Experienced SFR investors I meet and know usually come to a crossroads at a certain point in their investing careers. If they get to a point where they wish to continue after passing their goal of rentals or flips, they want something more, something bigger. Many venture into commercial real estate investing or ramp up their SFR buying from a few houses a year to a few packages of houses a year (like a tape of REO’s). Usually when doing either of these things they utilize what is called a Real Estate syndication.
A Real Estate syndication is simply a partnership that’s set up to buy (or sell shares of) real estate. The size of the partnership could range from a few investors to hundreds of investors requiring all the necessary SEC (Securities and Exchange Commission) requirements to be met. Once you’re pulling investor money for an investment where the investors no longer have a say, either about day-to-day operations or just plain voting rights, is when you’re starting to enter the world of selling a security. The most common formats for these types of syndications are usually either Limited Partnerships (LP’s) or Limited Liability Companies (LLC’s).
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Benefits of a Syndication
So, let’s look at some advantages of syndications starting with the syndicator themself. First and foremost, as a syndicator you get to use OPM (Other People’s Money), which is great because it mitigates your personal risk in your deal, plus instead of buying a small rehab with no money down you’re essentially doing the same thing except in this case it’s a 100 unit apartment complex. And many times in these types of deals involving OPM, you’re raising capital from investors who you plan to retire down the road after refinancing, leaving you with title to a substantially valuable property without needing much personal capital. Not only that, but you inherit a certain degree of asset protection and risk reduction, especially by utilizing a private placement and a separate entity for your investment structure. Most importantly though you have control. Not only control of the real estate, but of how it is managed so if anything in your deal changes you have the ability to alter the deal (within reason of course, you want to be able to go to these same investors for your next syndication).
You also have at least three major sources of profit. One is an acquisition fee, which could be a small percentage or flat fee just for finding, structuring, and acquiring the deal. I shouldn’t say “just” because it does require a good degree of work and knowledge, but it doesn’t necessarily require your own money. Another major source of profit is through asset management fees, which are typically a percentage of the assets under management. These asset management fees are simply for managing (or rather overseeing the team of people managing) the real estate in question. And the third way to profit is through equity participation, which could be anywhere from 5% to 50%+ depending on what you investors agree upon and accept. With control in the deal as the asset manager you can even set these fees, and if it’s a placement you have the ability to alter fee structures and the use of proceeds.
Challenges of a Syndication
One of the major challenges for the syndicator could be the initial cost of setting up a fund, which can cost anywhere from $20,000 to $30,000. The more knowledge and experience you have at putting together a fund the cheaper this will get. If you have a solid track record, business plan, and know your “Use of Proceeds” prior to meeting with your securities attorney, you will dramatically reduce your setup costs. Also, do not forget that you CAN pay for legal, accounting, and setup costs out of the capital raised. Now all that is easy if you’ve been able to overcome another big challenge for some syndicators, and that is having enough investor capital sources to begin with. Again, like anything else, the better your track record is and the better your team of experts are, the easier it is to find sources of capital. When I first started raising money, the guys that found the deal I invested in were relatively inexperienced but they managed to raise over $8,000,000 partially because of the team they built with experienced fundraisers, a site developer, a property manager, a broker, an accountant, etc.
Syndication Investors: Advantages and Disadvantages
Now, what are some of the advantages for an investor in the syndication? Well, not only are you able to be a passive investor in projects that are larger than you could probably do on your own with something like private money (which is generally short term), but you do not necessarily need to have any expertise to get involved in a large real estate project. You can also invest in many different asset classes and different types of properties. Plus, you don’t have to know how to rehab or renovate. Nor, do you have any maintenance or management to do. But, the best part is that your losses are limited to your total investment in the project. I was a “Class B member”, passive investor, in a real estate project once that went south several years ago and I watched the “Class A” members, managing members, who signed on the commercial loan lose everything and eventually had to file bankruptcy whereas I only lost my initial investment capital.
As far as disadvantages go, control comes to mind first. When you personally own something yourself and not a fractional share, you can jump in and alter the property or deal. But if you’re a class B investor, that option is out of your hands so it’s always important to know and trust who you’re investing with to be responsible. Now if you do lose money it is possible write it off a passive loss to offset a passive gain. As a silent passive investor, it’s usually not publicly known that you’re part owner in a project so you don’t necessarily tarnish your reputation as an investor.
All that being said, I think that if you want to take your real estate investing to the next level it will pay you to “Think Big” and employ the power behind the commercial syndication to get you there. Whether it’s commercial or large scale residential investing, remember to weigh these benefits and pitfalls when it’s your time to take the next big step; investing with a Real Estate syndication.
Photo: Wally Gobetz