I haven’t invested in real estate syndications at this point. That’s not to say that I won’t. I just really love investing actively in real estate…as you likely know.
But, I also recognize that not everyone will want to invest actively in real estate. You may be looking for something more passive…although remember that nothing is completely passive.
Can You Actually Achieve Real Passive Income?
For those of you who fall into this group, real estate syndications can be a great option to get your foot into real estate investing and diversify your investing portfolio.
My goal with this blog is to bring you as much authentic and genuine expert advice on these topics as we all journey to financial well-being. But, I don’t have any experience to share with you in this arena.
So, I thought I would interview someone who does!
Let’s set the stage
Cherry Chen is a full-time hospitalist in Dallas who also blogs as The Real Estate Physician. She also was a recent guest on The Doctors & Dollars podcast where she shared her real estate investing experience.
I really enjoyed having her as our podcast guest and learning more about real estate syndications.
So, I decided to pump her for more information to share with all of you! We go from soup to nuts (what does that even mean?!) on the topic of real estate syndications.
Let’s get going!
(And I mean it! Cozy up. This is one of my longer posts. But this is a tricky topic and an important one that I get asked about ALL the time. So I wanted to make it as accessible but also as thorough as possible!)
Real estate syndications FAQ
Q: What are real estate syndications?
A syndication is simply a way for people to pool their resources together.
A real estate syndication structure allows individuals to pool resources together to purchase an asset. By combining each individual’s knowledge, experience, time, and capital, everyone is contributing to the project. Everyone is sharing in the risks as well as the returns.
Without pooling resources together, it would be impossible to complete the transaction on an individual basis. This is why syndications are more commonly utilized for commercial real estate properties versus single family properties.
Commercial real estate typically includes properties such as multifamily apartments, self-storage facilities and manufactured home parks. Other common commercial real estate asset classes may include hotels, industrial warehouses, office parks and retail shopping centers.
Q: How are real estate syndications different from a real estate fund?
A real estate syndication is typically offering investors the opportunity to invest into one single property. In contrast, a real estate fund is typically offering investors the opportunity to invest into multiple properties. However, this definition is not 100% correct as syndications can include multiple properties. Also, some funds may be for single properties.
Generally speaking, investors diversify more in a fund as their capital spreads across multiple properties versus one single property. Depending on the fund, there may be additional fees charged to investors.
Q: How is it different from “traditional” active real estate investing?
(Traditional “active” real estate investing is how I invest in real estate. For a guide on that particular strategy, check out this post.)
For most people, “traditional” active real estate investing typically refers to investors purchasing properties to rent out. As an example, this can be a single-family home you purchase to rent out or put up for short or long-term rental. In this instance, you would typically save up to pay for a 20%-25% down payment and qualify for a loan. Factors such as your credit score, annual income and debt determine your loan terms and limits.
As the owner and loan guarantor, you have liability and ongoing responsibility to make the mortgage payments, which ideally your tenant would be doing for you if you are able to successfully rent out your property. Other expenses include property taxes, insurance, and a healthy reserve for emergency expenses. Beyond the financial and legal considerations, investors need to assess the time and experience an investment property may require of them in terms of managing the property.
As a passive investor in syndications, you can benefit from the sponsor team while still reaping the benefits of being a real estate investor.
You would not need to qualify or sign on the loans, nor have liability in these projects as a limited partner. The sponsor team manages the property so you don’t ever have to worry about dealing with “tenants, toilets, termites and trash.” Also, when you pool your money with other investors, you can invest in a better-quality asset (such as a 200-unit apartment complex). This provides economies of scale and leverage in terms of minimizing risk.
For more details on the benefits of passive over active investing for busy professionals, check out The Real Estate Physician Blog.
Q: Who typically runs real estate syndications?
A syndication usually runs through a limited liability company (LLC). The LLC is typically composed of general partners and limited partners.
The term “general partner” (GP) is synonymous with “syndicator” or “sponsor.” They are responsible for overseeing and managing the entire project and have unlimited liability.
The limited partners (LP), also known as passive investors, contribute a portion of the equity investment and have limited liability to the extent of their share of ownership. The GP is the active partner that manages and operates the property so passive investors don’t have to.
Q: So, I’m basically handing my money to someone and trusting them to invest it well. How can I as the investor make sure beforehand that they know what they’re doing?
It is important to learn how to vet a sponsor since they will have control of the project. One of the most common questions for investors looking into syndications is, “How do I know if I can trust the sponsor?” Investors will often first look to the investment returns. But the most important component of any syndication is inarguably the sponsor(s) who are leading the deal!
Syndications allow you to be a passive investor in which your capital is put to work. It is an attractive way to invest where you do not have to be active in the daily operations and management. This allows you to save time and effort and is an advantageous way to leverage your portfolio as a busy professional.
Since you are investing as a limited partner, you will have no control. So, vetting the sponsor is a critical step as you will be entrusting them with your investment. One of the advantages of a syndication structure is that you have direct access to them as limited partners. The key components to review when vetting a sponsor are:
Investors can find out general information from the sponsors’ website, which will often include their investment philosophy, acquisition criteria, and portfolio of their prior projects. Often, their contact information is available and you can reach out to speak to them directly if you are interested in becoming an investor. Remember, just as you are doing due diligence on the sponsor, they also need to do their due diligence to get to know you since syndications are often 5-7 year commitments.
There are several podcasts out there where you can learn more about the sponsor indirectly, as well as multiple real estate conferences for sponsors and investors to meet directly in person. Local real estate meet-ups are another avenue to meet sponsors.
2. Experience or Track Record
If you are going to be investing $50K into a syndication, it is important to know that your investment is in good hands. One way to build your trust is to find out what experience the sponsor has. How many deals have they closed? How many deals have they exited? You can also find out the specifics of each deal they have done by reviewing their portfolio. This information is often included in the investment offering as well.
Specifically, does the sponsor have experience with the same type of asset or in the same market that the investment is in? If not, what steps have they taken to mitigate any risk of entering a new market, or what research have they done to suggest that this is a good market to enter into?
3. Team Members
Often, there are other members of the sponsorship team excluding the lead sponsor. As you can imagine, there are many steps, tasks and responsibilities included in acquiring and managing a property. So, you will likely see other team members as part of the General Partnership. As an investor, you should understand who they are and what their roles and responsibilities will be in the deal.
Property management team:
This is often overlooked by investors but critical in the success of the deal. The property management team is the boots on the ground and involved in the everyday operations of the property. Everything they do has a direct link to the income or expenses of a property, and your returns as an investor. A good sponsor understands this and will have done a thorough job selecting who this team is.
4. Alignment with Investors
Each sponsor will have different fee structures which will be outlined in the investor subscription documents or private placement memorandum. As an investor, look for structures that demonstrate the sponsors’ interests as aligned with the investors. This is discussed in more detail in more detail here, Nuts and Bolts of a Syndication.
Skin in the game:
It is important to know if the sponsor has “skin in the game” so to speak. Most times, this refers to how much capital they are putting into the deal themselves. While not required, it is comforting to know that they are putting their own capital into the deal as well along with their investors.
While we all hope for a smooth investment, no one can predict with 100% certainty if there will be unforeseen circumstances that may arise through the lifetime of the investment. Good sponsors will provide timely, consistent, and transparent communication to their investors, typically on a monthly or quarterly basis.
Syndications are often 5-7 year commitments, so it is important to know going in that you will have access to the sponsor if you have any questions or concerns about your investment. This is one of the advantages of investing in a syndication you do not get vs. investing in a stock market or REIT.
6. Investor References
You can ask for prior investors’ contact information and speak to them about their experiences with the sponsor.
7. Sponsor Fees
This will be outlined in the private placement memorandum that is provided to investors for review. Often includes: acquisition fee, asset management fee, disposition fee. There are industry averages, but varies with each sponsor and each deal.
8. Sponsor Roles
This will also be outlined in the private placement memorandum. This document details the roles and responsibilities of the sponsor in the project.
Q: How do I, as the investor, make money from real estate syndications?
There are typically two ways an investor can make money from a real estate syndication.
- Through the cash flow generated from the project and
- Through the gains through the appreciation of the property.
Each project is unique in terms of its purchase price, rent, expenses and strategy. Thus, the cash flow and profits will vary depending on what type of project you are invested in. For example, a stabilized multifamily project may provide immediate cash flow. Conversely, a development may not provide investors with any cash flow until year 2 or 3.
When looking at syndications deals, investors will commonly see the offering report cash-on-cash (CoC), equity multiple (EM), and internal rate of return (IRR).
(Get ready for some math!)
As an example: Let’s say you invest $100,000 into a 5-year project with projected 8% CoC, 2X EM, and 15% IRR.
You could expect $8,000 ($100K x 8%) from the cashflow of the property in Y1, Y2, Y3, Y4, Y5, which would sum up to $40,000. If the EM is 2X, it means you should be looking to double your money, $100,000->$200,000 in total gains over the lifetime of the project. This $100,000 gain is the sum total from the cashflow and profit upon sale. So, when the property sells in year 5, you would receive return of your initial $100,000 principal in addition to the $60,000 in profit. The $40,000 (cashflow) + $60,000 (profit upon sale) = $100,000.
The IRR is not as straightforward to calculate. But is the standard metric investors can use to assess any investment, so it can be helpful when you are comparing investments.
Generally speaking, the IRR is the rate of return of an investment, which includes the absolute return. But it also factors in the time value of money.
For example, did you receive $100,000 in total gains equally throughout the lifetime of the project versus less cashflow, say $25,000, and higher profit upon sale, say $75,000.
Even though you still had $100,000 in gains, the IRR would not be the same. This is because it takes into account the timing of when you received the returns.
Q: How does the sponsor or person running the syndication make money from real estate syndications?
You will typically see the following fees for a syndication, though each syndication can be structured differently. The most common fee structure is typically around 1-2.5% for each of the categories listed below, along with a 70/30 or 80/20 profit split.
- Acquisition fee: this is a one-time fee based off the purchase price of the asset that is paid out to the sponsor upon closing of the property
- Asset management fee: this is a monthly recurring fee during the holding period of the property paid out from the revenue of the property
- Disposition or refinance fee: this is a one-time fee based off the sales or refinanced price of the property
- Sponsor’s share of profits: Each syndication has its own unique structure in terms of how profits are distributed amongst the partners. Investors will typically see an 80/20 or 70/30 distribution (LP/GP): 80% of profit distributed to LPs and 20% distributed to GP. There are variations across this spectrum from 50/50 to 90/10, though typically most deals are 80/20 or 70/30 distribution
The fees should be outlined in the offering documents and transparent to the investors. When looking at prospective investment opportunities, the sponsor will typically present the investor returns as net returns, which already taken into account the fees and profit splits.
Q: Do I need to be an accredited investor to invest in real estate syndications?
This will depend on the specific offering, whether it will accept only accredited investors, or non-accredited investors as well. This is important as syndications are offered through private equity offerings, which must comply with the Securities and Exchange Commission (SEC) rulings and laws.
An accredited investor, as defined by the Securities and Exchange Commission (SEC), must satisfy at least one of the following:
- Have an annual income of $200,000, or $300,000 for joint income, for each of the last two years, with expectations of earning the same or higher income this year;
- Have a net worth exceeding $1 million, not counting your primary home
An investor simply meets this definition or not based on their income or net worth. Some offerings will require verification through a third party, such as your CPA, otherwise, there is not a special test or course required to be accredited.
Q: Is there generally a minimum amount of money that I need to invest for a given syndication?
The minimum investment amount for a syndication is designated by the sponsorship team, so it can be variable. The majority of syndications have a $50K minimum investment, with typical ranges from $25K – $100K.
Q: Can I pull my money out of the syndication at any time that I want?
Generally speaking, the money you invest into a syndication is considered illiquid for the timeline of the project. (This means no, you cannot pull your money out at any point.)
Most syndications on average are about 5 years (3-7 years), so you should consider the timeline and other potential obligations before investing into a syndication.
Q: What happens to my money if the syndication makes a lot more money than expected?
This depends on how the syndication is structured; typically, the passive investor would also get to benefit from the upside as well.
A common syndication structure, for example, is 70/30, meaning 70% of the profits go to the passive investors, while 30% of the profits go to the sponsors.
You will hear this referred to as the “split,” referring to the General Partner (GP) / Limited Partner (LP) split of the profits.
Q: What happens to my money if the syndication goes bust?
As with any investment, there are no guarantees, even with an experienced sponsor.
As a passive investor in syndications, the most you can lose is your initial investment into the project. The caveat is if the project has a capital call (asks for more money from investors to keep the project afloat), though for most syndications, this is optional and not a requirement.
Although an investor could potentially lose all of their capital, it is more likely that the sponsor sells off the asset and is able to recoup and return some capital back to investors. This of course depends on many factors, but the point is that there is a tangible asset to sell.
Q: How hard is it to become a sponsor of real estate syndications? Can anyone do it?
Technically, anyone can potentially become a sponsor of a syndication, as you do not need a special degree or license to purchase real estate. There are distinct differences, though, when thinking of purchasing commercial real estate versus the typical single-family home.
The best way to think about this is commercial real estate is valued and operated like a business, so, in order to be a “qualified” buyer, a sponsor will be evaluated by the lender and seller based on their experience, team, credibility to close and operate a commercial property, along with certain net worth and liquidity requirements.
Q: Can I invest in real estate syndications from a self-directed retirement account?
It will depend on the sponsor, but yes, the majority of syndications will accept funding from a self-directed retirement account, such as SD-IRA or Solo 401K. In fact, this may be a source of capital many investors can take advantage of. One important distinction is that SD-IRAs are subject to something called the Unrelated Business Income Tax (UBIT), while Solo 401Ks are not.
Q: Who is the ideal investor for real estate syndications?
The ideal investor for a real estate syndication is someone who wants to invest or diversify into real estate but prefers to be passive rather than active.
The syndication structure provides investors the opportunity to invest into large commercial properties with a smaller amount of capital while still benefitting from the tax benefits of owning real estate.
Investors do not have control of operations, which is ideal for those who do not want to actively manage or deal with the headaches of directly owning real estate themselves.
Also, syndications are illiquid for 3-7 years and require on average $50K minimum, so you should have an adequate emergency reserve fund set aside and not invest capital you foresee needing over this time period.
Q: What are the tax benefits of investing in real estate syndications?
The tax benefits of investing in a real estate syndication come from being an equity owner of real estate.
Even as passive investors, you benefit from direct equity ownership without having to actively manage the property. W
hen you have equity in real estate, you can benefit from depreciation, just like single-family. In larger multifamily properties, there are ways to accelerate and maximize the depreciation benefits, which is then passed through to investors. The depreciation benefit is typically larger than the distributions from the investment, so it offsets your income from the investment.
This is the distinct difference between investing in syndications versus a REIT, in which you own shares of a company and the investment is taxed as ordinary income.
Wow! I think we really covered a lot of ground and I hope that the whole idea and process of investing in real estate syndications feels a lot for clear now. I know that it took me an embarrassingly long amount of time to wrap my head around this concept.
What do you think? Does investing in real estate syndications sound attractive to you? Any other questions I should have asked? Let us know in the comments below!
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