Real Estate Syndications: What Are They?
For those eager to invest in real estate, saving up capital to purchase property on your own isn’t the only way to go about it.
Real estate syndication is one method you can use to get involved in property ownership with less money, since you aren’t investing on your own.
This is our guide to real estate syndication, and what you need to know to get started.
What is Real Estate Syndication?
Real estate syndication is a multiparty agreement in which investors pool their money together in order to purchase investment property.
The logic behind syndication is this: by pooling our capital together, we can afford a much larger, more expensive property than any of us could on our own. This bigger investment ought to produce a larger return and more reliable cash flow for all members of the syndication than would a smaller property purchased individually.
As with any investment, there is risk involved. But for many, real estate syndications are appealing because they generally mean a more reliable investment for less personal risk (capital).
Syndications can be created for a wide range of investments, but commercial and residential real estate are among the most common types. The Securities and Exchange Commission (SEC) governs each syndication.
Roles Within a Syndicate
Deal Sponsor or “Syndicator”
The Sponsor is the person who puts the most time into actually identifying and vetting the property, recruiting investors, and managing the property once purchased (or heading up the relationship with a property management provider, like our team at Joseph Thomas).
As Manager or General Partner of the syndication, the Sponsor essentially manages the syndication as a full-time job, handling the paperwork, renovation and improvement plans, internal communication, and more.
The Sponsor usually invests some of their own money along with the passive investors, but they are the only one putting in “sweat equity”. Not only do they make their money from the appreciation and cash flow of the shared property, they also are paid through fees agreed to and paid by the passive investors as compensation for the value the Sponsor brings to the syndication, or help cover costs such as property management services.
Investors in a real estate syndication make their money by the positive cash flow and appreciation of the syndicated property. They are truly passive in their role, adding value to the syndication simply through the capital they contribute toward the purchase of the investment property.
For their contributions, they make their money through regular disbursements of positive cash flow through rental income and the property’s appreciation.
As a legally-recognized entity in ownership of property, most real estate syndications are set up as a limited liability company (LLC) or limited partnership (LP), with the sponsor acting as Manager or General Partner.
506(c) vs 506(b) Syndications
There are two basic types of real estate syndications, distinguished by the types of investors that may enter into them.
A 506(c) syndication is for accredited investors only and may be advertised publicly, while 506(b) syndications are open to non-accredited investors.
The pool of non-accredited investors that make up 506(b) syndications are often friends or family, since participants may only come from the Sponsor’s personal network of relationships. The Sponsor must be able to prove that they had a pre-existing relationship with any investor included in the syndication, accredited or non-accredited.
The 506(c) type, restricted to accredited investors only, may be publicly advertised, with investors recruited without any prior relationship to the deal’s Sponsor.
Rental Income Distribution
Depending on the syndication agreement, the Sponsor often receives an upfront payment for their efforts once the syndication is organized and the property has been purchased.
After that, rental income is distributed on a scheduled interval according to the percentage owned by each investor. When a property owned by syndication is sold, the proceeds are also distributed among the pool of investors.
But before the Sponsor receives profit from rental income, they make sure that all of the investors receive what is known as the preferred return.
The preferred return is an amount that is agreed upon when the syndication is formed as a minimum distribution for investors.
With a preferred return in place, the Sponsor is incentivized to manage the property to be as profitable as possible since they only receive a return once their pool of investors get paid above the minimum amount. Having a preferred return in place helps Sponsors recruit willing investors who can feel confident in the Sponsor’s deal and management of the property.
If a month or quarter is unprofitable by the time distributions are due, the Sponsor is obligated to distribute the preferred return while taking home no profits of their own.
For any remaining profit after investors receive their preferred return, the syndication splits the profits among investors and the Sponsor according to a previously established ratio.
For example, if $350,000 remains after preferred returns are paid, and the profit split is 80%/20% (to the investors / to the sponsor), then $280,000 would be divided among the passive investors and $70,000 would go to the deal Sponsor.
Most profit split agreements give the majority of profits to the investors. It’s difficult for a Sponsor to find willing investors with an agreement that puts far too much money in their pocket compared to their investors.
Positives Of Real Estate Syndication
There are a lot of benefits that can come with real estate syndication, if done right.
More Stable Investments
Typically, syndications are only formed for higher-value investment properties that are difficult for a single investor to afford. These high value properties tend to be more stable as revenue-drivers than cheaper properties. Plus, no single investor is taking on all of the risk.
Larger Properties and Projects
Another benefit of syndications involving large rental properties is the high level of potential cash flow that can be generated. For example, a 200+ unit multifamily property can likely bring in a lot more total profit for each investor than a typical single family property can for a solo investor.
Less Money Out-of-Pocket for Sponsors
Since many people are pooling their money together, syndication investors can benefit from income-driving deals without putting in as much of their own money as they would need in order to generate the same cash flow on their own.
Passive Investment Income
For those passive investors that join a real estate syndication (not the Sponsor), the investment really is passive. For many, the lack of day-to-day responsibility can be really appealing.
Negatives of Real Estate Syndication
While syndication may be a smart move for many, there are also some potential downsides, of which savvy investors ought to be aware.
Risk of Increased Vacancies
Under pressure to maximize profitability, some syndication Sponsors may push rent amounts to the limit, sometimes to the point that it becomes more difficult to find renters that are willing to pay. This can lead to increases in vacancies, if not managed wisely.
Risk of Investors Not Coming Through
Unfortunately, some investors who join a real estate syndication prove to be unreliable. Deals might fall through because of flaky investors. Or, a bad deal Sponsor could disappear with investors’ money.
You can see why 506(c) syndicates are typically more reliable, but investors should do their best to vet syndication opportunities of either type.
Syndication vs Real Estate Crowdfunding
A term that often gets thrown around in the same conversations as real estate syndication is “crowdfunding”.
While syndication is a type of structural agreement for co-owning property, crowdfunding is one method for finding real estate investment opportunities to join in on with others.
There are many online crowdfunding platforms where people can post investment opportunities in an effort to recruit a pool of investors. In essence, they function as real estate investment groups (REIGs).
Real estate crowdfunding was first started in the U.S. as a result of the JOBS Act in 2012.
Syndication vs Joint Venture
Syndication might sound similar to a joint venture, such as co-owning property as part of a joint tenancy or tenancy in common, for example.
While other types of property sharing exist, the key element that distinguishes syndication is the role of a Sponsor or Syndicator managing the acquisition and property operations for a team of passive investors.
A joint venture, such as a joint tenancy agreement, would involve multiple parties that are equally involved in the management of the investment property.
How to Get Started
If real estate syndication sounds like a good way to expand your investment portfolio, there are two ways to get started.
A) Become a Sponsor
Every syndicate needs a Sponsor. If you are the one with the knowledge and research for your market and are willing to take on the full-time responsibility of overseeing the investment, then perhaps you should Sponsor your own deal and begin finding investors to join you.
B) Find a syndicate to join
If you’d prefer the financial benefit of investing with others, but prefer a passive role, then you need to find a syndicate to join.
If you are an accredited investor, you can find syndication opportunities advertised publicly. If not, you’ll need to work within your personal network, either finding an active Sponsor or encouraging someone else to become a Sponsor to get started.
Property Management for Real Estate Syndicates in Utah
Our property management services in Utah provide for all the needs a real estate syndication might have for the smooth and efficient management of their rental property.
We have years of experience managing the kind of large, multi-unit property that is commonly sought out for syndication. Contact the Joseph Thomas team to learn how we serve syndication Sponsors and help grow profits!