Syndication is a word that might not be too familiar outside of the investment and “making-deals” world. Real estate syndications pool capital between multiple investors for a common goal or purpose. It involves creating groups that can collaborate on projects together. Apartment syndication applies that same purpose towards buying buildings or communities and executing its operations.
What are the Key Types of Apartment Syndications?
There are two primary types of apartment syndications:
- Traditional Syndications
In traditional real estate syndication, multiple individuals purchase a unit in an apartment building and enter into a rental agreement with the property owner. The unique benefit of this type of syndication is that you can purchase a property at a significantly discounted price due to its limited availability.
- Leveraged Syndications
In leveraged syndications, a group of individual investors pools their funds together to purchase properties at a fraction of the value. Investors in this type of syndication generally put up all the initial funds for the project and then receive rentals from the property for a set period. Investors involved in this type of syndication are typically required to fund all purchases and maintenance expenses from their funds.
Collateralized Debt Obligations
In secured and unsecured CDOs, investors take out loans against the assets in the property’s underlying pool to fund purchases and renovations. Once the money has been used up, investors in these types of CDOs can claim their shares back or liquidate their positions. Unsecured CDOs can be cashed out early, while secured CDOs typically require investors to stay with the property until it has been refinanced several times.
FLATS (Fractional Ownership Trusts) and VOTs (Vacation Ownership Trusts)
In FLATS and VOTs, individual investors purchase units in an apartment building through a trusted company created for that purpose. These trusts are typically used for tax purposes and distribute income/capital gains to investors based on predetermined percentages each year.
As any real estate investment goes, apartment syndication has the opportunity to be a successful investment for the involved partners thanks to the large potential appreciation of the real estate property/properties.
The types of fees and their ranges vary from deal to deal and from General Partner (GP) to Limited Partner (LP).
However, partners involved in apartment syndication can make money through options such as an acquisition fee, asset management fee, guarantee fee, refinance fee, and profit split.
Aside from needed roles such as a real estate broker, commercial lender, attorney, and potentially even a property manager, the major players in the apartment syndication (and other real estate syndication deals) are the General Partner (GP) and the Limited Partners (LP).
A GP is responsible for working with all the parties involved, from raising capital, locating and acquiring the property, investor relations, and the day-to-day operations that ensure the success of the syndication. A general partner can also be referred to as a sponsor or a syndicate.
The LP(s) are the passive investors in the syndication. Typically, an LP will be an individual passive investor or business that chooses to participate in the real estate syndication deal to share in the returns of regular cash flow distributions and the profit split once the property is sold without having to have an active role in the investment.
The roles of the other parties that are involved in these syndications include:
Real Estate and Securities Attorney
As with any real estate deal, apartment syndications require a lot of legal paperwork. A real estate and securities attorney is integral to real estate syndications. They will use their expertise and knowledge to take care of the legal basics, legal syndication research, and the creation of all legal documentation needed for all parties involved.
By preparing documents such as the operating agreement, the PPM or private placement memorandum, and the subscription agreement, the real estate attorney review helps to ensure that everything is legally documented and accounted for. This allows all parties to have a deeper understanding of what they can expect when they invest in the apartment syndication.
Commercial Real Estate Brokerage
The commercial real estate broker, or brokerage, aids in locating the complex/community for the apartment syndication. These properties may be listed or “off-market” investment opportunities that are still possible to acquire.
Because the broker or brokerage’s only role is to help acquire the property for the apartment syndication, their responsibilities end once the property has been acquired.
Property Management Team
Once the investors buy the property, a property management company becomes an integral part in the syndication. Working closely with the GP/Sponsor, the property management company becomes responsible for overseeing day-to-day operations, tenant needs, and executing anything else needed for the business plan that falls within their scope of practice.
Returns on Real Estate Syndication
Real estate investing, especially in apartment syndications, can be a very lucrative return for the major parties involved. With any investment, there is always a risk, and projected returns or anticipated fees that can be collected are: projections.
Listed are some ways the involved parties can anticipate returns on the apartment syndication.
Cash-on-Cash Returns: 6-8% per year
For the Limited Partners or LP, the passive income generated by apartment syndication can be 6-8% return per year. This return is generated after all other fees, mortgages, and operating expenditures are accounted for and factored.
The remaining funds are then distributed to the investors monthly or quarterly.
To get the best terms possible, the GP may bring an individual with a high net worth to sign the loan. The GP may also forgo this and sign the loan themselves if they have the means to qualify for the loan terms.
If a guarantor is involved, a fee of 0.5-5% of the principal balance is paid to them at closing. The riskier the loan, the higher the guarantee fee may be.
Additionally, in some instances, the GP may offer the loan guarantor a percentage of the GP as an added fee. This could be anywhere from 10-30% of the GP.
Depending on the structure of the LP compensation, a GP may also earn a split of the total profits. Profit splits between the limited and general partner(s) can be anywhere from 50/50 to 90/10 and promotes an alignment of interests as all parties are then financially incentivized to ensure the success of the apartment syndication.
The profit split at sale should be calculated based on profits after all LP(s) initial equity is returned and the GP fees have been paid.
The profit split can be a very lucrative return for all parties involved in a successful investment.
In some circumstances, apartment syndication may undergo a refinance as a part of the business plan. If this occurs, the GP is responsible for all the required backend work and will typically charge an asset management fee for the time and effort of 1-3% at refinance.
If a project doesn’t require refinancing, this fee will not be charged and collected by the GP.
How do general partners make money?
General partners (GP) operate and manage the apartment syndication investment. For their time and efforts, a GP will typically make money in an upfront fee that is charged at the closing of the property purchase. This fee typically ranges from 1-5% of the purchase price.
Additionally, a GP may make money from managing the property over time as part of the syndication. This fee can typically generate around 2-3% of gross earnings. This is usually paid out quarterly.
Projected Hold Time: 5 Years
When talking about all the benefits and returns, investors may be interested in how long they should anticipate holding onto their investment.
Since commercial real estate loans are typically 7 to 10 years on fixed terms, most syndications will project a 5-year hold time. This allows a buffer to hold on to the project for longer, if needed, based on the market during the projected time to sell.
Additionally, five years allows time to get into the apartment syndication deal, update anything needed to the property/community, and give the project time to appreciate without holding on for so long that the property may need updates again.
What is a qualified investor?
So, what makes a qualified investor?
In apartment syndications, qualified passive investors may invest as an LP. For this type of syndication, an investor may need to be accredited. This means the LP has had income for at least two years that exceeds $200,000 or has a net worth of $1M. A caveat is that the net worth cannot account for the investor’s equity in their primary residence.
If the investor has a spouse, the salary requirements are $300,000 or more for the past two years.
However, if an interested investor doesn’t meet these requirements, they may still be able to invest in apartment syndications as a sophisticated investor. This non-accredited investor type must have previous experience investing. Typically, this means they have knowledge and education outside of the stock market or are educated in alternative investments.
To note, non-accredited/sophisticated investors must be known to the GP to qualify to invest. This is because deals these passive investors qualify for (506(b)) cannot be marketed – more on this below.
Who can invest?
Luckily, qualified and non-accredited investors can invest in apartment syndications, depending on the type of syndication.
Regulation D of the Securities Act allows General Partners (GP) to open up the opportunity for real estate syndications without registering with the SEC, as long as specific guidelines are followed.
The two exceptions to be considered are the 506(b) and the 506(c). In apartment syndications, 506(b) is typically followed.
506(C) Vs. 506(B) Syndication
- The 506(b) allows the GP to work with registered and 35 non-accredited investors. The non-accredited investors must be known to the GP and qualify as sophisticated investors. 506(b) does not allow the GP to advertise the syndication.
- The 506(c) allows the GP to only work with registered investors. However, the 506(c) guidelines allow the GP to market the syndication to potential investors.
Why should I invest in real estate syndicates?
The fantastic thing about real estate syndications, and in this article, apartment syndications specifically, is that if you invest as a limited partner (LP), or passive investor, a lot of the work is done for you.
From all the leg work to acquire the property to any repairs, maintenance, or management of the property once acquired, as an LP, you can get into real estate investing and sit back and relax while the GP and other parties involved take care of everything.
A few Syndication Buzzwords You Should Know
Just like the average investor may not have heard, or been familiar with the term syndication, here are a few more buzzwords to ensure everyone is on the same page. Because ultimately, it’s essential to know the jargon to understand all the ins and outs of these deals.
Don’t worry, you will be talking like a professional syndicating agent in no time!
Fees, put, are just as fun as they sound. Regarding real estate investing, fees are an added cost that is taken before any returns are given.
As discussed above, typical fees will include acquisition, building management, refinancing, asset management costs, loan guarantees, and disposal fees. It is essential for an investor in apartment syndication (or any real estate syndication) to be aware and familiar with the different fees that will be associated, as these fees can begin adding or lowering the value of the asset as the deal goes along.
Not only are they great things of natural beauty, but waterfalls are also a term used in real estate syndication to reference the structure of how the returns on an investment will be distributed to the investors.
They can be as simple in their structure or, if needed, as complex as the deal requires for the parties involved. It is essential that every investor in the syndication understands the structure of the waterfall and agrees to its flow.
506(c) vs. 506(b)
As mentioned above, these real estate syndications are how deals are set to allow the GP or sponsor/syndicate to accept investors.
With 506(b) offerings, sponsors can offer deals to “friends and family,” as the offering is not allowed to be marketed. However, there are stipulations. Any accredited/registered investor can join the syndication, but only up to 35 non-accredited investors can be a part of the deal.
With 506(c) offerings, the sponsor can market the deal but is limited to accredited investors.
The deal sponsor is also referred to as the general partner (GP), syndicator, or sponsor. They are the person/party that is actively involved in the investing. They are involved in the underwriting process, executing all renovation and operating plans, raising funds, placing loans operating on assets, and managing investor relations, taxes, etc.
The structure of the syndication of property is diverse. These can be simple or complicated if it suits the deal. It refers to the way that returns are dispersed to the involved parties. Typically, the structures are referred to as waterfall structures or straight splits.
General Partner vs. Limited Partners
As described above, the General Partner (GP/Sponsor/Syndicator) is the one who initiates finding capital for the syndication and actively does all the work required for the syndication.
A Limited Partner (LP) is more hands-off and a partner that provides capital for the investment and collects returns based on the structure of the syndication.
A syndication investor is typically referred to as the limited partner, the party who passively invests capital into the syndication/deal/project. An investor can be accredited or non-accredited. The kind of investor they are may limit the type of deal they can invest in.
Apartment Syndication Deals Best Practices
When purchasing an apartment property for your portfolio, it is crucial to understand your different strategies. From a simple home renovation to creating a higher-yield investment property, the right brand partnership can transform your investment property into more than just an asset. Let’s explore some best practices when entering an apartment syndication deal:
Know the Market Trends and Buy With a Strategy
The market for apartment buildings, single-key rentals, and some multifamily properties is robust. However, there are also some distinct trends that you must be aware of to purchase an investment property that will increase your returns. For example, the areas that are seeing the most growth are cities like Austin, Texas, and Seattle.
These cities are experiencing high demand for both downtown living and high-end living. Another trend affecting the market is the increase in new construction. The number of apartments in the United States has been steadily increasing, and there has been a significant boost in new construction in the past few years.
The rise in new construction is likely due to the current favorable economic conditions. It can help you better understand the market and plan the type of property you want to purchase. For instance, new construction may be a good option if you want to buy a property in a high-demand area. Also, if you are looking to invest in a specific type of property, such as a high-end downtown property, you would want to ensure that the market trend is still strong.
Due Diligence Before Signing Contracts
When purchasing an investment property, you must do your due diligence and thoroughly evaluate all potential partners. If you find a partner you want to join forces with, you will want to make sure you thoroughly evaluate that person. It denotes that you should ensure they have the financial resources to join forces with you and understand the tax implications of working together. It is essential because you will share income, expenses, and expenses with your partner(s).
Identify some key factors that will help you determine a partner’s reputation. –
- How long have they been in business?
- Is the brand a member of any industry-specific associations?
- How many of their properties are under syndication deals?
- What is their track record?
- What are the partners’ financial profiles?
- What is the brand’s financial investment?
- What is the partner’s financial return?
- What makes the partners’ partnership unique?
- What does the chosen partner bring to the table that other brands cannot offer?
- How do you communicate and work together?
- What is the process for signing contracts and managing the partnership?
Understand the Tax Implications
The best way to ensure that you thoroughly evaluate a partner is to understand the tax implications of working together. Ensure that you fully understand the income and expenses associated with the partnership. If you are working with a specific brand, you will want to ensure that you understand their tax advantage. It may not apply to every partner, but it is essential to understand the type of tax advantage the partner offers. For example, you may be able to receive a tax advantage from working with a partner that is a high-net-worth individual.
Evaluate All Offers
Investors must constantly evaluate their syndication partners to ensure they get the best return possible. It’s essential to verify that all property details are correct and accurate. This includes the units, property type, size, and a complete list of all amenities. Double-check that your paperwork is in order and that all transfers are recorded correctly. While a listing agent will handle most of the paperwork for you, you need to ensure that you have the apt legal paperwork for each partner acquiring a unit.
Each partner will be required to transfer their ownership of the property to you as the property owner, and then you will hand it over to that partner. Once the paperwork is completed and recorded, you can take your profit from the property.
- While you may want to partner with all of your investors, you need to ensure that all partners’ numbers and financials are sound. This includes the current market value of the property and the future cash flow from the property.
- A successful partnership will allow you to capitalize on the value of your property. If one or more of your partners is interested in exiting their properties quicker or has other business priorities, you may not be able to capitalize on that value. And ensure that all your partners are interested in investing in your property for the long term.
Bottom Line: Key Elements Of A Success
Many syndication deals are available for investors looking to diversify their rental portfolio. However, ensuring that you get the best deal possible with the partners you select is vital. This includes thoroughly understanding each partner’s financials and ensuring you are comfortable with the agreement.
During the meeting, communicate your terms and conditions with your partners.
This will include the items:
- The commitment you are making to each partner – The amount of each partner’s equity.
- The loan length – What happens to the property after the partners’ return?
There are many options available for syndication deals. Rent-to-owns, common area flips, and single-key rentals are a few available options. It’s crucial to ensure that you fully understand the property’s price, as this will help you to get the best deal possible. The syndication agreement needs to be clear and concise. You need to include all terms and conditions of the deal. You also need to ensure that the agreement includes an explicit termination clause.