Real Estate Syndication and Its Benefit to Investors
What Is Real Estate Syndication?
It’s actually a pretty simple concept. Real estate syndication is a way for investors to pool their money together to buy a property. But between concept and reality, things do get a little more complicated. A basic understanding of real estate syndication in today’s market involves understanding a few more key details.
Why Syndication Makes Sense
Before jumping into the details, let’s first explain why investors choose to invest in real estate syndications. With syndication, an investor can pick a specific property, unlike a real estate fund or REIT. But a third-party professional does the work of buying, selling, managing and/or developing the property. Since most investors aren't looking to take on all those responsibilities this is another positive of a syndication deal.
By pooling money together investors can participate in bigger deals than they otherwise might. For example, owning a large multi-family apartment complex or downtown office center might be beyond many people’s means. In addition, syndication lends itself to building a diversified portfolio of properties across metros and segments.
In short, a syndication is a third option versus buying a property just by yourself or participating in a real estate fund, like a REIT or real estate investment trust. People who already own a rental property might decide to participate in syndications to also seek access to new properties in better metros and market segments outside their expertise or budget.
Those who already invest in a real estate fund might participate in syndications to seek better returns around individual deals. There is also a concept in finance called the illiquidity premium. This means for the inconvenience of locking money up in long-term investments, participants typically benefit from higher returns. If you can lock up your money in a property deal for around five years, then syndications often make a lot of sense.
At Wilson Investment Properties we focus on what we consider a sweet spot in the market for overlooked value. Deals that are too big for the typical individual investor and too small to be worthwhile for the big institutional investors. These are multi-million dollar opportunities in multi-family, industrial, retail, office or other commercial segments.
The syndication structure allows the combining of enough individual investor money to buy such properties and pursue well-defined, institutional-style value-creation strategies aimed at delivering superior risk-adjusted returns.
Partner Structure is Key
Syndication is simply a legal structure and framework for raising and investing money. Perhaps the most important aspect to understand is the partnership structure. There is a general partner or partners (GPs), responsible for buying, selling, managing and/or developing the property. There are also limited partners (LPs), who proportionately share in the associated income and profits.
Ultimately the value of syndication is derived from the value generated from the underlying real estate property. That means it’s very important to pick the right general managers, who can buy, sell, manage or develop real estate to create investor value. So, selecting the right syndication is in large part about picking the GP. Most of the time that means relying on the expertise of a single GP with expertise in one type of property.
But partner structures can be more sophisticated. For example, Wilson Investment Partners uses a syndication structure, involving partnering with co-GP partners, who are specialists in different types of properties across the nation. That gives us a bigger deal flow to draw from and allows us to select what we think are the best deals for our clients, whether it’s a deal with a partner possessing expertise in creating value around large multi-family properties in the Sun Belt, industrial properties in the Midwest or so forth.
It also means we’re selecting a few deals from a large flow of opportunities brought by our partners. We are also performing an additional level of due diligence, so investors know every deal we do with a partner meets our standards.
Beyond understanding the importance of the general partner, it’s also important to understand the limitations of being a limited partner. For starters, limited partners have limited liability. Unlike owning real estate directly, a limited partner is only at risk for the amount of money he or she commits to the deal.
Limited partners are not responsible for managing or developing the property. LPs don’t have to do that work or assume that direct legal liability. Conversely, LPs don’t have control to change rents, evict tenants, fire contractors or so forth. Those are all up to the GPs.
Legal Structure Decides Who Can Invest
There are different legal structures for owning property. In the case of syndication, it is a financial security with its value derived from the underlying property. For example, Wilson Investment properties sell shares of $50,000 each, so someone who wanted to invest $200,000 in a deal for a $5 million office center, would purchase four shares.
The Securities and Exchange Commission regulates financial securities in the U.S., along with state bodies. Syndications are typically organized under SEC Regulation D, Rule 506(b) or 506(c). Most Wilson Investment Properties syndications are 506(b) deals, which allows for accredited investors and up to 35 sophisticated investors to participate in any one deal.
If you have a net worth of $1 million dollars or more, not including the value of your primary residence, you are an accredited investor. Or if you have an individual or combined income for the last two years of at least $200,000 or $300,000, respectively, you also meet the standard.
The definition of a sophisticated investor is vaguer. But if you have sufficient experience and knowledge to understand the risks of the investment, and do not need the funds to maintain your lifestyle--meaning you can withstand a loss and don’t have a need to liquidate the funds before the deal is officially exited, often by the property being sold to a new owner--then you are a sophisticated investor.
There is one more requirement for participants in a 506(b) deal. He or she must have a pre-existing substantive, relationship with the general partner. That’s because no public advertising or marketing is allowed. Fortunately, if you’re on our relationship list and getting this newsletter you likely already have a substantive, relationship with Wilson Investment Partners. As a result, you can reach out to us to learn the details on any upcoming syndications.
Communications, conversations and so forth between a potential investor and the GP is how such relationships are created. Without them, you cannot be offered a 506(b) syndication deal, even if you start a relationship as soon as you hear about a deal you like. On the other hand, a 506(c) syndication can be publicly marketed and sold, but only to accredited investors. The nature of the investment itself has nothing to do with whether syndication is issued under Rule 506(b) or 506(c). The difference between the two is about who can participate.
Although accredited investors can self identify in a 506(b), when it comes to a 506(c), verification is required, such as a letter from an investor’s certified public accountant (CPA). If you see an online advertisement for a syndication deal, it’s almost certainly a 506(c). The ability to publicly advertise is why Wilson Investment Properties will do an occasional 506(c) deal that is not available to our sophisticated investor clients and requires formal verification from our accredited investors.
More About Syndication
Those are some of the basic details around what syndication is, who can invest and why it makes sense to do so. In Real Estate Syndication Part 2, we will be discussing investment returns, fee structures and how the Internet has changed the syndication landscape. Of course, if you have any questions, we would be more than happy to address them directly. If so please feel free to email us. We will also be discussing the basics and structures of syndications in our upcoming webinar, as well as our next BACOMM event, where the team would love to meet you.