Investing with a real estate syndicate provides a group of investors with many advantages. Multifamily real estate syndication enables this group of passive investors (limited partners) to pool their capital to make an investment in a large multi-unit property. Each limited partner owns a fractional share of the investment.
Each investor gains the benefit of being able to investment in a much larger property deal than they could otherwise commit to. The main task of the passive investors is raising funds for making the investment. All other aspects of the property deal are handled by the syndicate sponsor (general partner), including the eventual sale of the property.
Another advantage of investing in real estate through a syndicate is the valuable opportunity of learning from more experienced investors. You can leverage the collective experience, cumulative knowledge and combined expertise of the sponsor and the other passive investors. This is extremely helpful to anyone who is new to syndication property investing.
Five Valuable Tips for Evaluating a Real Estate Syndication
Today, over one trillion dollars of real estate investments are transacted through syndication every year. Especially for novice passive investors, it can be somewhat overwhelming to locate a top-quality real estate syndicate. There are varied acceptable structures for good caliber property syndicates. Yet there are some structures and best practices that are adhered to by all optimal-quality syndicates.
After the JOBS Act (Jumpstart Our Business Startups Act) was enacted in 2012, there was an influx of novice real estate syndicators on the market. This paved the path to crowdfunders, or middlemen, who raised and provided funding for these new syndicates. In exchange for a fee, these middlemen monitored investors who participated in property deals with syndicates.
Today, crowdfunders vet these real estate syndicators and their investing deals according to different syndication platforms and criteria. For this reason, it is essential for new and potential passive investors to evaluate these new syndicators and their investing deals carefully. Due to this type of industry deregulation, it is crucial for both older and new passive investors to thoroughly assess a syndicate, its structure and its property deals before investing.
Five essential tips for assessing the quality of a real estate syndication include the following:
- Syndicate Track Record
Before considering joining a syndicated investment deal, determine the track record of the syndicate. Research the type and quality of investment assets that they manage. Also look at their annual volume of transactions. It is also wise to examine the results of different investment deals that a syndicate has offered, transacted and managed.
Does this REI syndicate have a loyal group of investors who eagerly fund investments on an ongoing basis? Determine whether they have repeat investors or must depend on crowdfunder-marketers to fund their investment deals. Are they willing to supply names of their regular investors as references?
- Syndicate Legal Business Structure
All multifamily real estate investments should be transacted and managed by a syndicate with a legal business structure. The majority of REI syndicates today are either Limited Partnerships (LPs) or Limited Liability Companies (LLCs). The two categories of legal participants in syndication property deals are the general partner (sponsor) and the limited partners (passive investors).
When syndicates are legally structured, quality asset protection is ensured for both the general partner and the limited partners. The general partner has the responsibility of setting up the syndicate as a legal entity. This sponsor also has the duty of generating all essential and relevant legal documents for the information and use of the passive investors.
- Essential Syndicator Assumptions
Before you can determine whether a syndication project aligns with your investing goals, you must understand the syndicate’s assumptions. Assumptions are essential for all investment projections, regardless of whether the investment involves stocks and bonds or property syndication.
Syndicator assumptions should be founded on past market performance, current industry dynamics and relevant trends in demographics. Syndicates compute targeted financial returns and standardized financial statements according to informed assumptions.
Yet these projections of future financials can be both beneficial and deceiving or, at least, confusing. Some syndication sponsors who are less than trustworthy may project excessively high investment returns that are unfounded to attract investors. To avoid making a bad investment, compare these targeted or standardized returns with the syndicate’s financial returns on previous investments.
If the returns on prior investments do not measure up to their targeted projections, you will know that their assumptions are unreasonably high and not realistic. Yet if a real estate syndicate frequently attains or surpasses its targeted returns, you can tell that more dependable, realistic assumptions are being used. You can realize that this syndicator is offering more reliable and profitable property investments.
- Structure of Distribution Waterfall
One of the documents that you will become familiar with in real estate syndication investing is the Private Placement Memorandum (PPM). With similarities to a stock investment prospectus, the PPM includes a detailed description of a syndicate’s investment project. The PPM also includes the investment distribution waterfall.
It reveals how capital is divided between the syndication sponsor (general partner) and the passive investors (limited partners). This explanation of capital distribution includes the syndicated investment’s years of activity as well as the time of disposition.
Regardless of how the distribution waterfall is structured, there are two major concepts of importance:
- The major portion of an investment’s profits should be issued to the passive investors; and
- Most of the syndication sponsor’s profits should be based on their overall performance. The more money that the sponsor makes for the passive investors, the greater the sponsor’s compensation will be.
- Investment Exit Strategy
Before participating in a multifamily REI syndication project, you should be very familiar with the syndicator’s investment exit strategy. Do they engage in long-term buy and hold property deals or short-term fix and flip projects? Is their main interest and focus on longer projects involving value-adding properties or shorter deals offering fast capital returns?
What are the tax benefits, if any, of investing with a specific real estate syndicate? Do they make use of 1031 exchanges for tax deferral, or will you owe a significant amount of taxes at the time they sell your investment property?
In order to become a successful passive investor with an REI syndicate, select your syndication property investments carefully. Make sure that you invest with a syndicate that has the capacity and investing strategy that best aligns with your real estate investing plans and goals.
Get to Know Syndicates by Performing Due Diligence
You should be sure to determine whether a real estate syndicate specifies that its participants be accredited or sophisticated investors. The majority of syndicates are structured with one of the following two SEC Regulation D exemptions:
- Exemption 506(b). This exemption requires that investors (as many as 35 for each deal) be sophisticated. This simply means that such investors must have a thorough education in finance. A limitless number of accredited inventors may be accepted for syndication property deals. This exemption permits sponsors only to offer new property investments to their current client base.
If you are interested in property investing through a syndicate, you must build a good relationship with the sponsor. You can do so by registering on their website and showing strong interest in the multifamily property investment deals that they offer. You can also learn about many valuable aspects of syndication property deals by getting to know the more experienced investors and the sponsor in a syndicate.
- Exemption 506(c). This type of property investment specifies that all investors must be accredited and have a net worth of at least $1 million, not counting home property values. Investors may also quality with incomes of $200 K as a single person or $300 K if married. Exemption 506(c) investments also require verification, which is typically given by a CPA or by a qualified third party.
Examine a Syndicate’s Rate for Preferred Returns and Dividends
Take time to examine and assess a syndicate’s rate for preferred returns and dividends before making a commitment to invest your capital. Stabilized real estate typically produces revenue in the form of rents paid by tenants. Sponsors of these syndication deals often provide a preferred return to their passive investors.
The return increases at a predetermined rate. Prior to any profit-sharing when the property is eventually sold, the return must be issued. While some property investment deals have a set preferred return that is based on the investor’s first capital investment, others decide this return as a percentage of the net cash flow that is actually generated.
Dividends are frequently confused with preferred returns, yet dividends are the payments issued during a property deal’s hold period. They may be paid on a monthly or quarterly schedule. Dividends are actually issued at the syndicate sponsor’s discretion. These financial rewards are sometimes interrupted by unforeseen vacancies or other expenses throughout the holding period.
Investing in multifamily properties through an REI syndicate offers many valuable advantages to passive investors. If you are new to syndication real estate investing, take time to evaluate every syndicate and syndication investment deal carefully before participating.
As a well-informed and savvy passive investor, you can build an impressive property portfolio. You can also enjoy the many benefits of accruing high profits as a successful real estate syndication investor.