited Liability Company or LLC) between the general partners and limited partners and the apartment complex is purchased.
The projected hold time for this project was initially set forth at 5 years. During this time period, the business plan including “forced appreciation” as it was a value-add deal.
Improvements to the property were made such as:
- upgraded fixtures
- new flooring
- granite countertops
- stainless steel appliances
- new cabinets
- new signage
- update fitness center
- rehab existing pool
- parking lot upgrades
- painting (interior and exterior)
- new landscaping
- internet and wifi update
During this time period improvements were being made, the rents were gradually raised to the same amounts being charged by other local apartments with the same amenities.
Due to the increased rental income, the syndication sends the passive investors a share of the profits from the rental properties every quarter. (Profit #1 rental income)
After five years, a buyer is found and the complex is sold for $15 million ($65M) over the original sales price.
At this time, the limited partners get back their initial investment plus a share of the $15 million profit from the sale. (Profit #2 appreciation)
Remember, during this five year hold period, all of the passive investors received distributions on a quarterly basis from the profit made with the rental income.
What’s the Investing Process?
The next logical question you’re probably asking yourself is, “How do I invest?”
Here are the steps for getting into the syndication game.
- The sponsor sends out a “deal offering” email that an investment is open.
- Review the offering memorandum (property description) and make an investment decision.
- Submit the amount you want to invest to the sponsor.
- The sponsor holds an investor webinar, where you can get more information and ask questions.
- The sponsor confirms your spot in the limited partnership and sends you the PPM (private Placement memorandum)
- Fund the deal via wire or check.
- The sponsor confirms that your funds have been received.
- You’ll receive a notification once the deal closes and what to expect next.
