Investing, Real Estate

Real Estate Syndications: The Ultimate Profit Machine

Written By: Mike Reyes
Reviewed by: Mike Reyes
Last Updated July 21, 2023
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city skyscrapers

The popularity of real estate syndication has resurfaced in recent years. Investors today are looking to diversify their investment portfolios beyond traditional stocks and bonds, and syndication can open this door for them.

It’s an exciting tool for those wanting to increase their exposure to high-value real estate without purchasing the property directly. This blog will closely examine real estate syndication, structure, types, workings, profit potential, risks, and more.

What is Real Estate Syndication?

Real estate syndications occur when investors pool their money to jointly purchase or build a commercial real estate property. Most individuals cannot afford to construct or buy large properties by themselves. But by forming a syndicate, they can raise enough capital to invest in commercial real estate.

The investors could be individuals, investment companies, or both. They provide capital and share the profits and risks of the investment.

The concept of real estate syndication dates back to the early 20th century when wealthy individuals pooled their resources for sophisticated real estate investments. Since then, many regulations have been imposed to standardize the syndication.

Today, it is a common practice in the real estate industry.

How does a Real Estate Syndication work?

Typically, two parties are involved in the real estate syndication deal- the sponsor and the investor.

The process begins when the sponsor or the syndicator identifies a real estate opportunity. The sponsor then prepares a business plan and outlines the investment strategy, risks, and potential returns.

Next, the sponsor solicits funds from accredited investors interested in investing in the real estate project in exchange for an ownership interest in the property. Once enough capital is raised, the sponsor acquires and oversees the property management.

Investors earn periodic returns from the investment through dividends or cash distribution. The syndication typically lasts for 3 to 7 years. At the end of the project,  the sponsor usually sells the real estate and distributes the proceeds to investors in proportion to their ownership interest.

Modern real estate syndication usually happens through real estate crowdfunding platforms. Collecting funds through such platforms is easier; many sponsors list their opportunities there. The platform acts as a middleman between sponsors and investors, collects a capital-raising fee, and deals with regulatory requirements.

Types of Real Estate Syndication

Modern house Against Sky

Investors can participate in different real estate syndications, depending on their investment goals and risk tolerance.

Here are three main types of real estate syndications:

Commercial Real Estate Syndication

Commercial Real Estate Syndication invests in commercial properties like office buildings, shopping centers, or industrial warehouses.

This type of syndicate is suitable for investors looking for steady rental income and long-term capital appreciation.

Equity Real Estate Syndication

In an equity real estate syndication, investors purchase shares in a company that owns and operates properties.

This type of real estate syndication allows investors to have a more hands-off approach to real estate investing while benefiting from potential profits and appreciation.

Real Estate Debt Syndication

 In a real estate debt syndication, investors fund developers or operators to finance a specific project. This type of real estate syndication usually funds large-scale commercial real estate projects. They are less risky than equity syndication as they provide investors with a fixed rate of return.

Each type of real estate syndication has its advantages and risks. We suggest investors carefully consider their investment goals and risk tolerance before investing in any one kind of real estate syndicate.

How to structure a Real Estate Syndication?

line of residential properties

A syndicate is typically structured as a limited liability company(LLC) or a limited partnership (LP). The sponsor serves as the Manager or General Partner of the syndicate, while the investors are members or limited partners.

An LLC operating agreement in the case of an LLC or a partnership agreement in the case of an LP governs the syndicate. The real estate syndication agreement specifies each party’s rights and duties, including voting rights, cash distribution structure, rights of the sponsor to collect management fees, etc.

The structure of a real estate syndication is described in a private placement agreement (or “PPM” for short. The PPM describes the opportunity more formally than the syndication’s marketing material and discusses the risks, distributions, and key terms. Typically, the PPM is drafted for the syndicator by a syndication attorney.

The sponsor usually contributes up to 20% of the required capital and collects the rest from the investors or limited partners. But when it comes to returns, typically, investors have the first right.

For instance, if the syndicate promises 12% preferred returns to investors, the sponsor can collect a return only after paying investors their promised 12%. (More on profit distribution later)

How Real Estate Syndications make money for Investors

Real estate syndication makes money for investors in the following ways:

Equity

Equity refers to the ownership stake in the property. When investors contribute funds to the syndicate, they become equity holders.

All equity holders are entitled to a portion of the profits generated by the property. They can receive earnings from rental income, appreciation in property value, and profits after the property is sold.

Rental Income

A syndicate also earns income by renting out the property it has bought. The sponsor is responsible for managing the rental property and collecting rental income.

They are also responsible for distributing the income to passive investors, usually pro-rata, based on the equity they hold in the property.

Profit after liquidation

When a syndicate sells or refinances an investment property, the investors are entitled to profit from such sales. The sponsor is also entitled to a portion of the profits and any fees or compensation outlined in the syndication agreement.

Profit Distribution Model in Real Estate Syndication

people meeting around a table

Depending upon the agreement between the sponsor and other real estate investors therein, the profit distribution model can vary from syndicate to syndicate.

Here are two general ways of splitting profits for many real estate syndications:

Straight Split Model

This is the simplest profit split model in real estate syndicates. As the name suggests, this model uses the same percentage split for all returns, including rental income and any profit from the sale of assets.

For instance, if an 80/20 split is decided on the agreement, 80% of all returns (net income and profit on a sale) will go to the limited partners or investors and 20% to the general partner or the sponsor.

Waterfall Model

Another common profit split structure is the waterfall structure, which distributes profits in tiers. Each tier has a different profit split.

This model usually uses a preferred return for investors. The preferred return is a guaranteed distribution percentage(assuming the syndicate is profitable) that passive investors receive before a syndicator collects his return.

For instance, if the syndicate promises a preferred return of 10%, the syndicator will receive a return only if the syndicate generates a return of more than 10%.

Often, preferred returns are accrued. In other words, if passive investors do not receive their total promised return in one year, the difference is carried over into the following year. In the next year, the syndicate pays the previous due in addition to that year’s promised return to the passive investor before paying anything to the syndicator.

But what happens to returns above the threshold, in this case, the 10%? The sponsors and investors may agree to split the profit in this 2nd tier as they deem fit, perhaps a 50/50 or 60/40 split.

The waterfall structure can be a win-win for both the sponsor and the investors. It protects the investor’s interest while incentivizing sponsors to work harder to get their share of the profit.

Choosing A Real Estate Syndication Structure

glass windows of a skyscraper

When choosing a structure, no one model reigns supreme over the rest. The choice depends on the goals and preferences of the sponsors and investors.

A straight split design distributes profits equally among investors, while a waterfall structure prioritizes some investors with a preferred return before distributing profits to others. The straight structure may be simpler but may not provide the preferred return to certain investors.

On the other hand, the waterfall structure is more complex but can offer higher returns to preferred investors. Many investors prefer the water structure as it provides a guaranteed return safety net.

Ultimately, the choice of structure should align with the investment strategy and goals of the syndicate, as well as the sponsor’s and investors’ preferences.

Who can invest in a Real Estate Syndicate?

So we’ve discussed how real estate syndicates work and the types and structures of real estate syndications available for investment. But who can invest in these syndications, and what rules and regulations govern them?

Traditionally, real estate syndications were only available to wealthy and accredited investors, who had to meet specific income and net worth requirements. However, recent changes in the law have opened up the market to a broader range of investors.

506 (c) vs. 506 (b) Syndications

The Securities and Exchange Commission (SEC) regulates real estate syndications. The most common types of real estate syndication offerings are 506 (c) and 506 (b).

506 (c) real estate syndication offering allows for general solicitation. The syndicator can advertise the deal publicly, but only accredited investors can invest.

The SEC defines an accredited investor as someone with an annual income of $200,000 (or $300,000 together with a spouse) or a net worth of at least $1M, excluding the value of your primary residence.

Investors must provide documentation proving their accredited status to participate in a 506 (c) offering.

On the other hand, 506 (b) offerings do not allow for general solicitation. Here, the syndicator cannot advertise the deal publicly. However, non-accredited investors may be able to invest in a 506 (b) offering as long as they have a pre-existing relationship with the syndicator and meet their financial suitability standards.

Benefits of Real Estate Syndication

People Sitting Around Wooden Table

Real estate syndications offer several advantages to investors. Here are some of the most significant ones:

Diversification

Successful real estate investors will often suggest diversifying your investment portfolio instead of putting all your eggs in one basket. Real estate syndications provide this opportunity for investors.

Investors can spread their real estate investments across different property types and markets. It can help mitigate the risk of investing in a single property.

Potential for higher returns

Real estate syndications have the potential to generate higher returns than other types of investments.

It is especially true over the long term, as real estate values tend to appreciate over time.

Passive income

Investing in real estate syndications can provide investors with passive income through rent or profits from the property sale.

Unlike direct real estate ownership, investors need not actively participate in acquiring, managing, and selling property.

Professional management

In real estate syndications, sponsors take responsibility for managing the property.

They are often professionals capable of profitably running the syndicate project. As such, investors can take a hands-off investment approach and enjoy steady cash flow.

Limited liability

Real estate syndications are often structured as LLCs or LPs. It means that the liability of investors is limited to their investment.

Investors need to be personally liable in case of legal issues or financial problems with the project. It reduces the risk for investors and provides them with peace of mind.

Drawbacks of Real Estate Syndicates

keys and papers for real estate

While real estate syndications can offer many benefits, there are also some potential drawbacks to consider:

Lack of control

One drawback of investing in real estate syndications is that investors have limited control over property management.

The real estate syndicator is responsible for making decisions about the property, and investors may have little say in it. They usually play only a passive role in the syndicate.

Lack of liquidity

A real estate investment can be relatively illiquid, so turning your investment into cash may take time.

Unlike stocks or bonds, which can be bought and sold quickly, real estate investment can take time to sell. Therefore, investors should consider their liquidity needs before investing in a real estate syndicate.

High minimum investments

Real estate syndications often require high minimum investments, which may make them inaccessible to some investors.

The high initial investment requirement ensures that only serious investors participate in the syndication. However, it can be a barrier to entry for some people who want to invest in real estate syndications.

Investment risk

Real estate asset values can fluctuate. There is always the risk that the property will not perform as expected. Sometimes the investment can result in lower returns or even losses.

Economic factors, local real estate market changes, and unexpected expenses can all affect the syndicate’s performance. Therefore, we suggest investors carefully research the market and the property before investing in a real estate syndication.

Tax Benefits, Forced Appreciation, and Write-Offs

Real estate syndication can provide a range of benefits to investors, including tax benefits, forced appreciation, and write-offs. Let’s take a closer look at each of these benefits:

Tax Benefits

Real estate syndication offers several tax benefits to investors. Investors and syndicators can use several tax strategies to reduce their tax liability, such as depreciation deductions, 1031 exchanges, and passive activity loss deductions.

  • Depreciation deductions allow investors to deduct a portion of the property’s value over time, reducing their taxable income.
  • A 1031 exchange allows investors to sell a property and reinvest the proceeds in another property, deferring taxes on the gains.
  • Passive activity loss deductions allow investors to deduct losses from rental properties (if any) against their other income. It helps reduce their overall tax liability.

Forced Appreciation

Forced appreciation occurs when property value increases due to improvements made to the property by the syndicator rather than from market trends or external economic factors.

The syndicator may renovate or upgrade the property to increase its value and make it more attractive to potential buyers or renters. It is a common strategy used in real estate to generate higher returns for investors.

In short, forced appreciation enables investors to profit even in a slack real estate market.

Write-Offs

Real estate syndication also offers write-offs to investors while calculating their taxable income.

They can deduct their real estate syndication investment expenses, such as property taxes, mortgage interest, repairs, and maintenance. These write-offs can help reduce their taxable income and lower their tax liability.

How do sponsors profit from Real Estate Syndication?

person ticking checklist

Not just investors, sponsors can also make profits from real estate syndications. They can earn money from syndication in the following ways:

Acquisition fees

The sponsor is responsible for finding and researching the property and putting the deal together.

They usually charge an acquisition fee for this service, ranging from 1% to 5% of the total project size. Some sponsors may also charge a flat fee.

Asset Management fees

The sponsor can charge 1% to 5% of the property’s income as an asset or property management fee.

It is compensation for sponsors for managing the real estate portfolio, updating investors on the latest developments, and looking after taxes.

Equity participation

The sponsor also earns a cut of the profits from the investment for putting his stake and expertise in the project. The amount can vary from 5% to 50% of the profits. The rest goes to investors.

This also includes the proceeds from the sale of the syndicate property. The syndicate agreement may spell out different splits for the rental income and proceeds from the sale of syndicate property.

Is Real Estate Syndicate a good investment?

Real estate syndications can be a good investment opportunity for many. Its main attraction is that it enables you to invest in large projects that may not have been feasible for you to invest individually. Besides, it offers many benefits, such as meaningful passive income, portfolio diversification, and tax benefits.

However, as with any investment, real estate syndicates carry certain risks. The investment is subject to market risks and price fluctuations. Also, some commercial real estate syndicates are expensive, even for accredited investors. Because of their huge initial outlay, only institutional investors can invest in them.

Investors must take some time to study the market and perform due diligence on sponsors before parking their money in real estate syndicates.

What is the risk of Real Estate Syndication?

Close-up Photo of Survey Spreadsheet

As with any investment, real estate syndication also comes with some risks that investors should be aware of. Some of the risks of real estate syndication include:

Market risk

Real estate values can fluctuate. There is always the risk that the property will not perform as expected. Investors may earn lower profits or even incur losses in some cases.

Real estate syndications are subject to various legal and regulatory requirements. Failure to comply with these requirements can result in penalties or other legal issues.

Project-specific risks

Each real estate syndication project has risks, such as construction delays, tenant issues, or unexpected expenses.

Investors should note that these risks vary for each real estate syndication and the underlying property. It’s essential to carefully evaluate the potential risks and returns and make an informed investment decision.

How to find Deal Sponsors and Syndicate opportunities

Earning passive income from a real estate syndicate may be easy. But the challenge lies in finding an investment opportunity that meets your investment goals and liquidity needs.

If you are an accredited investor, here are a few steps you can take to find deal sponsors:

Syndicate websites

Real estate blogs and crowdfunding platforms are the first places you can start your search. For real estate blogs, you can find groups like BlueLake-Capital with a wealth of helpful information. For crowdfunding, there are sites like Fundrise, CrowdStreet, RealtyMogul, PeerStreet, and Roofstock.

Some popular crowdfunding platforms are Fundrise, CrowdStreet, RealtyMogul, PeerStrret, and Roofstock. 

Network

Start networking to find your next big investment opportunity quickly.

Try attending real estate conferences, seminars, and events where you can meet syndicate sponsors and fellow investors. You can land an opportunity sooner or later by building a solid network.

Real estate brokers

Real estate brokers can be another excellent source for finding deal sponsors and syndication opportunities. They have access to off-market deals and can introduce you to sponsors looking for investors.

Social media

Leverage the power of social media to find deals without hassle. Follow real estate professionals and influencers on social media platforms like LinkedIn, Twitter, and Instagram. They often share valuable information, real estate strategies, and updates on real estate syndications and investment opportunities.

Do not forget to do your due diligence when searching for a real estate deal, sponsor, or syndication opportunity. It is best to look into the sponsor’s track record and past performance, understand the investment structure and potential risks, and consult your financial advisor before investing in real estate syndication.

Conclusion

Real estate syndication presents a promising investment opportunity for accredited investors seeking to broaden their portfolio with real estate investment without the challenges of owning properties outright.

However, like other forms of investment, real estate syndications have pros and cons. Therefore, you must know the investment’s dynamics well to make this profit machine work in your favor.

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