How It Works: A Guide to Real Estate Syndication
Key Takeaways
- Real estate syndication makes large-scale real estate investments available to a broader pool of potential investors.
- In most cases, real estate syndicates are formed as either Limited Liability Companies or Limited Partnerships.
- While the basic underlying concept is similar, there are several important differences between Real Estate Investment Trusts (REITs) and Real Estate Syndicates.
Real estate syndication makes large-scale real estate investments available to a broader pool of potential investors. A longstanding investment technique, syndication allows investors to participate in much larger projects than they usually could if operating on their own. This means the potential for profit is much greater than with conventional real estate investment opportunities.
How Real Estate Syndication Works
As mentioned previously, real estate syndication brings together capital from a pool of investors to purchase a large-scale property. Examples include commercial real estate such as massive apartment complexes, trailer parks, storage facilities and office buildings. Some real estate syndicates also buy land and erect structures from which they profit.
In legal terms, a syndicate is formed between the syndicator and the investors.
Syndicators — also known as sponsors and general partners — structure and operate the syndicate. Among their responsibilities are underwriting the deal and conducting due diligence on potential investment properties. They craft the business plan and arrange financing, too.
The syndicator also conducts negotiations with the seller / sellers of the property, raises needed capital, locates potential investors, and manages relations with those investors. Asset management and the guidance of the property management team fall under the purview of the syndicator as well.
A typical syndicator’s cash investment will be between 5% and 20% of the capital required to finance the deal. Investors supply the rest. As might be imagined, the more capital the syndicator has invested in the deal, the better it is likely to be managed. In other words, investors would do well to seek opportunities in which the syndicator is as much at risk as the investors.
Investors – also sometimes referred to as limited partners — are largely passive in real estate syndicates. Their primary function is to provide part of the capital required to purchase the property. In return, they receive income distributions from the property while the syndicate owns it. These usually occur on either a monthly or a quarterly basis. They also get a percentage of the sale price when the property is sold. Equity pay-down, appreciation, and capital gains tax benefits accrue to investors as well.
Real Estate Syndication Legal Structures
In most cases, real estate syndicates are formed as either Limited Liability Companies or Limited Partnerships. The syndicate’s operating agreement specifies the roles of the syndicator and the investors in the deal. Among the stipulations are distribution rights, voting rights, and the arrangement by which the syndicator and investors are to be compensated.
Syndicate investors familiar with Venture Capital, Private Equity and Venture Debt will find the structure similar. The main purpose of the operating agreement is to ensure that everyone understands their roles and how revenue will be shared.
Real Estate Syndicate Revenue Distribution
Syndicators usually earn an upfront profit — typically referred to as an acquisition fee — which averages between .5% and 2%. Investors get a preferred return of between 5% and 10% of their investment amount, before the syndicator takes a share of the remaining profit.
At that point, the split varies depending upon the amount outlined in the agreement. For example, in an 80/20 split structure, investors will each get a share of 80% of the remaining profit and the syndicator will get 20%.
The date payments start will vary according to the time the investment needs to mature. This can be anywhere from six to 12 months, or seven to 10 years.
All investors earn a share of the profits.
Pros and Cons of Real Estate Syndication
There are several benefits to be derived from participating in a real estate syndicate. First and foremost is the opportunity to earn passive income. Even better, this income can be earned with far less effort than that usually required of active landlords.
Syndicates also garner several tax benefits for investors, such as the ability to deduct depreciation — even while enjoying the appreciation that typically occurs with real estate over time. Syndicate participants also enjoy a fair amount of control, as they can decide with whom they will specifically invest. Syndication offers diversification opportunities as well, in that investors can participate in as many projects as their capital base will permit.
On the other hand, the larger the potential profit, the more risk the investment entails. Projects don’t always work out as pitched. Investors must choose the syndicator with whom they work carefully.
This is particularly true when one considers that the minimum investment amount is typically $50,000 or more, which is why syndicate participants are usually required to meet the criteria of either accredited or sophisticated investors.
Real Estate Syndication vs REITs
While the basic underlying concept is similar, there are several important differences between Real Estate Investment Trusts (REITs) and Real Estate Syndicates. Most REITs operate as publicly traded companies in which investors can purchase shares.
This has the potential to spread an investment across multiple properties, as opposed to the single project in which a syndicate investor participates. While this grants the investor a significant degree of diversification, it also means they likely will not know exactly where their funds are put to work.
Meanwhile, a syndicate is formed for one specific project. This affords the investor knowledge of the project, the business plan supporting it, and the syndicators. Having this data makes it easier to vet the opportunity.
On the other hand, REITs must adhere to regulations established by the Securities and Exchange Commission, because their shares are publicly traded. Syndicates have no such requirements. (It should be noted that private REITs also exist that aren’t listed on the exchanges nor are subjected to many of the same SEC regulations.)
REITs also usually require less capital from an investor to participate. Generally, most syndicates require an investment of at least $50,000. Moreover, investors in syndicates must be classified as accredited or sophisticated. REIT investors are not required to meet those qualifications.
Another key difference is the way the tax burden is applied. Revenues derived from an REIT investment are considered regular income and taxed accordingly. Syndicate participants can take advantage of deductions for depreciation, which can offset their other income.
Either way, both opportunities hold the potential to provide many of the benefits real estate investors enjoy, without active participation. The decision as to which approach to take depends largely upon the capital one has available to invest as well as their desired returns, tax considerations and qualification as an accredited or sophisticated investor.
Real Estate Syndication and Portfolio Diversification
Real estate syndication as an alternative investment opportunity could be a potentially good portfolio diversification tool — for investors capable of meeting the capital and classification requirements. Securities experts agree that maintaining portfolio diversification can serve as a hedge against market volatility.
Traditional asset allocation envisions a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split incorporating 20% alternative assets may make a portfolio less sensitive to public market short-term swings.
Real estate, private equity, venture capital, digital assets and collectibles are among asset classes deemed “alternative investments.” Broadly speaking, these private market investments tend to be less correlated with public equities, and thus offer potential for diversification. This can help protect a portfolio during periods of extreme market downturns.
Alternative assets such as these were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors who buy in at very high minimums — often between $500,000 and $1 million. Yieldstreet was founded with the goal of dramatically improving access to alternative assets by making them available to a wider range of investors.
Learn more about the ways Yieldstreet can help diversify and grow portfolios.
Investing in Real Estate Syndication
Networking with other investors who are interested in real estate syndication is a good way to find potential deals. Developing such relationships can help expand an investor’s knowledge base, as well as garner referrals to reputable syndicators.
What's Yieldstreet?
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