A real estate syndication is a business organization with a sponsor and a group of investors that purchases and manages a large commercial property. This offers average people the opportunity to put money into large-scale commercial deals.
- They work by pooling investors’ money under the control of a sponsor who contracts the property and manages the investment
- The legal structure is usually an LLC or LP to protect both the sponsor and the investors
While these present the opportunity for high profits, they aren’t for everyone. It is a single asset investment, so the risks are high. Also, you own a large asset that you can’t easily sell.
How Does Real Estate Syndication Work?
Real estate syndication works by allowing investors to pool resources with other people. They can finance projects much bigger than they can afford alone. This concept is also called crowdfunding. It starts with a sponsor, or syndicator. They find deals, do due diligence on the project, and then structure the program. They then recruit investors to fund the project. There are three ways to make money on this type of investment:
- Acquisition fees – Sponsors find the property and structure the deal.
- Asset management fees – The manager of the property and syndicate partnership usually earns 1% of gross revenue.
- Equity participation – Investors usually have a 5% – 50% stake. They earn a preferred rate of return on invested capital. Then they earn a percentage of remaining cash flow/equity.
Basically, these are business entities that pool money for large commercial projects. They give people the opportunity to participate in projects that they weren’t able to in the past.1
What is Crowdfunding?
Crowdfunding is a business strategy that allows people to fund single asset commercial properties. It has great profit potential, but it also has high risks. These:
- Let you invest in a single property
- Have high-profit potential
- Offer steady income and equity appreciation
- Diversify your portfolio
- Allow you to finance a commercial without management issues or tenant problems
While this may sound good, there are drawbacks. This is not for everyone. Some things to consider are:
- It is much riskier than other types of investments because it’s backed by only one asset
- You can’t easily sell them if you need money
- You may not see any income until the venture starts to make a profit
These ventures have high-profit potential and high risks. They aren’t for everyone, and you should learn as much as you can before putting money into one.2
What is a Sponsor?
A sponsor is also called a syndicator, and they manage and operate the deal. They are the most important part of the team. The success of the project depends on his/her competence. Their responsibilities include:
- Sourcing the project
- Raise funds to finance the purchase
- Contract the property on behalf of the syndicate
- Manage operations of the property
Often, in addition to this sweat equity, they put capital into the venture. A sponsor typically puts in 5% – 20% of the total equity. Therefore, they have the biggest stake in the success of the project.3
Real Estate Syndication Vs. REIT
A real estate investment trust (REIT) finances income-producing commercial properties, but it doesn’t put money directly into a single asset as syndication does. There are several important differences between the two:
- REITs fund a portfolio of properties instead of a single property.
- With a REIT you buy a share of a company and don’t have direct ownership of a property.
- You invest in a REIT by buying stock, but syndications require contracts. They have more complicated ownership structures.
- Minimum investment amounts are much lower for REITs.
- REITs are as liquid as any other stocks. Syndications are among the most illiquid investments available.
- Tax benefits for syndications include depreciation, while REITs have the same tax implications as other stocks.
Which is right for you? Carefully consider the pros and cons of each. Generally, if you have less money and are more risk-averse then invest in REITs. If you need to diversify and can wait longer for your investment to produce, then consider syndicates.4
Real Estate Syndication Structure
A real estate syndicate is usually a limited liability company (LLC) or a limited partnership (LP). These protect the interests of the sponsor, any limited partners, and passive members. The legal entity grants rights that include:
- Sponsor’s management fees
It also sets forth the operating or partnership agreement depending on the legal structure. These are like setups for other private funds in the venture capital industry.5
Final Thoughts on Real Estate Syndication
This is a new field that took off after the JOBS act passed in 2012. Today, there are several crowdfunding platforms that analyze deals and present them to potential investors.
These platforms make syndication more accessible for people, but you do need money. Under exemption 506(c) in the federal law investors in these syndicates must be accredited. This means you have assets of at least $1 million excluding your primary residence, an income of at least $200,00 per year for an individual, or an income of $300,000 combined income for a couple.
These requirements underscore the importance of financial competence when investing in these riskier opportunities. A couple of good platforms to examine if you are a credited investor are Crowd Street and Realty Mogul. Fund Rise is a good platform to examine even if you are not accredited.