What is Real Estate Syndication?
Investing in Property as a Group
It is common for most people to associate real estate investing with purchasing a house and renting it out. In this typical situation, there is usually one investor purchasing the home. This investor finds the property, purchases it, coordinates the renovations, and then rents it out. This characteristic investor wears all hats.
Single-owner investing is very common with smaller properties but is less common with large commercial and multifamily properties. Larger properties are usually purchased by a group; more commonly referred to as a real estate syndication.
Real estate syndications involve the combination of several general partners (investment managers) and usually dozens of limited partners (passive investors) to purchase a property as a group.
Real estate syndications are an alternative to the common theory of purchasing a single-family home by yourself. Investing in property as a group; allows individual investors the ability to own a portion of an otherwise unattainable large real estate asset. The property is then owned by all of the individual investors and operated by the general partners.
One benefit associated with investing in a real estate syndication is that passive investors are able to invest in larger assets that are managed by experienced professionals. The limited partners bring the majority of the funds required to purchase and reposition the property while the investment managers bring their knowledge, finances, and team to the table in order to handle all of the active duties.
The major benefit of real estate syndication investing is that limited partners are passive investors. Once a limited partner makes their investment; their work is done. The investment managers handle all of the other responsibilities. They identify the property, purchase it, coordinate renovations, oversee management, and ultimately sell the property. Both the passive investors and the investment managers split profits generated from the property’s operations and the sale of the property; with the majority of profits going to the passive investors.
Most real estate investors don’t want to manage tenants, toilets, or termites. For these investors, investing in a property as a group is a great solution. They get all of the benefits of real estate ownership; passive cash flow, appreciation, tax benefits, professional management, etc. without the hassles and time commitments required with being a traditional landlord.
In addition, real estate syndications have the potential for high returns. Many passive real estate investors will see annual returns of 8-15%, and sometimes even higher. As with any investment, there are risks involved with investing into real estate syndications and passive investors should only invest what they can afford to lose.
Real Estate Syndication vs REIT
A real estate investment trust, commonly referred to as a REIT; is a company that invests in multiple commercial real estate properties. Investors purchase shares in the REIT and own a portion of the company; instead of directly owning a part of a specific property. REITs are usually publicly traded companies but, they can also be privately held. REITs are similar to real estate syndications since investors are able to generate passive income while the REIT’s managers handle and oversee all of the operations.
There are several big differences between real estate investment trusts and real estate syndications (investing in a property as a group).
1. Ownership Structure
When investing in a REIT, you are purchasing shares in a company, similar to investing in a public stock. The investor does not directly own the actual real estate; they own shares in the company that owns the real estate.
When investing in a real estate syndication, you are investing directly into a specific property. The general partners and the limited partners (passive investors) will actually own the entity (usually an LLC or LLP) that owns the asset. In other words, the investors have direct ownership of the property.
2. Control Over Investments
Real estate syndication investors have the ability to review and select specific properties and deals to invest in. The syndication operators will provide all investment offering documents and information to investors in order for them to make an educated decision prior to investing.
When investing in a REIT, you are handing over all control to the company. The company will make all of the decisions in regard to what markets to target, what property types, and what specific properties to purchase. Individual investors are able to perform their due diligence on the company and its managers but, they have no control over the properties that will be purchased.
3. Investment Minimums
When investing in a REIT, there usually are very small minimums; sometimes as little as $100. This makes it very appealing to many investors; especially new real estate investors.
On the other hand, when investing in a real estate syndication, the minimum investments are much higher; usually $50,000. This higher minimum investment creates a barrier to entry for many new real estate investors.
When investing in a REIT, you are purchasing shares of a company that is easily redeemable at any time. This liquidity is one of the main differences between REITs and real estate syndications.
Real estate syndication investors are directly investing in an actual piece of real estate. Similar to when you are purchasing a home or a rental property yourself, you are unable to quickly sell a property for market value.
During the real estate syndication hold period, the investor’s funds are illiquid and cannot be sold. If the passive investor needs their money back before the estimated sale date, they should avoid investing in a real estate syndication.
5. Tax Benefits
Tax benefits are one of the best advantages of investing in real estate syndications. When you are directly investing in a property, you receive a number of tax benefits, including depreciation. The depreciation deduction allows investors to deduct the value of the property over time. In other words, as the business plan for the property is being implemented, and the value of the asset is increasing; the IRS allows investors to deduct a portion of the value every year.
The depreciation benefits can be very substantial and can possibly offset your other income. It is very common for the depreciation deduction to exceed the actual cash flow an investor is receiving from the property. Put simply, as you receive actual cash distributions from property operations; you are showing a loss on paper. When the depreciation surpasses the positive cash flow; you are not paying taxes on the cash flow. The taxes would be deferred until the property is sold. If you reinvest into another similar syndication during the same year as the sale of the first property; you might be able to defer taxes even further (speak to your accountant about your specific situation).
When investing in a REIT, the company must distribute at least 90% of its taxable income to shareholders every year in the form of dividends. These dividends are taxed as ordinary income, which will make your tax bill larger, not smaller.
Returns can vary extensively from investment to investment however, when reviewing the historical data (https://www.fool.com/research/reits-vs-stocks/) for exchange-traded U.S. REITs over the past 5 decades, REITs averaged a return of 11.9% per year. By comparison, the S&P 500 returned 10.7% over the same period. If you were to invest $100,000 into a REIT; on average, you could expect a return of $11,900 per year in dividends.
A typical multifamily real estate syndication will return 15%-20% per year when combining the cash flow with the profits from the sale of the property. After making a $100,000 investment; investors can expect a return of approximately $20,000 per year, for 5 years. Simply put, an investor could double their money over this 5-year period.
This difference in returns; along with the fact that most cash distributions from a real estate syndication will be tax deferred; significantly increases the investor’s returns over a 5, 10, or 20-year period.
Commercial Real Estate Syndication
Commercial real estate syndication offers the ability for investors to combine resources in order to acquire larger and higher-quality commercial properties. Commercial real estate syndications are security offerings that consist of two groups of people; the investment managers (general partners) and the passive investors (limited partners).
There are a number of benefits to commercial real estate syndication when compared to purchasing a rental property directly.
• Larger Properties
Commercial real estate syndications pool the investment dollars of many different investors; allowing the group to purchase larger properties, in better locations. Instead of just a few investors each investing $100,000 to purchase a $2 million property; with a commercial syndication, hundreds of investors are now able to invest $50,000 each and purchase a $20 million property. Allowing investors to diversify their portfolio with high-quality commercial real estate assets easily.
Most real estate syndication firms will target “institutional-grade” properties. These are the best commercial real estate assets. These assets are typically newer, in great, growing locations, have high-quality tenants, and are the most sought-after commercial real estate assets. Without the use of a commercial real estate syndication; these assets would remain owned by the typical institutional investors; life insurance companies, pensions, insurance companies, hedge funds, mutual funds, etc.
Institutional-grade commercial real estate assets hold their value the best, generate very consistent income, and are typically more liquid (easier to sell) because the pool of buyers (institutional investors) is very well capitalized (even during a recession).
• Less Volatility
Volatility is not a concern that many new real estate investors consider when buying their first rental property. They purchase a duplex and each tenant will pay their rent on time, every month, right? Any experienced real estate investor will tell you that this is just not the case. Small rental properties are especially volatile and this volatility only increases as the class of the property decreases.
Large commercial properties, on the other hand, offer exceptional stability. In a 100-unit apartment complex; if you have 10 units that are vacant or the tenants are not paying rent, you still have 90 units (90 income streams) generating revenue. Compare this with a duplex with 1 unit not producing any income (vacant, non-payment, eviction, etc.). It puts the owner in a very tough position.
A business plan for a commercial real estate syndication usually consists of making the property more efficient and profitable. This business plan typically takes a few years to complete however; small positive changes will be noticeable in the first couple months. Investors will see the value of their asset increase as the property is repositioned.
• Lower Investment Amounts
Most banks and credit unions that lend on investment real estate will require a 20%-30% down payment. Add in the other costs of purchasing real estate; closing costs, renovation budget, reserves, working capital, etc., and the total percentage could increase into the 40%-45% range. An investor looking to purchase a $300,000 rental property, might have to come out of pocket nearly $90,000 to just purchase the property, plus another $30,000 in order to reposition the property correctly. This investor now has over $120,000+ invested into a small rental property.
Compare this with a commercial real estate syndication. Syndications typically have a minimum investment of $50,000. This would allow the same investor to place their capital into 2 different syndication deals. Instead of this investor having exposure to just a few rental units in just one market; the investor now has exposure to possibly hundreds of rental units (income streams ) in multiple markets. Lower investment minimums help to diversify the investor’s portfolio.
• Completely Passive Investing
Commercial real estate syndications are true passive investments. Investors have no involvement in the deal after they have completed their investment. The investment managers (operators) oversee the entire project. They hire the property manager and sign off on vendors and contractors. They have weekly calls with the property manager while making frequent visits to the asset. This is done while passive investors receive regular distributions from the property operations.
This is quite a different experience from the small real estate investor who is self-managing their properties or has even hired a professional property manager. The investor always has some level of involvement. This could range from the person who clears a drain in the middle of the night to the investor with a property manager who just reviews financials, signs off on large repairs, and makes surprise property visits but, there is always some level of involvement.
Commercial real estate syndication is completely passive. Many passive investors in these deals are successful entrepreneurs and professionals who like the benefits of real estate but do not want to spend hours every week overseeing their own properties. Other passive investors consist of previous landlords themselves who are burnt out and want to take a hands-off approach to real estate investing or current landlords who want to grow and diversify their portfolio.
• Professional Onsite Property Management
Onsite property management is one of the most overlooked benefits of investing in a commercial real estate syndication. Many small rental property investors will have a handyman that comes to their property when there is an issue or a leasing agent that will meet potential tenants at the property when they are renting an apartment. This works, but it is very inefficient. The tenant needs to call the manager who then needs to contact the handyman or leasing agent and then contact back the tenant. Then the handyman needs to drive to the property and address the issue. If the handyman has other jobs, they might not get to the property for hours or even days.
Large commercial properties have onsite property management. This is a team of people that run the property and their work is overseen by the offsite property management company. This team consists of handymen and leasing agents. When a tenant submits a service request through the property’s website; the request is routed directly to the onsite handymen who are able to quickly address the problem in a fraction of the time it would take an offsite handyman. The onsite staff is paid a salary making each service request much less expensive to address when compared to an offsite handyman.
Potential tenants who are interested in renting an apartment, are able to speak to someone, right away, onsite, view the apartment, and complete an application all at the same time; without any advance notice. This dramatically decreases unit downtime.
Real Estate Syndication Non-Accredited
If you have performed any research on real estate syndications, you will quickly realize that most real estate syndications are only available to accredited investors. Unfortunately, this misleads many potential investors into believing that they need to be accredited in order to invest in a real estate syndication. Nothing could be further from the truth.
Non-accredited real estate syndication investing is a possibility but, it takes a couple of extra steps on the part of the investor. First, the investor needs to seek out real estate syndication companies that accept nonaccredited investors. These companies will write certain phrases on their website to indicate the types of deals they do. Examples of these phrases will include; 506-B deals (nonaccredited investor terminology), open to all investors, nonaccredited investing, etc. Secondly, the investor needs to reach out to these companies; usually by completing a short “invest with us (https://harborsidepartners.com/investors/)” form. It is important to note that nonaccredited syndication deals will never be advertised and per the SEC (Securities and Exchange Commission) rules; deals are only able to be offered to investors that have a substantive relationship with a partner of the company. That relationship starts with a call.
Real Estate Syndication Companies
Professional syndication operators (general partners) run real estate syndication companies. The real estate syndication companies, work with passive investors (limited partners) to purchase, reposition, and then resell commercial real estate assets.
Real estate syndication companies have a number of roles and responsibilities:
• Research different real estate markets
• Underwrite hundreds of potential properties in the selected market and submit offers
• Negotiate deals and place properties under contract
• Work with attorneys to draft the necessary paperwork
• Perform due diligence on the physical property, financials, and the title
• Cover all expenses and deposits prior to closing on the property
• Speak to passive investors and raise the necessary funds
• Close on the property
• Change property management, renovate the property, maintain high occupancy
• Distribute profits from operations to the limited partners
• List and sell the property once the project is complete
• Distribute profits from the sale to the limited partners
Real estate syndication companies are not limited to the type of properties they are able to syndicate. These properties include; apartment buildings, industrial properties, retail real estate, commercial office space, land, mobile home parks, and self-storage complexes.
How to Invest in Real Estate Syndication
The first step in the real estate syndication investment process is to make contact with potential syndication companies by completing the Invest with Us form on their website. Next, you will most likely get on a call with a partner from the syndication firm. They will answer all of your questions and provide you with an overview of their investment strategy while adding you to their email list in order to be alerted when they have a new deal.
Once you receive a new deal alert email, quickly review the deal and if it is of interest to you, submit a soft reserve (also known as a soft commitment) on the firm’s website. There is a link to it in the new deal alert email. The soft reserve holds your spot in the deal while you perform your due diligence and get any questions you might have answered.
The next step is to start your due diligence. Review all of the deal particulars; where it is located, who is managing it, how old is it, what is the business plan, what are the proposed returns, etc.
Next, perform your due diligence on the syndication company. How many deals have they done? How long have they been investing in real estate? Are they full-time or part-time real estate investors? What is their track record? What type of systems or partners do they have in place to assist their team during the repositioning process?
After you have completed the due diligence and you want to move forward with investing; contact the sponsor and let them know. They will typically send you a link to their investment portal so that you are able to complete the necessary paperwork. The paperwork will consist of a Private Placement Memorandum (PPM) and a Subscription Booklet. The PPM outlines the details; of the deal, the sponsors, the property, the risks, the roles of each member, and how the profits will be distributed. You will complete and sign the Subscription Booklet and then wire your investment funds to the bank account details listed in the Subscription Booklet. It is important to always call and verify the bank account details with the sponsor (over the phone) prior to wiring the funds.
Have the sponsor read back the correct bank account details while you verify it is the same as what you see on your end.
Once your wire is received, the sponsors will countersign the Subscription Booklet which confirms your acceptance of the deal. At this point, you have just invested in a real estate syndication and your work is done!