OPM - How to Syndicate with Success
I get asked a lot of questions about syndication by people that are interested in investing in syndications and by others that are interested in putting one together. Syndication can seem daunting and the thought of raising money can be intimidating. With a little bit of knowledge and a paradigm shift, doing a syndication or investing in one, can be easy and profitable.
Raising money is to be taken seriously and diligently and is not meant for everyone. You are dealing with other people’s hard earned money. They are trusting you with a large portion of their funds. They do not expect you to lose it and expect that you will treat it with the highest regard. Even if you can treat their money better than your own, you should hesitate to use their money. Ask yourself a few questions:
- 1.Are you able to underwrite conservatively and properly operate the asset and fully execute the business plan?
- 2.Do you have the experience necessary and have you built a team?
- 3.Can you communicate effectively with your investors?
- 4.Are you able to treat other people money better than your own?
- 5.Are you willing to put your own money at stake?
- 6.What will you do if things take a bad turn?
If you can answer those questions honestly and the right way, then you may be ready to raise money, if not, then work on your weaknesses first.
How much profit should I give away?
For me this comes down to a few things. First, what is your experience? If you have a fantastic and large track record, then you can pay less. If not, then pay more. Second, what is the risk associated. The more risk, the better your investors should be paid.
How I see it, is that most companies want to give their investors a healthy 14%+ Internal Rate of Return and 7-9% cash on cash return annually. This return is not to be guaranteed, but that is what they try to attain. I will pass on a deal if I am not able to conservatively hit my desired return to my investors. Internal rate of return is the return they will get through the life of the loan if they could re-invest their money. It combines the monthly or quarterly cash flow they receive, the principal that is paid off on the loan and the profit made at the sale. Then we account for the amount of time that the asset was held and when the profit was paid.
What type of structure should I use?
Again this is your preference as well as your investor’s preference. I pay out based on the profits. My limited partners (the money investors) get shares of the asset and they are paid based on the overall profit that the investment makes. My investors are given money 3 ways:
1. Paid based on the cash flow of the property
2. Paid based on the profit at the sale of the property. They get their portion of the equity.
3. Given their principal or portion of principal back at a refinance (this doesn’t provide profit)
You can also pay a straight interest rate or a combination of interest rate and a small equity position. If you pay an interest rate, just be sure that you can hit an attractive interest rate for your investors and still make money yourself. Paying an interest rate is lucrative for the General Partner in deals that have a lot of equity and will be sold in a few years. You will get paid very little during the operation of the asset, but upon sale, you stand to gain 100% or close of the equity that was gained.
In an equity partnership how do the splits look?
The most common split that I see is a 70/30 split with a 6-8% preferred return. 70% of the profit goes to the investors and 30% goes to the General Partner/Sponsor. The preferred return of 6-8% means that the investor received that percentage before the general partner gets paid. Once that amount is hit, then they split the profits above that.
There is typically and Acquisition fee is between 2-3%. This is based on the purchase plus renovation amount. This amount is paid up front or can be differed until the sale.
The last fee is an Asset Management fee. This is usually also 2-3%, based on the gross income of the property. This fee pays for the sponsor’s time and effort as well as some soft costs, like admin, travel, etc. This fee is often paid after the investors are paid.
Some companies also charge a disposition fee of 1-3%. This means at the time of sale the sponsor gets paid an additional 1-3% of the sale price. Many companies also have a waterfall clause. This will state that after the limited partners are paid X%, then the split will go to 50/50 or some other ratio.
Please understand that the splits and profits mentioned are examples and not to be used as the right percentages to use. Consult with your investors and attorney to find a profit split that is right for you.
How do I set a syndication up?
Use a Securities Attorney! Attorney’s cost money, it’s true, but please don’t try to skimp and do it yourself or use a template. In my opinion you should fact check everything I have said and anything else you’ve read with your attorney. Be sure to get them involved before engaging investors so that you do not violate SEC rules. I see people posting online and standing up at networking events asking for money. This makes me cringe. Likely they are breaking the rules and their offering is in jeopardy (and not the fun TV game show).
Understand that syndicating is a business and should be treated as such. If you are going to grow in real estate you can do it on your own and go slowly with your own money. There is nothing wrong with doing that! If you want to grow a large company with a lot of assets under management and get other people involved then read and research more on syndication and take a serious look at it to decide if it is right for you.
To your success!