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What Is Real Estate Syndication? How It Works, Benefits & Drawbacks
Owning real estate for investment purposes can be a great path to wealth. Depending on the property, it can generate predictable cash flow, capital gains and provide tax benefits. Besides being lucrative, real estate investing can be a hedge against inflation and an excellent way to diversify your investment portfolio.
There are several ways to invest in realty, from purchasing Real Estate Investment Trusts (REITs), rental single-family or multi-family properties, flipping houses, building an investment property, or joining a real estate syndication.
Your choice in real estate investing will depend on the specific role you seek or want to avoid. Suppose you prefer to be a passive real estate investor as part of a group investing in one property and avoid the burdensome duties of landlords. Real estate syndication may be attractive to someone with capital who prefers to be a passive investor rather than getting involved in an investment property’s operational aspects.
What is Real Estate Syndication?
The structure of real estate syndication consists of two groups: syndicators and investors. The syndicators are real estate professionals of an investment company who team up with individual investors to make the syndication happen. This way, they combine operational expertise and pool financial resources to invest in a project that would be too expensive to tackle individually. Typically, returns are split between syndicators and investors by 70/30 or 80/20. Investors should see a higher participation rate to feel “sponsors have skin in the game.”
A syndicated investment is an excellent way for individual investors to invest in a specific project. Still, it is far from a get-rich-quick scheme. You may be accustomed to long investment periods if you are already a buy-and-hold stock investor. The average holding time for the project is about five years, but some projects may be shorter or take as long as eight to ten years. This timeframe is a considerably long lockup period for some people who may prefer greater liquidity.
The average annualized returns are 15% to 20%. Some deals offer preferred returns averaging 6%-10%. (Preferred returns are paid to investors before the sponsors take their portion of the returns.)
The Structure of A Real Estate Syndication
Syndicators are sponsors of the real estate syndication, organized as a Limited Liability Company (LLC) or partnership. As a partnership, the syndicators serve as the general partners (GPs) of the investment company that structure the syndicate and operate the property. They find and vet the specific property, perform due diligence, work with lenders, underwrite the deals, and arrange the deal’s funding.
They should have expertise in investing in real estate property, negotiating with the seller, developing and executing a business plan, property management, and finding investors and capital. They manage the asset and schedule meetings to share the property’s progress and essential information with investors, similar to the investor relations function of any investment.
The GPs do the heavy lifting by executing the plan as sweat equity. Sponsors are in charge of the decision-making, which may be difficult for passive investors who want to provide their input, like moving the project faster or in a different direction.
By financing the capital, passive investors or limited partners (LPs) receive proportionate ownership interests and get monthly or quarterly income distributions from the rental income of the asset as part of their return on investment. Besides investing, passive investors are responsible for paying various management, loans, refinancing, and acquisition fees that the sponsor should disclose.
Like many investments, especially real estate, there is never a guarantee about the timing or amount of profitability, and you can lose money. Longer term, investors should realize capital appreciation upon completion and sale of the project.
Benefits of Real Estate Syndication
- Passive investing is free from burdens from tenants to fixing things like toilets.
- Investors can choose specific properties offered by GPs or through crowdfunding opportunities.
- Receive income distributions.
- Receive potential capital appreciation from the sale of the real estate project.
- Tax benefits through K-1 tax filings from depreciation write-offs, pass-through deductions, or a 1031 Exchange.
The Drawbacks of Real Estate Syndication
- Eligibility requires you to be an accredited investor (see below).
- There are several risks related to the project you should assess before joining. They include economic impact, the sponsor group’s misjudgment of the housing market, material supply constraints, rising costs, or other variables.
- Lack of control as money is tied up until the project’s completion, making it an illiquid investment compared to REITs and other marketable securities. It could become problematic if you face a personal financial difficulty.
- It is a more extended timeframe to realize capital appreciation.
How To Participate As A Real Estate Investor
One of the biggest challenges for an investor in a syndicate is becoming an investor with a reputable syndication group. Do your research, find Facebook groups, attend conferences, and talk to other real estate investors. Before committing to the real estate syndication, read the risk factors, read and understand the asset identified in the legal documents, and question the real estate group’s projections. Consider seeking advice from a real estate attorney experienced in syndications.
Although you cannot exit the real estate syndication, you can protect yourself by having an emergency fund with ample liquidity. Although I have done my share of successful real estate investing, I often share one of my most challenging experiences on a real estate project that taught me a lesson about real estate risks, notably recurring delays, added costs, and lengthened timeframe, eliminating most of the property’s profitability.
Various Individual Properties That Work In A Real Estate Syndication
Specific individual properties may work as part of a real estate syndication, including:
- Single-family or multi-family rental properties
- Commercial property
- Industrial buildings and parks
- Mobile home parks
- College housing
- Senior housing
- Retail rentals
Accredited Investor Requirements For Real Estate Syndication
Real estate syndication has been around for decades. Becoming part of a real estate syndication was challenging unless you knew someone in the investment company or had a financial advisor who opened the door to real estate investment opportunities.
Before the Securities and Exchange Commission (SEC) creation, investment companies would advertise and privately solicit funds from wealthy investors who dominated participation in available syndicates. The SEC, through the Securities Act of 1933, governs the raising of capital through real estate syndication, considering all new private offerings must register with the SEC for approval before soliciting investor funding, similar to the issuance of new securities.
Investing in real estate syndication is subject to Rule 506 of Regulation D, and the SEC outlines accreditation requirements. There are several different ways to be qualified as an accredited investor, including:
An accredited investor, in the context of a natural person, includes anyone who has:
- earned income that exceeded $200,000 (or $300,000 together with a spouse or spousal equivalent) in each of the prior two years and reasonably expects the same for the current year, OR
- has a net worth over $1 million, either alone or together with a spouse or spousal equivalent (excluding the value of the person’s primary residence), OR
- holds in good standing a Series 7, 65, or 82 licenses.
Becoming part of a real estate syndication was challenging unless you knew someone in the investment company or had a financial advisor who opened the door to real estate investment opportunities.
How Does Real Estate Syndication Differ From REITS?
Although passive investors favor REITs, they sometimes confuse these with real estate syndication.
REITs are publicly-traded securities that are more like a mutual fund of many income-generating properties. By law, REITs must distribute more than 90% of their earnings as dividends and may generate attractive capital appreciation. As marketable securities, they are highly liquid, and you can buy and sell them anytime.
Real Estate Syndication
Real estate syndication’s strategic focus is on a specific real estate property identified by the sponsor before investors contribute their funds. The investors are locked into the operational plan managed by the sponsor, who determines when to sell the property. Investors receive distributions monthly or quarterly but receive potential capital appreciation based on a prescribed split with the sponsor.
JOBS Act Spurred Crowdfunding Opportunities
The Jumpstart Our Business Startup (or JOBS) Act of 2012 relaxed solicitation rules, making real estate syndication more accessible through real estate crowdfunding, allowing real estate investors to participate in syndications as long as they meet specific criteria and satisfy accreditation requirements.
Crowdfunding means funding a project by raising small amounts of money from a group of investors, which aligns with real estate syndication. Several crowdfunding sites, CrowdStreet, EquityMultiple, and RealtyMogul, provide real estate investment opportunities, allowing accredited investors to participate in individual properties. They vary in minimum investments, fees, timeframe, and specific projects.
Real estate investing can be lucrative. A real estate syndication is an attractive way to invest in a specific real estate property as part of a team, with a common goal of enjoying predictable cash flow, potential capital gains, and tax benefits while diversifying your real estate portfolio. As a passive investor, you’ll avoid the onerous decision-making and duties.
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This post originally appeared on Finance Quick Fix.
With a passion for investing and personal finance, I began The Cents of Money to help and teach others. My experience as an equity analyst, professor, and mom provide me with unique insights about money and wealth creation and a desire to share with you.