What Does Real Estate Syndication Mean?

Key Takeaways

• Real estate syndication might be particularly attractive to investors who don’t want the bother of property management.
  

• Syndication permits investors to put capital in properties that they wouldn’t be able to handle on their own. 
  

• Syndications offer potentially high returns.
  

Many investors are intrigued by the prospect of real estate investing, but don’t wish to manage the investment independently. That’s where real estate syndications come in. They have the potential to help investors gain the benefits of ownership – tax advantages, cash flow, appreciation, for example – sans the labor or headaches that can accompany property management.

In other words, if awakening in the middle of the night to address a sudden electrical issue is not something an investor wants to do — or can do — a passive real estate investment approach might be a good strategy.

Here is what real estate syndication means.

What is Real Estate Syndication?

This is a group of investors or investment companies that unite to raise capital to buy large commercial real estate property such as apartment buildings, land, mobile home parks, self-storage units, or to construct a new property.

Syndication is a way for investors to invest in properties and projects that are markedly larger than they could handle on their own. For example, most individuals aren’t in a position to one day just decide to finance and build a resort on their own. However, a syndication wherein members pool their funds might be able to make the project go.

That’s why it’s important for investors to know about real estate syndication: they may have opportunities as part of a group that they wouldn’t have by themselves.

Who are the Parties Involved in Syndication?

Real estate syndication primarily involves sponsors — also known as syndicators and general partners — and limited partners (LPs) or passive investors. Contemporary real estate syndication can also involve a real estate crowdfunding platform. 

It is the sponsor’s role to structure and run the syndication and deliver robust returns to the syndication’s passive investors.

Sponsors’ duties, for which they should have a track record, include:

• Scouting out a property
• Working with a real estate attorney to forge a contract – LLC Operating Agreement or LP Partnership Agreement — to set forth and protect parties’ rights.
• Underwriting the deal
• Exercising all care and caution regarding the property (due diligence)
• Scheduling regular meetings about the asset’s progress and next steps
• Putting together financing
• Holding talks with the seller
• Crafting a business plan
• Identifying investors
• Raising necessary capital (syndicators usually invest between 5%-20% of the required equity).
• Collaborating with property management personnel

The role of the limited partner is to provide part of the capital required for property acquisition – between 80%-95% of the total — in exchange for ownership shares of the property.

As previously mentioned, crowdfunding platforms can also play a prominent role in real estate syndication. Some sponsors opt to feature their investment opportunities on a platform that serves as a go-between for sponsors and investors. In return, the platform gets a fee for raising funds and hewing to regulatory requirements.

How Can One Profit from Real Estate Syndication?

Profits are generated through property appreciation and rental income. The sponsor distributes the latter among investors on a monthly or quarterly basis. At length, as the property’s value grows, investors’ rental income increases. When the asset is ultimately sold, investors can potentially reap large profits.

Payment of rental income or profits hinges on the time needed for investment maturity. How long a syndication lasts depends on the sponsor and property type. The typical syndication runs between three and seven years. 

Sponsors frequently get an upfront profit share called an acquisition fee up – usually around 1% of the property value — for acquiring the deal. Many syndications also offer investors a benchmark payment called a preferred return. Annual preferred returns are typically between 5% and 10% of the initial investment.

What is an Example of a Successful Real Estate Syndication Transaction?

The way in which syndications are structured motivates sponsors to focus on cash flow and make certain investments do well for all parties. In other words, the extent of a sponsor’s investment in a deal determines their alignment with investors.

Say a limited partner (LP) invests $50,000 in a deal that includes a 10% preferred return. Once the property earns sufficient cash to enable payouts, the LP could take home $5,000 annually. Once every LP gets a preferred return, the balance is distributed between the sponsor and LPs. This amount is based on the structure of the syndication’s profit split. In a situation in which the profit split structure is 70/30, investors get 70% of the profits, and the sponsor gets 30% — after preferred returns are distributed.

Advantages and Disadvantages of Real Estate Syndication 

The benefits of participating in a real estate syndication include:

• Potentially high returns. Investments that work out well can generate strong returns. 
• Passive income. LPs can receive monthly or quarterly passive income distributions. 
• No “landlord” stress. Through syndications, investors can put capital into real estate without the irritations that can accompany managing a property and tenants.
• Tax breaks. Through partial real estate ownership, investors can take advantage of tax benefits through their K-1 filings.
• Capital gains. As with any property, its value should go up over time, raising the return on investment.
• The power of choice. Investors are free to select the properties into which they wish to invest.
• Diversification potential. Investors can participate in multiple real estate syndications simultaneously.
• No experience necessary. Investors do not need a lot of real estate development or management experience to participate. 

The disadvantages of joining a real estate syndication include:

• Syndicator risk. Before providing capital, investors must be certain they are dealing with seasoned and credible real estate syndicators. 
• Investors are locked in. This means they will lack liquidity and control for the entire holding period.
• Sponsors make decisions. They are the ones that determine whether to sell a property or refinance.
• No opportunity to build equity. This is unlike outright property ownership.
• Performance linked to a single property. Investors can sustain large losses if the asset doesn’t perform as expected.
• Some deals fail. Investors would do well to keep in mind that, while excellent returns are possible, not all deals work out.
• Inconsistent income. LPs likely won’t get income immediately, particularly if the property is a renovation or development project. Further, income may vary markedly from year to year.
• Limited partners usually must be accredited investors. According to the U.S. Securities and Exchange Commission, an “accredited” investor has an earned income of more than $200,000 ($300,000 together with a spouse) in each of the previous two years and expects to earn that amount in the current year. Another way to qualify for the designation is to have a net worth of more than $1 million.

Is Real Estate Syndication a Viable Option for Investors?

There is no such thing as the perfect investment. While such syndications do have the potential to deliver significant returns, they are not the best fit for everyone. For one thing, investors cannot withdraw their money at will, which is different from stocks and bonds. So one must be certain they will not need the money in the immediate future.

Also, syndications might be out of reach for some investors, as minimum investments are often around $50,000 or more. 

Syndication vs REITs

While real estate syndication might resemble a real estate investment trust (REIT), there are some key differences:

Real Estate Investment Trust

• Akin to a mutual fund that owns, operates, or backs properties that produce income.
• Can provide a steady income stream to investors in the form of dividends.
• Publicly traded like stocks, REIT shares are liquid assets.

Real Estate Syndication

• Calls for an investment in a physical property.
• Locks investors in for the agreed-upon term and the sponsor decides when to sell or refinance the property.
• Provides access to large, expansive investment opportunities with asset management services.
• Offers a number of tax advantages.

Real Estate Syndication and Portfolio Diversification

Adding investments to a portfolio that do not have a direct correlation to the vicissitudes of the stock market can help insulate investors against equity market fluctuations. Alternative investments such as real estate syndication can be a good way to help accomplish this. 

Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

In addition to real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a significant degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.

However, Yieldstreet has opened a number of carefully curated alternative investment strategies to all investors. While the risk is still there, the company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. 

Moreover, investors can get started with a relatively small amount of capital. Yieldstreet has opportunities across a broad range of asset classes, offering a variety of yields and durations, with minimum investments as low as $500.

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

Summary

There are numerous benefits to participating in real estate syndication, such as property ownership without the problems and inconveniences associated with property management. But there are several drawback as well, including illiquidity and inconsistent income. Investors who choose the real estate syndication approach should be certain to vet the syndicator before locking themselves in for a period of years. Building kinships with like-minded investors can also yield viable syndications.