How Are Real Estate Syndications Structured?
In a syndication investment, the sponsor will form a special purpose entity (SPE), which will hold title to the property and be the borrower on the loan. The SPE is a legal entity typically structured as a Limited Liability Company (LLC) or a Limited Partnership (LP) and managed by the sponsor in the form of a Manager LLC or General Partner, respectively. Passive investors become "members" of the LLC or become "limited partners" of the LP. Lenders will want a newly created, property-specific SPE to make sure that this new entity has not engaged in prior business and potentially incurred liabilities. In addition, the SPE protects passive investors from potential liability due to investor ownership of the property in the event of a lawsuit.
Prior to accepting investor funds, the sponsor is required to provide prospective investors with offering documents. A securities attorney should prepare these documents. The offering package consists of the following:
- ⦿ Private Placement Memorandum
- ⦿ Operating (or Limited Partnership) Agreement
- ⦿ Subscription Agreement
- ⦿ Business Plan/Investor Pitch Deck/Investment Summary
The Private Placement Memorandum (PPM) is the disclosure document that describes things such as the structure of the company, how the company will be operated and managed, risks of the investment, projected distributions to investors, fees, conflicts of interest, and liquidity of the investment. Although real estate syndications can be great investments, these opportunities generally have a lack of liquidity, and investors should be prepared to hold interest for at least the entire project hold period. The use of a PPM in a syndicated opportunity functions similarly to a prospectus for public offerings of stocks, bonds, and mutual funds.
The Operating Agreement in the case of an LLC entity or Limited Partnership Agreement in the case of an LP entity is the contractual agreement between the sponsor and the passive investors. The agreement describes the duties and rights of the parties involved in the transaction, such as investor distributions, bylaws, voting rights, and fees collected by the sponsor.
The Subscription Agreement is for investors to certify that they meet the qualifications and suitability to invest in the offering. In this agreement, the investor will indicate the amount of money to be invested.
The business plan or pitch deck is the "marketing" piece that details the investment opportunity and its financial projections. This document may be accompanied by other related documents such as the purchase and sale agreement, asset appraisal, and inspection report.
In a properly structured and aligned opportunity, the bulk of the sponsor's profits should be based on the performance of the asset, but there may be several non-performance-based fees:
- ⦿ Acquisition Fee - for finding the asset, conducting due diligence, and structuring the opportunity; typically 1-3% based on the purchase price and is paid to the sponsor at closing
- ⦿ Asset Management Fee - for ensuring execution of the business plan (i.e., oversight of the property management company and investors); typically 1-3% of monthly revenues
- ⦿ Refinance Fee - for refinancing the asset
- ⦿ Loan Guarantor Fee - for loans that require a personal guarantee by the guarantor
- ⦿ Disposition Fee - one-time fee for selling the asset
Not all these fees will be present on every opportunity, and, if present, their amounts will vary. The most common fees in syndicated deals include acquisition and asset management fees. These fees are not paid by the investors but are business expenses and accounted for before projected investor returns. Fees merely compensate the sponsor to perform work that the business would otherwise have to hire and pay a third party to perform.
*This is a simplified overview of syndications and offering documents and is neither intended to be comprehensive nor legal advice. Check with www.sec.gov for specific criteria of accredited and sophisticated investors. Please consult with a securities attorney prior to engaging in a syndicated opportunity either as a sponsor or passive investor.
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