You’ve heard of investment clubs. You’ve heard of crowdfunding. Now meet their much more powerful cousin, real estate syndication.
Real estate syndication allows the average person to realize high-dollar returns on investing in commercial real estate. Although it’s been around for many years, real estate syndication has recently seen a surge of interest as the general public has become more familiar with crowdfunding platforms like GoFundMe.
A decade ago, fewer than 50,000 people were actively participating in real estate syndication. By 2019, more than 120,000 people had joined real estate syndicates and this number will likely continue to grow. Let’s take a closer look at what real estate syndication is and how it typically works for the average investor.
Life Bridge Capital is a leading real estate syndication company. We offer our investment partners the opportunity to leverage shares of multifamily rental properties into a passive monthly income. Learn More
A Closer Look
Real estate syndication is a way for investors to join forces to invest in a large property, typically one too big for one individual to purchase alone. This is much like the way individuals invest in a product, business idea, or charity on a crowdfunding platform online. In the past, only the very wealthiest individuals could take part in these real estate syndications in the past. Today, thanks to the JOBS Act passed in 2012, even smaller individual investors can generate passive income by investing in a syndication.
The Real Estate Syndicate Relationship
Real estate syndication is essentially a relationship between a sponsor, also known as the general partners, and a group of investors. The sponsor acts as the orchestrator of the deal, putting in the most footwork. This means that the sponsor bears the responsibility of finding the property, raising capital, and managing the day-to-day operation. Individual investors in the syndicate, however, do not have as much responsibility—they can simply invest the money in the deal and reap the benefits.
Because the sponsor usually puts in the sweat equity, they’re responsible for at least 5% of the required equity capital. The investor’s responsibility is between 80-95% of the total. The more equity the sponsor has in the deal, the better for the investor.
Here’s a quick look at the real estate syndication market:
- In 2019, over 120,000 investors participated in syndications, and participation continues to grow
- The average size of a real estate offering was $3 million
- Passive investors came up with 80-95% of the initial capital investment
- Sponsors came up with over 5% of the initial capital investment
- Investors received a preferred return ranging from 5-10%
- The average preferred return was 8%
- Sponsors netted an acquisition fee of .5-2%, with an average acquisition fee of 1%
- Sponsors netted a property management fee between 2% and 9%
How Do Investors Make Money in Real Estate Syndication?
So, how do you actually make money as an individual investor in a real estate syndicate? Let’s walk you through the process with an example. We’ll use Skyscraper Building as the property name purchased by our imaginary real estate syndication.
Let’s say a real estate syndication buys Skyscraper Building at 221 Making Money Way, an apartment building in Florida containing 400 units:
- Property Purchase. Skyscraper Building’s sales price goes for $50 million. The bank requires a 30% down payment to qualify for a loan on the remaining $35 million. The general partners contribute $1.5 million and turn to investors for the remaining $13.5 million of the required down payment.
- Improve Profitability. During the next five years, the syndication makes repairs and performs upgrades to Skyscraper Building, raises the rental prices, and finds ways to make the property more profitable.
- Collect Rent & Pay Out Profits. During the same five-year period, from the rental income, the syndication returns to its investors a portion of the profits Skyscraper Building generates every quarter.
- Property Sale & Pay Out. After those initial five years, Skyscraper Building sells for $65 million. The investors now get back their entire initial investment, part of the $15 million in profits from the sale, and received quarterly payments during that period.
How Does A Real Estate Syndication Sponsor Make Their Money?
The sponsor participates in the upside of the real estate syndication deal. Even though each real estate syndication and sale is different, a sponsor always acquires a fee in addition to the equity they earned. The sponsor’s fees are clearly outlined ahead of time in the Private Placement Memorandum or PPM.
The typical fees paid to the sponsors are:
- Acquisition/Transaction Fee. This fee is typically 1-3% of the entire transaction value. A sponsor looks over quite a few deals before they find the right one. Acquisition or transaction fees help offset inspection, travel, and vetting costs associated with finding a valuable investment property for a real estate syndication.
- Disposition Fee. A disposition fee is what a sponsor earns at the end of the deal. This fee is a one-time fee equal to 1-2% of the sales price for reimbursing the sponsor any expenses incurred at the sale time.
- Asset Management Fee. The sponsor also manages the asset, including property management supervision, hiring contractors, managing renovations, up-to-date accounting, and investor communications. The asset management fees equal 1 to 2% of the gross revenue generated by the property.
A Real-World Example of Real Estate Syndication
If you’re wondering how real estate syndication works in the real world, let’s look at an example from Life Bridge Capital. We made an investment in Lincoln Springs Apartments, a 180-unit Colorado Springs apartment complex.
Although Colorado Springs has recently experienced more than triple the nation’s average wage growth, many of the city’s citizens still seek affordable housing that’s accessible on a modest income. They’re looking for a nice apartment that won’t be too expensive.
This made the Lincoln Springs apartment complex attractive to Life Bridge Capital and our Passive Investors. While the complex was a bit run down and undervalued for the marketplace, it could easily be rehabbed into a mid-priced apartment complex that would attract plenty of new renters.
We quickly determined that the apartment complex needed new roofing, but this could be covered by a previous insurance claim. With some fresh landscaping, parking lot paving, and relatively minor interior upgrades, rents on the property could be increased by about 7% while still staying within the preferred range for the rental target market.
Lincoln Springs project highlights:
- Purchase Price $19,500,000
- 21.70% Projected IRR
- 2.09x Equity Multiple
- See the full project summary
The Legal Structure
Structured as a Limited Liability Company (LLC) or a Limited Partnership (LP), the sponsor of a real estate syndicate plays the role of General Partner or Manager. The investors participate as passive members or limited partners. The LLC Operating Agreement and LP Partnership Agreement are essential documents. They outline the sponsor’s and investors’ rights, which can include voting rights, rights to distributions, and the sponsor’s rights to entitled fees in the investment management. The LLC or Limited Partnership structure is similar to the other private funds in Venture Debt and Venture Capital. Such legal entities protect the sponsor and the Limited Partners if the deal goes wrong.
Direct Buy vs Real Estate Syndication
Buying a property yourself is one way to invest in real estate. But many investors don’t have the initial capital to purchase a sizeable property on their own. Additionally, the average investor doesn’t have or doesn’t want to spend a lot of time hunting for profitable real estate. After the purchase, the work doesn’t end. There is managing, maintenance, and other day-to-day business that many people have no interest in when it comes to substantial properties. Investing in a real estate syndication, however, allows investors to participate in the real estate market for less capital while leveraging professionals’ expertise and avoiding the hassles of day-to-day management.
How Much Can You Make Investing in Syndication?
Like with any real estate investment, past performance doesn’t guarantee future performance. Returns through syndications average about 8 to 15% for investors. A holding period is typically three to five years but could be as long as ten years or as little as six months. Suppose there is a $50,000 investment with an 8% preferred return but a projected total Investment Return Rate or IRR of 15%. In that case, if the syndication runs for five years, an investor receives $4,000 a year. When the building gets sold at the end of five years, investors receive their initial investment back and a percentage of profits from the sale, bringing the total return on the investment to the IRR projection of 15%.
Is A Syndication Like A REIT?
No. A real estate investment trust (REIT) is similar to a mutual fund. A REIT is publicly-traded, and it holds a plethora of real estate assets. A real estate syndication, however, is not a publicly-traded entity, and it typically contains just one property. Syndications historically earn more than REITs. REIT prices move in the stock market’s direction, while real estate values do not track the same as the stock market movements. Syndications also offer significant tax breaks over a REIT, depending on the tax situation.
Advantages of Investing in Real Estate Syndication
Real estate syndication is the future of real estate investing, and it’s trending more all the time. Here are just a few benefits of investing in real estate syndication:
- Pooling Resources
- Going From Undervalued to Highly-Valued
- Investing in Multifamily Commercial Projects
- Making Bigger Investment for Bigger Returns
- Portfolio diversification
- Professional expertise/advice
- Ability to take part in larger deals
- Passive income and cash flow
- Personal credit protection
- Minimizing risk
- Utilizing other’s connections
Let’s take a closer look at each of these benefits:
It’s an effective way for a group of investors to pool their financial resources and make smart investments. While $10,000 might not buy much real estate on its own, when you join a group of like-minded investors in a real estate syndication, you have much higher buying power.
Going From Undervalued to Highly-Valued
The group can invest in bigger, more valuable properties than each person could afford alone. Many of these projects may be currently undervalued in the marketplace but could be revamped and rebranded to sell/rent for a much higher price than the initial price.
Investing in Multifamily Commercial Projects
Multifamily commercial properties like apartment complexes and condo communities are some of the most profitable projects for real estate syndicates. The average investor wouldn’t be able to invest in these types of projects alone, and probably wouldn’t even know about them without the sponsor’s expertise.
Making Bigger Investments for Bigger Returns
It’s about having more financial resources, but you also have more intellectual resources to invest wisely. Your real estate syndicate helps you make bigger, bolder investments based on actual marketplace data and proven results in the past.
Financial advisors say not to put all the eggs into one basket. An investment portfolio needs diversification. This means that a portfolio should contain varying investments to minimize risk. If the stock market tanks, for example, real estate could manage just fine. Real estate syndications are an excellent addition to a portfolio, allowing you to diversify into a new asset class.
Real estate syndication sponsors have done this before; they understand how to hunt for the right deals, know what is required to squeeze every profit dollar out of a real estate deal and what it will take to raise the property’s value. Syndicate investors can benefit from dealing with sponsors who have years of experience in this market instead of attempting to navigate through it alone.
Ability to Take Part in Larger Deals
There is more money to be made when anything gets done on a larger scale. Single-family homes and duplex sales create profit, sure. Still, it’s hard to compete with the profits from trading skyscrapers, mobile home parks, apartment complexes, office parks, and other enormous real estate deals. Yet these types of investments have been historically off the table for many individual investors for various reasons, including lack of funds, insufficient expertise, or inadequate time for management responsibilities. By pooling money with other like-minded investors, however, one has access to larger deals than they could undertake as a single investor.
Passive Income and Cash Flow
Many real estate syndications have monthly or quarterly cash flow payments, in addition to the larger payout at the deal’s culmination. There is nothing as satisfying as seeing mailbox money every month that requires little to no time and effort. These payments are useful additional cash for vacations, renovations, emergencies, college, parent’s eldercare, and investing in other real estate deals.
The United States’ tax code makes allowances for investors in real estate syndications to enjoy depreciation benefits. Although these benefits largely depend on your individual tax situation, real estate typically has favorable taxation compared to other investments.
Personal Credit Protection
A person doesn’t have to accumulate piling debt onto their credit report. The real estate syndication obtains its own loan from the bank, independent from an investor’s personal credit. Applying for bank loans as a single entity to purchase real estate directly leads to a hit or several on personal credit. The syndication’s debt, however, won’t affect your credit score any more than buying a mutual fund.
When buying real estate directly, sometimes a person winds up spending more than they intended. Unexpected repairs, lawsuits, and other unforeseen expenses turn a projected profit windfall in a downward projection quickly. Putting money into a real estate syndication, you can only lose what you can afford to or choose to invest and not more.
Utilizing Other’s Connections
Some of the best real estate deals won’t ever hit the open market. As with any sector related to real estate echoes, connections are critical. Without those vital connections, people often miss out on the most profitable deals. The sponsor in a syndication network in the business regularly, allowing them the ability to more easily find deals that would otherwise fall below the average investor’s radar.
Finding the Right Real Estate Syndication
You wouldn’t just hand your money over without adequately looking into a business, especially with real estate. Vetting a few real estate syndications is crucial before investing. The sponsor’s reputation, success rate, expertise, years of experience, reasonable financial assumptions in the private placement memorandum, and financing terms are factors that matter when working with a real estate syndication. The split distribution of profits aligns the sponsors’ interests with investors, making it another critical factor. Some sponsors offer different investor classes featuring varied rates of return.
Like with any investment, the investor should do their due diligence and understand their investments. Investors are lured in every day by too-good-to-be-true investment opportunities. An attractive feature of a real estate syndication investment is its favorable tax treatment. Real estate sponsors can use depreciation to offset income, reduce current taxes on cash distributions, and deferrable taxes until the property gets sold. Ensure you understand these and all the factors when dealing with a real estate syndication.
Getting Started With Real Estate Syndication
As you can see, passive investors are well-positioned to realize large returns on the right kind of property investment. We invite you to learn more about this and other previous projects Life Bridge Capital has successfully sponsored along with our investors, and decide for yourself whether this route to passive income is right for you.
Ready to try real estate syndication? Contact Life Bridge Capital today and start your investment journey with the Life Bridge Capital team.