Real estate syndications are becoming more popular as investors seek to complete larger deals and more individual investors consider these alternative assets for their portfolios. Many want to step up to create their own syndications. This can be overwhelming from the start because there are a variety of ways to organize and many different variations of how money is raised, returns are offered, and profits are earned.
Here are some of the options for structuring your own syndications.
Legal & Organizational Structures
Real estate investment trusts (REITs) have long been away to put together large real estate deals and portfolios. They can be either privately or publicly traded and listed on stock exchanges. REITs can actually be organized as corporations or trusts as well. They are unique in that they must pay out at least 90% of their taxable income in dividends. In addition, you need at least 100 members to create a REIT. No fewer than five people can hold more than 50% of the shares.
Related: The Big 62-Point List of Apartment Syndication Terms Serious Investors Should Know
Limited liability companies (LLCs) are one of the most common structures for large investment deals. With an LLC, you will have managing members who will be sponsors or active organizers and investors, as well as passive capital investors who will be classified as regular members of the LLC. These entities offer a lot of flexibility in how control and returns are shared, as well as in how taxes are dealt with.
Limited partnerships (LPs) are also common syndication structures for sophisticated investors. These include a general partner (GP) who acts as the organizer or “sponsor” and who will take care of the active investing. Limited partners are the passive investors who provide capital for projects. More sophisticated investors often choose to organize in Delaware for privacy and tax purposes. Many believe partnerships have a longer and more established history and legal precedent for limiting taxes and providing truly limited protections.
Fundraising, Fee & Payout Structures
Debt vs. Equity Fundraising
The two main types of syndications involve raising debt financing or equity capital. Each has its advantages. Some funds use their capital to either invest in hard real estate assets or paper assets in the form of mortgage notes. Then there are mixed models that do both or versions that combine private capital or debt with commercial mortgage loans.
In other structures, the sponsor will promote and offer preferred returns. This means that those passive partners are owed a predetermined rate of return on their money before the sponsor can take any profit share. Only after those dividends are paid does the sponsor get to participate in the profit action.
The most common preferred return I’ve seen is a 7-8% preferred rate of return, followed by a 75/25 split of profits after that, with the sponsor receiving the smaller share. A preferred return simply means those investors get paid first. Only after they have been paid the promised rate of return can the sponsor get a split of the remaining profit.
Straight Equity Split
Syndicators can give their investors straight ownership splits. A majority split going to investors such as a 90/10 split is quite normal, however this can vary. Returns will be split according to ownership or share percentages. For example; if the deal makes $100,000 next quarter, the sponsor takes $10,000 of the profit. The balance is split accordingly among the other investors.
Sponsors have a variety of other ways to earn and profit in syndications as well. Some try to structure their deals in a way that gives potential investors a lot of confidence, because interests need to be closely aligned for the long-term. Others are very good about balancing this with earning enough to fuel their team to do the best work at every stage of the process. After all, it takes a great deal of time and money to pull everything together. This often means earning fees at acquisition, securing funding, refinancing, managing construction, facilitating property management, and overseeing the liquidation of assets.
It is also very important for syndicators to know their costs. In addition to standard transactional and property management costs and lender fees, there are going to be extra expenses. Plus, fundraising can take up most of your time at the beginning. This may include SEC attorney fees, technology, and certainly a great deal of marketing.
There is growing interest in creating new real estate syndications. There are many ways to do it—in fact, I am still learning them myself! Done well, the rewards can be fantastic for everyone involved. Fortunately, it has become even easier to raise capital and manage investors thanks to new syndication software. Just ensure you know the costs and best practices. Then begin by testing the waters.
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