Raising enough money to make a down payment on a good rental property is becoming harder and harder, especially with the way that real estate prices keep rising. Prices are hitting record highs, meaning the downpayment required continues to increase. Meanwhile, competition is increasing due to low supply, meaning investors need to more quickly find leads, analyze them, and place offers on deals.
Real estate syndication offers investors a tool to help alleviate some of the financial burdens that the current market environment is exacerbating. Investing in a real estate syndication can tie up less of your cash, and could be a great way to scale up and grow a real estate investment portfolio faster. Let’s take a closer look.
A real estate syndication is when investors team up and pool their capital to purchase, develop, own, and manage a large real estate project that would normally be out of reach for an individual investor.
Examples of real estate syndication opportunities include new home developments, small and large apartment buildings, agricultural land, and commercial real estate. Real estate syndication investing can apply to any real estate asset class.
A real estate syndication has two main parties: Syndicator and passive investors.
Also known as the general partner (GP) or sponsor, a syndicator is responsible for locating, purchasing, developing, and managing the real estate syndication. The main responsibilities of a syndicator include:
The GP or syndicator is responsible for ensuring that a real estate syndication meets or exceeds the objectives outlined in the business plan. In a real estate syndication, the buck stops with the syndicator.
A passive investor places capital in a real estate syndication, similar to investing in a crowdfund, or as a silent partner in a limited liability company (LLC) or limited partnership (LP). In exchange for investment capital, a silent investor:
Provided that the project goes according to plan, a passive investor in a real estate syndication will receive the same benefits of owning property directly, including appreciation, net cash flow, additional equity as any mortgage is paid down, and the tax benefits of owning investment real estate.
Sharing of the recurring cash flow and profit when a property is sold in a real estate syndication can be structured a variety of different ways, depending on what the syndicator and passive investors agree to. There are two general ways that profits are split in a real estate syndication:
Also known as a percentage split, examples of a straight split of cash flow and profits in a real estate syndication could be 90% passive investors/10% syndicator, or 80%/20%, 70%/30%, or 60%/40%.
With a 90%/10% split, if a real estate syndication generated $50,000 per year in net cash flow and a profit of $500,000 when sold, the passive investors would receive $45,000 of the annual cash flow and $450,000 of the sale profits, to be shared on a pro-rata basis based on the amount of capital invested.
A preferred return is a guaranteed distribution percentage (assuming syndication is profitable) that passive investors receive before a syndicator gets paid. For example, if passive investors are promised a 10% return, syndication must generate returns of more than 10% before the syndicator receives a cent.
Oftentimes, preferred returns are accrued. In other words, if passive investors did not receive their full promised return in one year, the difference is carried over into the following year, in addition to that year’s promised return, before the syndicator is paid.
In most cases, investing in a real estate syndication is only available to accredited or sophisticated investors. According to the Investor.gov website from the U.S. Securities and Exchange Commission (SEC), an accredited investor is a natural person who:
Other categories of accredited or sophisticated investors include an entity in which all equity owners are accredited investors, or an entity or trust with assets in excess of $5 million, such as a family office.
An exception to the accredited investor rule is a 506(b) real estate syndication, also known as a “friends and family” syndication. Rule 506(b) allows a syndicator to raise capital from up to 35 non-accredited investors and an unlimited number of accredited investors, provided there is a pre-existing relationship and the opportunity is not advertised to the general public.
Placing capital in a real estate syndication with other investors creates more buying power, increased opportunities, and potentially more lucrative deals:
As with any other type of investment, there are some potential drawbacks to a real estate syndication to consider:
While there are plenty of potential advantages to syndication, finding the right real estate syndication to invest in is sometimes easier said than done. Some ways to find the best real estate syndication opportunities include:
The job of a real estate investor is to find a trusted syndicator with a proven track record of success to place capital with. Once the right real estate syndication is located, the syndicator will do all of the work to make the project a success while sharing any profits with passive investors.
That said, investors who want to leverage other people’s money (OPM) can syndicate funds from other investors for their deals to help build out their real estate portfolio faster and use less of their own capital. Explore how to scale your real estate investing business, or learn what to do after you master real estate wholesaling!