What Is A Real Estate Syndication?
Real estate syndication is an effective way for a group of investors to pool their capital in order to invest in larger properties and projects than they could as individual investors. This structure allows investors to invest passively while the fund operator or “sponsor” handles the management aspects and day-to-day duties of the project.
One of the great benefits of investing in syndications is that it gives investors the opportunity to leverage other operators’ expertise with their capital. This can open up doors to new asset classes, which helps diversify investors’ holdings, while delivering high returns. This is one of the many reasons several that my list of The Best Real Estate Investments For 2014 are structured as syndications.
Let’s say you have a background in flipping single-family properties in Kansas City, MO. You may have the vast majority of your portfolio allocated to that asset class in that specific market. However, if you are able to invest in a syndication with an operator who has a solid track record of success repositioning self-storage facilities in Florida, you are able to get exposure to a new asset class without having to leave your Kansas City house-flipping business.
Here’s how it works…
- The operator will locate a property and create a syndication where he will pool investors’ capital. There will be a small (.05-5%) acquisition fee that the operator will receive for pinpointing the property and closing the deal.
- There will be a preferred return to investors so that they get paid before the operator receives gains from cash flow and equity. Usually, the preferred return will range from 8-12%. This means, if the preferred return is 8%, the investors must receive an 8% return before the operator gets paid from equity or cash flow.
- Also, the operator will be receiving a small (1-3%) fund management fee for his duties relating to the day-to-day management of the fund.
- The real bulk of how sponsors should be making money in real estate syndications is through the equity and cash flow participation split. After the preferred return is satisfied, the remaining cash flow and gains from appreciation will be split at the negotiated rate. Usually, the operator will receive anywhere from 20-50% of the proceeds after the preferred return is met. The size of the split will depend on the track record of the operator, how much of his expertise is necessary for the performance of the fund, and how profitable the opportunity will be to investors.
When you structure your opportunities like this, the sponsor only makes good money when the investor makes money. That way, both the sponsor and the investors’ incentives are more closely aligned for the fund’s performance.
Let’s look an example where a syndication structure would be beneficial…
Let’s say that the self-storage operator, Self-Storage King, has located a 100-space property that can be purchased for $9,000,000.
Because of the Self-Storage King’s track record, the operator is able to secure a loan for 65% of the purchase price.
$9,000,000 x 65% = $5,850,000 (Loan Amount)
$9,000,000 – $5,850,000 = $3,150,000 (Capital Needed for Down Payment)
This means the operator of Self-Storage King needs to come up with $3,150,000 to purchase the property.
Most typical individual investors don’t have access to three million dollars, so the sponsor creates a real estate syndication in order to leverage other people’s capital with his expertise.
Here is a breakdown of a typical structure…
- The operator intends to buy the property and hold it for 7-10 years.
- There will be a $25,000 minimum investment.
- There will be an 8% preferred return to investors.
- Above the 8% preferred return, there will be a 70/30 split to the investors from proceeds from cash flow and equity.
Here is a typical breakdown of expected returns for an opportunity like this…
- Average Cash on Cash Return 11%
- Total IRR after sale of the Property 17%
As you can see, this structure will allow you to invest in any asset class that you can find a reliable sponsor in, regardless of your expertise or the purchase price of the asset. Not only this, but you are able to invest in real estate syndications completely passively, as there is a fund manager who will handle all day-to-day activities and decisions. In fact, that is what you pay him for!