Real estate syndication is an effective method used by investors to pool their capital to invest in larger properties and projects compared to doing investing individually. This is a structure that provides a passive investment while the fund operator handles the management aspects and daily duties of the project.
One of the benefits of syndication investing is that it provides opportunity for investors to leverage other expertise of operators with their capital. This will open new doors to asset classes, which will diversify the holdings while delivering high returns. There’s no doubt that many investments are structured as syndications.
For example, if you have an experience with flipping single-family properties in Kansas City, MO, you could have the vast majority of your portfolio allocated to the asset class in that specific market. However, if you could invest in a syndication with a highly skilled operator in Florida, you can get exposure to a new asset class without leaving your Kansas City house-flipping business.
Here’s how it works:
- The operator will find a property and create a syndication where the capital of investors will be pooled. An acquisition fee of .05 to 5% will be received by the operator for locating the property and closing the deal.
- There will be a preferred return of investors so that they will get paid before the operator receives gains from cash flow and equity. The average preferred return is between 8 to 12%. This means that if the preferred return is 8%, investors must receive an 8% return before the operator receives payment from cash flow or equity.
- The operator will also be receiving a 1 to 3% fund management fee for his duties relating to the daily management of the fund.
- The real bulk of how investors will be making money in real estate syndication is through the cash flow and equity participation split. Once the preferred return has been met, the remaining cash flow and gains from appreciation will be split at the agreed rate. The operator will normally be receiving somewhere around 20 to 50% of the proceeds after the preferred return has been met. The size of the split will vary on the operator’s track record, how much of his expertise is needed for the performance of the fund, and how profitable the opportunity is for investors.
When opportunities like this are structured, the operator will receive good money when the investor starts making money. Through this, both the sponsor and the investors’ incentives are more aligned for the performance of the fund.
Here is an example where syndication structure is beneficial:
For example, a self-storage operator has located a 100-space property that can be bought for $9,000,000. Because of the operator’s track record, they are able to secure a 65% loan 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 that the operator must come up with $3,150,000 to purchase the property.
Most individual investors don’t have $3 million dollars in their account so the sponsor must create a real estate syndication to leverage the capital of other people using their expertise.
This is the breakdown of a typical structure:
- The operator will buy the property and hold it for 7 to 10 years.
- A $25,000 minimum investment is required.
- There will be an 8% preferred return to investors.
- Above the preferred return, there will be a 70/30 split to the investors from the proceeds of cash flow and equity.
This is a typical breakdown of expected returns for an opportunity like this:
- Average Cash on Cash Return of 11%
- Total IRR after sale of the Property of 17%
This structure will provide you with an investment property on any asset class that you can find a reliable sponsor, regardless of the purchase price or your expertise of the asset. You are also able to invest in real estate syndications through passive means because of the fund manager who can handle your daily activities and decisions.