SS187: Unveiling the Secrets of Commercial Property Syndication

SS187: Unveiling the Secrets of Commercial Property Syndication

Commercial property syndications are an ever-popular investment vehicle. In this episode, Charles discusses the ins and outs of commercial property syndications.

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Talking Points:

  • Commercial real estate syndication is an investment strategy that allows investors to pool their resources to purchase commercial properties. This approach gives investors access to larger, possibly more profitable commercial real estate properties that aren’t typically available to individual investors to buy or manage by themselves.
  • When we talk about commercial properties, what are we referring to?
    • Office buildings
    • Retail Properties
    • Industrial warehouses
    • Self-storage complexes
    • Mobile home parks
    • Hotels
    • And Multifamily apartment complexes (apartment buildings with 5 or more units)
  • The typical syndication structure consists of 2 parties.
    • The first is the sponsor, also known as the general partners, GPs, key principles, deal operators, etc. This group organizes the syndication and handles all aspects of the project. From choosing the market, identifying the property, assembling the team, raising capital from the general partners and the limited partners, closing on the property, working to execute the business plan, and ultimately selling the property.
    • The second are the investors, also known as the limited partners, LPs, passive investors, etc. The investors simply review the deal and invest their capital. Once the investors have wired their funds, their active role in the project is over.
  • Let’s break down the typical syndication process.
    • Formation. The sponsor locates a commercial property, underwrites the property, and conducts thorough due diligence, including market analysis and financial projections for the proposed business plan. They enlist the services of their team, including their attorney, lender, property manager, property inspector, and various contractors, to complete this step. Usually, 2 attorneys are used: an SEC attorney to handle the syndication documentation and filings and a real estate attorney who will handle the closing and work with the seller’s legal counsel.
    • Capital Raising. Once the deal is in motion, the sponsors begin the fundraising process, where they will contact their investor base and offer them the opportunity to invest in this new project. There will be a pitch deck, a webinar, and the ability to get on a call with a general partner’s team member to discuss the opportunity. Investors must review and sign several legal documents to proceed and wire their investment funds.
    • Management. Once the deal has closed, the real work begins. The sponsors work to execute the business plan over the next 5-7 years while providing monthly updates to the investors along with regular profit distributions, usually beginning 6-12 months after closing. During the investment hold time, sponsors will work to improve operations.
    • Exit and/or Liquidity Event. Once the business plan has been executed, or in many situations, a potential buyer contacts the sponsor or the sponsor’s broker to buy the property and complete the business plan themselves; either way, the property is sold, and funds are distributed to investors and sponsors as outlined in the syndication documents.
  • Some of the main benefits of syndications include:
    • Diversification. Investors can diversify their portfolios by passively owning a portion of various commercial properties across different markets and asset classes.
    • Access to Larger Properties. Syndication allows investors to participate in larger properties and projects, which are usually unavailable to individual investors.
    • Professional Management. Experienced sponsors oversee the entire property and all contractors and employees required to operate it. Of these contractors, the most notable is the property management company.
    • Possibility for Higher Returns. Larger properties typically can provide their investors with higher, more consistent, less volatile returns because of the economies of scale.
  • What are some of the risks associated with syndications?
    • Sponsor Risk. The success of any syndication largely depends on the sponsor’s experience, integrity, knowledge, and management skills.
    • Real estate investments, in general, are illiquid investments, and investors need to invest funds they do not need to access during the investment hold time, which could be upwards of 10 years.
    • Market Risk. Market dynamics can change during an investment’s hold time. If the property is in a growing market and neighborhood, this will increase the investment’s value, but if the market begins to decline, it can negatively affect the property’s value.
    • Legal and Regulatory Risks. If local laws around real estate and the specific asset class change (think COVID eviction moratoriums), the property’s value could be negatively affected.
  • What are the key metrics used when analyzing a syndication?
    • There are several metrics that a potential investor will review before investing, but the 3 main ones include:
      • Internal Rate of Returns (IRR). This metric evaluates the investment’s profitability and considers the time value of money and all cashflows over the investment period.
      • Cash-on-Cash Return. The cash-on-cash return is the annual pre-tax cash flow divided by the total cash invested. It represents the actual cash return on the investor’s capital.
      • Cap Rate (Capitalization Rate). The cap rate measures the property’s income-generating ability, calculated as the annual net operating income (NOI) divided by the property’s purchase price. Debt or leverage is not a factor in the cap rate calculation.
      • Equity Multiple. Equity multiple is the total cash distribution from an investment divided by the total equity invested. An equity multiple of less than 1x means you are getting back less than what you invested, an equity multiple of 1x means you have broken even, and an equity multiple of 2x means you have doubled your money.
    • When performing due diligence on a project, what are some of the main factors you want to review?
      • Sponsor Review. Is the sponsor experienced in this particular asset class? Have they successfully completed similar deals? Do they have a team on the ground that can execute the business plan?
      • Property Analysis. What is the physical condition of the property? How old is it? Is there any deferred maintenance?
      • Market/Neighborhood Analysis. Is the market growing? Is the neighborhood on the way up or the way down? For apartment complexes, is it close to retail and restaurants but still in a residential area?
      • Business Plan Analysis and Financial Review. Is the business plan feasible? Are the rent projections attainable? Are the comparables accurate? Are the repair and renovation budgets accurate? Is the debt fixed or floating rate?

Commercial property syndications allow investors to invest in large real estate opportunities while benefiting from professional management and limited risk. The advantages of being a passive investor, including quickly diversifying your portfolio and the potential for higher returns, come with some tradeoffs. Their investment is illiquid, and they do not have any control over the property. This requires passive investors to thoroughly vet not only the property and project but also the sponsor.

Transcript:

Charles:
Welcome to Strategy Saturday; I’m Charles Carillo, and today we’re going to be discussing unveiling the secrets of commercial property syndication.

Charles:
Commercial real estate syndication is an investment strategy that allows investors to pool their resources to purchase commercial properties. This approach gives investors access to larger, possibly more profitable commercial real estate properties that aren’t typically available to individual investors to buy or manage by themselves. When we talk about commercial properties, what are we referring to? This can be office buildings, retail properties, industrial warehouses, self-storage complexes, mobile home parks, hotels, and multi-family apartment complexes. So apartment with five or more units. And the typical syndication structure consists of two parties. The first is the sponsor, also known as the general partners, gps, key principles, deal operators. And this group organizes the syndication, handles all aspects of the project from choosing the market, identifying the property, assembling the team, raising capital from the limited partners, closing on the property, working to execute the business plan, and ultimately selling the property.

Charles:
Now the second group are the investors also known as limited partners, the LPs, passive investors, and the investors simply review the deal and investors their capital. Once the investors have wired their funds, their active role on the project is over. So let’s break down the typical syndication process. Number one is the formation. So the sponsor locates a commercial property, underwrites the property, and conducts thorough due diligence, including market analysis and financial projections. For the proposed business plan, they enlisted services of their team, including the attorney, the lender, the property manager, property inspector, and various contractors to complete the step. Usually two attorneys are used an SEC attorney to handle the syndication documentation and filings, and a real estate attorney who will handle the closing and work with the seller’s legal counsel. Number two is capital raising. So once the deal is in motion, the sponsors begin the fundraising process where they will contact their investor base and offer them the ability and to invest into this new project.

Charles:
Now there will be a pitch deck, a webinar, and the ability to get on a call with a member of the general partners team to discuss the opportunity, investors must review and sign several legal documents to proceed and wire their investment funds in. Number three is management. So once the deal’s closed, the real work begins. The sponsors work to execute the business plan over the next five to seven years, while providing monthly updates to the investors, along with a regular profit distributions that usually begin six to 12 months after the closing on the property. Now, during the investment whole time, investors will work to improve operations, and number four is the exit and liquidity event. So once the business plan has been executed, or in many situations, a potential buyer contacts the sponsor or the sponsor’s broker to buy the property and complete the business plan themselves.

Charles:
Either way, the property is sold and the funds are distributed to investors and sponsors as outlined in the syndication documents. Now, some of the main benefits of syndications include number one, diversification. So investors can diversify their portfolios easily by passively owning a portion of various commercial properties across different markets and different asset classes. Two is gonna be access to larger properties. So syndication allows investors to participate in larger properties and projects, which are usually unavailable to individual investors. Three is professional management. So experienced sponsors oversee the entire property and all the contractors and employees required to operate in of these contractors. The most notable is the property management company. Four is the possibility for higher returns. Larger properties typically can provide their investors with higher, more consistent, less volatile returns because of the economies of scale that it has. So what are some of the risks associated with syndications off the bat?

Charles:
Number one, sponsor risk. The success of any syndication largely depends on the sponsor’s experience integrity, knowledge, and management skills. Next is illiquidity. So real estate investments in general are illiquid investments and investors need to invest funds they do not need to access during the investment whole time, which can be upwards of 10 years. Next is market risk. So market dynamics can change during an investments whole time. If the property is in a growing market neighborhood, this will increase the investments value. But if the market begins to decline, it can negatively affect the property’s value. Next is legal and regulatory risks. If local laws around real estate and the specific asset class change, think covid and eviction moratoriums, the property’s value could be negatively affected. What are some of the key metrics used when analyzing a syndication? So there are several metrics that potential investor will review before investing, but the three main ones include the internal rate of return, which is IRR, and this metric evaluates the investment’s profitability and considers the time value of money in all cash flows over the investment period.

Charles:
The next is gonna be the cash on cash return. Now the cash on cash return is the annual pre-tax cash flow divided by the total cash invested, and it represents the actual cash return on the investor’s capital. Number three is the cap rate, the capitalization rate. Now the cap rate measures the property’s income generating ability calculated as the annual net operating income. The NOI divided by the property’s purchase price and debtor leverage is not a factor in the cap rate calculation. Now I said there’s gonna be three, but there’s actually four ’cause there’s one more I want to add in here. And it’s called the equity multiple. The equity multiple is a total cash distribution from an investment divided by the total equity invest it. Okay, so in an equity multiple of less than one X means you’re getting back less than what you invested an equity multiple of exactly.

Charles:
One X means you have broken even, and an equity multiple of two x means you have doubled your money. Now, when performing due diligence on a project, what are some of the main factors you wanna review? So for us, it’s sponsor review, it’s a sponsor experience. In this particular asset class, have they successfully completed similar deals? Do they have a team on the ground that can execute the business plan Property analysis? So what is the physical condition of the property? How old is it? Is there any deferred maintenance? Next is the market and neighborhood analysis. Now, is the market growing? Is that neighborhood on the way up or the way down for apartment complexes? Is it close to retail and restaurants, but still in a residential area? Real estate is so hyper-local that you really have to drive the neighborhood because each block can change and the rents and the profitability and the success of a project can really change by street.

Charles:
Lastly, it’s gonna be the business plan and the analysis and financial review. Now, is the business plan feasible? Are the rent protections attainable? Are the comparable accurate? This is a big one. They people will put comparable like rent comparable of what they’re saying. A property can reach in rental but the comparable they’re using is miles away. Or it’s 10 years or 20 years newer. These aren’t good comparable. Are the repair and renovation budgets accurate? Is the debt fixed or is it floating rate? Commercial property syndications allow investors to invest in large real estate opportunities while benefiting from professional management and limited risk. Now, the advantages of being a passive investor, including quickly diversifying your portfolio and the potential for higher returns come with some trade-offs. Their investment is ill liquid and they do not have any control over the property. This requires past investors to thoroughly vet not only the property and the project, but also the sponsor.

Charles:
So I hope you enjoyed. Please remember to rate, review, subscribe, submit comments and potential show topics at globalinvestorspodcast.com. If you’re interested in actively investing in real estate, please check out our courses and mentor and programs at syndicationsuperstars.com. That is syndication superstars.com. Look forward to two more episodes next week. See you then.

Charles:
Have you always wanted to invest in real estate, but didn’t have the time, didn’t know where to find the deals, couldn’t get the funding and didn’t want tenants calling you. Since 2006, I’ve been buying income producing properties and great locations that provide us with consistent passive income. While we wait for appreciation in the future and take advantage of tax laws while we’re waiting and unlike your financial advisor, we invest alongside our investors in every property we purchase. Check out to investwithharborside.com. If you like the idea of investing real estate, if you like the idea of passive income partner with us at investwithharborside.com, that’s investwithharborside.com.

Announcer:
Nothing in this episode should be considered specific, personal or professional advice. Any investment opportunities mentioned on this podcast are limited to accredited investors. Any investments will only be made with proper disclosure, subscription documentation, and are subject to all applicable laws. Please consult an appropriate tax legal, real estate, financial or business professional for individualized advice. Opinions of guests are their own information is not guaranteed. All investment strategies have the potential for profit or loss. The host is operating on behalf of Syndication Superstar, LLC, exclusively.

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