Syndication vs traditional financing - dumb question

7 Replies

Dumb question incoming - 

Why would a lead/sponsor investor opt for syndicating a deal vs accessing traditional lending? It seems like I'm hearing syndication deals offering passive investors a return of 10-20% and traditional financing for an apartment complex can be had for 8-14%, so why not go with the cheaper money?  Clearly, I'm not wrapping my head around this in the right....educate me, please! 

Sure if you have the monies to take down and rehab the property then I agree go get a commercial loan, and keep all the profits. Most Multifamily deals that we search out make more sense to syndicate with smaller returns since we are looking at $5 million on up in regards to acquisition cost of our properties, so it makes more sense to syndicate. Hope this helps. 

@Travis White this isn’t an either/or situation, you are talking about different portions of the capital stack.

Traditional lending rates are actually between 3% and 6% for the most part depending on the LTV and type of loan. So certainly it's desirable to obtain financing. But you can only get financing for 75% to 80% of the purchase price, or in some cases purchase price plus rehab cost. What about the rest?

Syndication is typically used to fund the equity portion. In simple terms that’s the down payment, closing costs and rehab (or portion of the rehab that the loan won’t cover, as the case may be).

So it is not that syndicators are going without conventional loans, instead they are going without their own cash, or less of their own cash, to close deals. You can’t get conventional financing for that part. 

In general, syndicators use a combination of both debt ("traditional financing) and equity (the syndication piece).

On the debt side, they would source say 70-80% LTV (from Fannie, Freddy, a bank etc...)

and they would have an interest rate in the 4-4.75% range.

On the equity side, they would source 70-90% of the needed equity (from private investors, private equity etc...) and provide the additional 10-30% from their own capital.

In exchange, they usually give the the investor 70-80% of the cashflow and upside, usually yielding the investor 12-20% on their money. The reason that the investors require these higher returns is because they hold a much riskier position than the bank, as if the property value falls by say 10%, the investors lose half their money.

In the same situation where the property value falls by 10%, the bank still has their position covered by the property value and they don't lose anything. So as you can see from this example, the bank is in a less riskier position and thus does not require as high of a rather of return. The reason the banks aren't interested in lending at a higher LTV is because they are in the business of lending on collateral, not in real estate investing.

So to answer your question,syndicators use debt as that is they're cheapest option. However, since the banks would not lend then them full amount, they are forced to use a different sources (private investors etc...  who require the higher rates) for the amount above what the bank would lend.

@Brian Burke and @Ari Bauer answered the question well. But why would you give up a 70%+ of the profit? When you are taking down a $10mm building for instance you will need to come up with $3mm+ for the down payment, closing expenses, reserve account and likely as least some type of immediate repair account. Not many people have that kind of money to take down deals on their own, so they find partners. Now instead of saving for years and years to finally be able to do just 1 deal, you are able to do many deals and create a business with efficiency. A small part of a big deal is better than 100% of no deal. 

Being a syndicator, however, is not to be taken lightly. I think a lot of people think that using other peoples money sounds so good and easy, but you are taking on a massive responsibility. If you decide to go this route, study, learn and gain experience before you start using other peoples money. 

Ok, thank you guys so much for the insight here; this all makes a whole lot more sense to me now. 

My initial thought was that deals were financed 100% through syndication and that wasn't making sense to me. 

@Ari Bauer - thanks for the piece about investor risk vis a vis a 10-12% return, that makes sense. 

I'm just getting started investing now...hopefully someday soon I'll be back with more questions as I move up the food chain. 

Thanks again! 

I do not know sponsors that take a 20% promote. Typical depending on deal size can be up to 50%. The sponsor usually gets little remaining ongoing cash flow so the true payoff is the equity growth on the back end. If that piece is too small for sponsor then it's not worth their time to put in years of work for a tiny payoff.

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