A real estate syndication is a form of passive investment, and it’s worth learning more about it to determine if it is a good fit for your investment portfolio. Each investor must decide how, why, and where they want to invest. The question of how is largely one of deciding to invest actively or invest passively. With real estate investing, there are a wide range of investment opportunities, from actively buying a property, fixing it up, and then selling it, or renting property out, to passively investing in paper securities like REITs, real estate funds, and shares in publicly listed real estate companies. Read more to learn about how to invest in real estate through syndication.
Let’s start with what real estate syndication is and then look critically at some of the reasons why you would, or would not choose to invest.
The basics
A real estate syndication is a partnership between a group of investors who combine their skills, resources, and capital to purchase and manage a property they otherwise can’t afford individually. Typically, the investment properties purchased in real estate syndications are multi-family properties, apartment buildings, commercial, retail, or industrial properties.
There are three main role players in a real estate syndication. A Sponsor, also called a General Partner, makes the syndication happen. The Sponsor puts in the sweat equity to find investment properties, negotiate deals, find investors, and manage and oversee the syndication. Limited Partners are the passive investors that contribute their capital to purchase a property. Finally, the Property Management Team, which is either part of the Sponsor’s company or an outsourced service provider who takes care of the day-to-day activities related to the operation of the property. They oversee leasing activities, renovations, and value-add activities to increase the value of the building and/or improve revenues from the property.
The money
It’s important to understand real estate syndicates in terms of the money: who invests money, how the investment makes money, and who receives that money.
Who invests money? A real estate syndication collects money from investors, the Limited Partners, to purchase a target investment property. Money should also be contributed by the Sponsor. As an investor, you want to be sure that the Sponsor has skin in the game. Real estate syndicates have been around for hundreds of years. Back in the day, a group of investors would have to find each other, usually in family, social, or business networks. Today, with the internet, anyone can set up shop, call themselves a Sponsor and solicit investors. You want to find a Sponsor who puts their own money into a project and has demonstrable experience in real estate investing.
How the investment makes money? A real estate syndication makes money based on the expertise of the Sponsor and the Property Management Team. The Limited Partners are passive investors and play no role in day-to-day operations. The general aim of the real estate investment undertaken by the syndicate is to purchase an investment property that presents opportunities for appreciation and income. Appreciation, the increase in the value of the property, can be achieved by making physical improvements to a property or adding amenities that would be attractive to tenants. A commercial property’s value comes not just from the value of the buildings, but also from the income the property generates. It is the Property Management Team’s role to improve the operation of the building to improve its cash flow. Once the property syndication has turned things around, the property will generally be sold to a new set of investors who will undertake the long-term operation of the building. Real estate syndicates are more like fix-and-flip investors rather than buy-and-hold investors.
Who receives the money? The Sponsor and the Limited Partners receive regular returns in the form of a share of the rental income generated by the property. Also, once the property is sold, their initial investment plus a share of the profits from the sale is returned to them. Bear in mind that the Sponsor may receive a larger portion of the returns and the profits relative to the size of their investment because they also contributed their sweat equity and expertise. The Property Management Team will be paid for the services they provide. They may also be incentivized by a share of the rental income and profits from the sale.
Some things to think about
Pay attention to the structure of the real estate syndication. Look at a few different offers to get a feel for how much each role player gets from the investment. You can request a document called the Private Placement Memorandum (PPM) which provides in-depth information about the structure of the investment.
An advantage of syndication is that you, as a smaller investor, can also participate in large deals. Investments can range from a few dollars on crowdfunding websites to much larger sums directly with property syndication companies. However, you are not investing in a big basket of properties, like when you invest in a REIT, but rather in one property at a time. This can represent a cluster risk in your investment portfolio, and if you invest in a dud, you can lose your money.
Your money is usually tied up for the length of the holding period, holding periods are undetermined amounts of time, even if there is an estimate, that estimate can range wildly depending on many uncontrollable factors. While a target holding period will probably be defined in the PPM, real estate markets are unpredictable. Since it may take longer than expected to close on the deal, complete renovations and turn the property around, and also eventually sell the property, the holding period can be longer than anticipated. During the holding period, you should continue to receive regular returns, but you will only receive your principal back once the property is sold.
Do your due diligence
The importance of doing your own, detailed due diligence, cannot be stressed enough. Investing in real estate syndications can be very lucrative, but not all property syndicates are the same. There are reputable companies with extensive experience and expertise in turning properties around and making money for their investors. There are also countless hustlers out there trying to convince you to invest your hard-earned cash with a slick website they set up a month ago. Make sure to research the names of people before doing business with them. Look out for subtle clues they may be a fraud, some of these include obvious spelling and grammar mistakes, pushiness that leads you to feel uneasy and big unrealistic promises. Read Avoid Scammers Online and for more real estate posts read Passive Income from Real Estate Investing Pipe Dream of a Realistic Proposition? And Creating a Financial Plan.
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