HOW INVESTING IN REAL ESTATE SYNDICATION WORKS
A real estate syndicate is an investment vehicle that opens up the world of real estate for everyday investors. It can represent a key piece of your investment portfolio and offer exposure to the real estate market.
If you’ve traded stocks or owned equity in a business, the concept of real estate syndication shouldn’t be too unfamiliar. The ways for a real estate investor to profit are similar. But first, let’s look at a recap of a real estate syndication.
RECAP OF REAL ESTATE SYNDICATION
We’ve previously discussed real estate syndication and how it’s used for investors to fund real estate projects. Here’s a quick recap.
Real estate syndication is the process of gathering capital from multiple investors in order to fund real estate projects. From an investor’s perspective, this gives them access to real estate investments they wouldn’t otherwise be qualified for by enabling them to purchase equity or shares in the property or project. In a sense, real estate syndication is a way to crowdfund real estate investments.
There are two parties in real estate syndication deals: sponsors and investors.
Sponsors are usually represented by a management team within a real estate investment company. They serve as the real estate professional and expertise in the equation.
The sponsor’s job is to identify lucrative real estate projects, gather investors for funding, manage the lifecycle of the project and ensure appropriate returns for investors.
Investors can be anyone who is accredited to invest in real estate syndications. They are responsible for the majority of the financing for designated real estate syndications.
Syndicators are given equity in the project in exchange for their investment, and are entitled to their share of the profits and value of the property, whether it’s commercial real estate or residential.
Real estate syndications usually take the form of a Limited Liability Company (LLC) or Limited Partnership (LP). This benefits investors and shields them from any liability in excess of the capital they put up as investment.
WAYS TO PROFIT FROM REAL ESTATE SYNDICATION
With the basic understanding of a real estate syndication and the role each party plays, let’s take a look at how sponsors and investors profit from the process.
But before getting too deep in the weeds, review the stats below regarding real estate syndications.
Commonly Cited Syndication Stats
The stats below are common for real estate syndications:
- Average syndication size: $2.3 million
- Investor commitment: 80-95%
- Sponsor commitment: 5-20%
- Average preferred return: 8%
- Average sponsor acquisition fee: 1%
- Sponsor property management fee: 2-9% Gross revenue
Ways the Sponsor Profits
Let’s start by analyzing how sponsors profit from real estate syndication.
- Acquisition Fees: Sponsors have an acquisition fee that’s typically 1% of the acquisition costs associated with the property. This fee can range up from 1% to 5%, or you can see this as a flat fee (i.e. $25,000). These fees are generally negotiable with other investors brought into the deal.
- Property Management Fees: Sponsors typically get a fee for managing the property as well as the syndicate partnership. This fee is represented as a percentage of gross revenue, and is usually 2-9%.
- Equity Participation: Sponsors also get in on the action through their equity stake in the project. This entitles them to an appropriate portion of the profit and returns of the project.
You will see sponsor equity stakes anywhere from 5-50% depending on their experience and specifics of the deal, but more typically sponsors limit their equity participation to a maximum of 20%.
Ways the Investors Profit
Now let’s turn our attention towards the investors and explore the ways they profit through real estate syndication.
For investors, because real estate syndication is similar to buying shares of a company, their compensation mechanisms are similar as well.
- Preferred Returns: Investors usually get paid out preferred returns on a regular basis (i.e. annually or quarterly). This can be looked at as a type of dividend. On average, investors receive an annual preferred return of 8%.That means when revenue is determined, investors get paid out 8% as a preferred return before profits are split between equity stakeholders.
- Equity Participation: Very similar to owning shares of a company, investors have equity that gives them fractional ownership in the underlying asset. Investors usually own between 80-95% of the equity in real estate syndications.After fees and preferred returns are distributed, the remaining revenues are distributed amongst the equity holders proportionally. Along with revenues, investors with equity participation are also exposed to price fluctuations in the underlying asset. If the property rises in value, investors benefit.
Real Estate Syndication Example
Let’s assume a real estate syndication purchases a property for $1,000,000. Investors cover the acquisition and property management fees.
The project gets underway and starts generating $150,000 a year in profits. Before anything else happens, investors are entitled to their preferred return. Assuming the average of an 8% preferred return, investors receive $80,000 from the initial profit, 8% of 1 million.
That leaves $70,000 remaining in profit to split among equity stakeholders. Assuming an 80-20 investor-sponsor equity split, investors would see an additional $56,000 while the sponsor gets $14,000.
In this particularly generous scenario, investors would see a return of 13.6% for that year. In addition, they still have ownership in the property and benefit from an appreciation in value. This gives investors opportunity to profit on the backend of the deal when the property is sold or refinanced.
HOW TO FIND A TRUSTWORTHY INVESTMENT COMPANY
Investing in real estate syndication often means you will be working with a real estate investment company. Investment companies will put in the leg work to assemble a team and pool the capital necessary to make a successful project possible.
Now how do you identify an investment company to partner with? This is where another stock market-type example comes in handy:
You as an investor know you want to invest in the gold sector. You want to add a few mining projects to your investment portfolio, but how do you go about finding a successful company or project to invest?
The answer lies in the management team. You want a team that’s been involved with several successful mines in the past. You want a team that carries credibility and transparency so investors can reasonably trust their capital is in safe hands.
The same is true in real estate. Management teams with a combination of experience, credibility, and transparency are critical for investors in real estate who want to make their money back along with some tidy profits.
- Experience: The sponsor’s team should have a strong track record of acquiring, managing and successfully completing similar real estate projects.
- Credibility: The sponsor’s team members should have solid reputations for integrity and success within the real estate community.
- Transparency: The sponsor should be transparent about the process, even as things don’t go as planned. There should be consistent communication about how they are maximizing value for investors.
After locating a management team built for success, you should always evaluate the real estate project yourself and assess where it falls on your personal barometer for risk tolerance.
Now you know how a real estate syndication works, how you can profit as an investor, and some key factors to a successful investment company.
Here are some final questions to consider before you embark on your real estate journey with an investment company:
1. How Reliable are Projected Cash Flows?
You want to analyze the projected cash flows and determine if they are accurate and reliable. An investment with a single tenant might be more reliable than a multi-tenant project.
A single tenant with a long-term lease can be extremely consistent if you believe in their stability as a business or tenant overall. However, a project with multiple tenants on shorter leases allows flexibility in rent prices to stay on pace with market rates.
2. What is The Exit Strategy?
You need to understand the sponsor’s exit strategy for the investment. How long do they intend to hold the property? What principle will remain for investors at the end of the investment period?
Do you as an investor have the ability to liquidate your equity stake before the end of the investment period? Investors should know how they are getting their capital back when the project is completed.
Find a company that will be able to meet your needs as an investor and also provide the return you’re looking for. Best of luck!