BASICS OF LEADING REAL ESTATE SYNDICATIONS

Summary: A real estate syndication is a way for you to acquire large real estate assets by pooling together money from passive investors. Sponsoring a deal is an attractive path for real estate investors because it can be highly lucrative (as opposed to passively investing in a deal, which is far less lucrative). In this article, we’re going to cover the basics of leading a syndication.

[Disclaimer: We are not accountants, lawyers, or financial advisors, so please consult your own team of professionals about the topics covered in this article.]

This is the first in a series of articles covering real estate syndications. While there are many articles covering syndications, most are aimed at educating passive investors about how to invest in a syndication.

Many of our readers are on the active side of real estate investing. Meaning they buy their own rental properties so they can?achieve higher returns?and?shelter W2 or 1099 income. Therefore, this series will focus on the active side of syndications.

What is a Real Estate Syndication?

A syndication is when people pool their money to buy large real estate assets. Such as apartment complexes, mobile home parks, storage facilities, and retail complexes.

The people who identify the investment properties and do all of the work to put together the deal are called deal sponsors or general partners (GPs).

The people who put their money passively into the deals as investors are called limited partners (LPs) or passive investors.?

What are the Two Main Types of Real Estate Syndications?

There are two main types of syndication offerings: 506(b) and 506(c).?

With a 506(b) offering, deal sponsors can raise money from individuals who are not accredited. To be accredited, you need to make at least $200,000 for the last two years as an individual and $300,000 if you are married OR you must have a net worth exceeding one million dollars.

In a 506(b) offering, the deal sponsor must have a pre-existing relationship with every non-accredited investor. This is another reason it’s called the “friends and family offering.” The deal sponsor can also raise money from accredited investors. However, they’re not allowed to advertise the offering like they can with a 506(c) offering.?

As mentioned above, the main difference with the 506(c) is that the deal sponsor can market the offering publicly. However, every investor in the deal needs to be accredited.?

All of these rules are put in place by the Securities and Exchange Commission in order to protect investors. The idea is that accredited investors are supposedly more sophisticated and less likely to invest in a bad deal. For non-accredited investors, the protection is the pre-existing relationship. The thought is that a deal sponsor would be less likely to take advantage of a friend or family.

How are Deals Typically Structured?

Syndication deal structures vary from simple to complex.

The basic deal structure is called a straight split. This is where all of the cashflow and capital gains are split according to a defined percentage.?

This percentage ranges from 50/50 to 90/10 between the LP and GP, with 70/30 being one of the most common splits.?

For example, a deal with a 70/30 split with $100,000 in monthly cashflow would be split with $70,000 going to the LP and $30,000 to the GP. When the property is sold for let’s say $10 million in capital gains, the LPs would receive $7 million and the GP would receive $3 million.

As mentioned, the straight split is the simplest deal structure. From there, there are multiple variations involving preferred returns or changes in the equity split once the LPs receive their initial capital contribution back.

A preferred return is when LPs receive a certain percentage of their initial capital contribution, typically 6-8%, before the GP receives anything. For example, if an LP contributes $100,000 and the preferred return is 8%, they’ll receive $8,000 per year before the GP is paid.

In addition to the above equity split, the GPs collect a number of different fees. Examples include an acquisition, asset management, refinance and disposition fees. We’ll cover these fees in more detail in a future article where we explore how much a GP can make leading a syndication.?

What Are the Different GP Roles?

There are multiple roles on a syndication team. Below are some of the most common roles.

Lead sponsor(s):?This is the person who brings the deal together. They are typically the ones who find the deal and bring the GP team together. Usually, they have the most experience and can lead a syndication on their own, but choose to bring in other people to join the GP team to fill a certain need or role.?

Capital raiser/investor relations: This role involves bringing in passive investors (LPs) who want to invest in syndications. You educate them about syndications. You talk to them about the asset and you get them to invest their money. Once they are invested, you are then responsible for keeping them updated on a regular basis throughout the life of a project. Which can span many years. Keep in mind, that raising funds without having a formal operational role is considered a violation of SEC laws. You should consult with a syndication attorney if you are thinking about bringing on a capital raiser onto your team.

Key principal/loan guarantor:?Many of the loans on these larger assets require guarantors. Who are often referred to as key principals. The guarantors need to have a net worth that matches the amount being borrowed. A certain percentage of that net worth has to be liquid. For example, if the loan is for $9 million, you would satisfy the requirements if you had three guarantors with a net worth of $3 million. If the liquidity requirement is $900,000, you have to have this amount in liquidity among the three guarantors.?

Who Do You Need on Your Support Team?

The GP team typically leverages numerous specialists throughout the life of a deal. Below are some of the common team members you’ll need on your support team.

Syndication Lawyer

The syndication lawyer helps you pull together all of the documentation required to raise funds and guide you throughout the process so you stay compliant with SEC rules. Generally, you’ll need three documents: 1) private placement memorandum (PPM), 2) operating agreement and 3) subscription agreement. The lawyer you hire will explain these documents to you in detail and walk you through the syndication process from start to finish.?

Real Estate CPA?

The real estate CPA will help you understand the tax implications for both the GPs and LPs. You’ll want to understand these tax implications not only for yourself as the GP, but also so you can explain it to the LPs. You’ll need to understand terms like?cost segregation/bonus depreciation,?real estate professional status, long-term capital gains and carried interest. You should involve your real estate CPA early on in the process.

Property Manager?

Your property manager is essential for executing your business plan. For example, if you have a lot of renovations planned, they’ll be the ones who will coordinate the renovations as units become vacant. Once the renovations are completed, they are essential for getting them filled with qualified tenants paying market rent. For larger properties, you’ll want a property manager who has extensive experience operating larger properties. These companies typically place on-site staff at the property. This usually makes sense economically when you get to above 50 or 60 apartment units. Usually, one staff member mans the office and handles leases and tenant issues, and another staff member handles maintenance of the property.

Contractors?

If you are planning to add value to the property through renovations, then you’ll need a good general contractor on your team. Ideally, they’ll have experience with larger properties and have the manpower and the ability to source building materials at a discount.?

What Are the Tax Benefits for Deal Sponsors?

Deal sponsors are on the active side of real estate investing, so they have access to the best tax benefits.

As an active participant in real estate, they can use those hours to qualify for?real estate professional status?(REPS). Once they qualify, they can use the losses generated from the deal to shelter active income.?

Passive investors on the other hand cannot shelter active income. Their losses are considered passive losses. When educating passive investors about the tax benefits of investing in real estate syndications, it’s important to not mislead them into thinking that the losses can be used to shelter their W2 or 1099 income.?

Barriers to Leading a Syndication

If you’re already investing in mid-sized cashflowing rentals (20-40 unit multifamily properties), then the leap to leading a syndication isn’t as big as you might think. Having?led one ourselves recently, the biggest barriers are probably going to be lending and raising money.?

Most lenders are going to want to see that you have experience acquiring and managing a similar-sized property. If you don’t have this experience, one option is to bring on a general partner who has more experience.?

In terms of fundraising, if you are going for a 506(b), then you need to have a large network of friends and family who have money to invest. Ideally, you start building your database of contacts well before you need to raise the money. If you are going for a 506(c), it helps if you have some sort of following already. Maybe you lead a local real estate investing club, or you are a leader in your hospital or healthcare system. You might even have a blog or podcast. Either way, the important thing is that the potential investors know, like, and trust you.?

Key Takeaways

If you’re thinking about leading a real estate syndication, there are generally two main paths you can take to become a general partner. We’ll cover this in a future article. But in brief, you can either be a capital raiser or you can build up to it by investing in your own rental properties. We’ll talk about the pros/cons of each approach. Be sure to check it out when it’s published!

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