Real estate syndication is often the simplest and safest way for new investors to participate in large multi-unit real estate investing. Passive investors (limited partners) can focus on their sole task of raising and pooling capital to fund a large multifamily investment deal. Experienced career investors can take on the role of sponsor (general partner) for property investing syndicates.
A syndicate can be described as a type of monetary fund that is backed by real estate. It is similar to an REIT since the capital from each passive investor is pooled. Yet there is one major difference since the majority of REITs typically hold a large number of properties.
They can even hold hundreds or thousands of separate properties. In contrast, real estate syndicates deal with single property investment deals. Also, REITs are often required to comply with tax regulations and mandatory disclosure and distribution requirements.
Participants in a Real Estate Syndication Deal
The sponsor of a syndication property investment then manages all aspects of the deal. From purchasing a multi-unit property to issuing payouts and distributions to the passive investors to the final sale of the property, the sponsor handles the investment project. The passive investors can wait for their financial return on investment (ROI) while focusing on other investments or business pursuits.
Going forward from the signing of the real estate property purchase contract to creating and issuing the Private Placement Memorandum (PPM), the sponsor handles an impressive amount of paperwork, including loan documents. Yet the structure of real estate syndication is surprisingly simple and straightforward. There are actually just three major phases of a syndication property investment.
The Three Main Phases of Real Estate Syndication Investing
The three primary phases of a syndication real estate project are the following:
- The Organization Phase
- The Operation Phase
- The Liquidation Phase
Phase One: Origination Phase of Real Estate Syndication Investing
During the origination phase of a real estate syndication investment, an attractive multifamily property is located by the sponsor. After due diligence is performed to ensure that it has good potential for making profits, financing is secured via the passive investors. The sponsor then negotiates a suitable purchase contract, and the investment deal is closed.
Throughout the lifetime of this investment, the sponsor follows a carefully structured business plan for managing the investment. The sponsor performs audits of the investment property’s financial track record and makes in-person inspections of this multifamily building or complex. The general partner (sponsor) also validates the property title and corrects any obstacles that might delay the closing.
Next, the general partner applies for an appropriate loan and secures loan guarantors if needed. The steps to follow are:
- Arranging commercial appraisals;
- Creating a business entity (LLC, corporation) to hold the investment asset;
- Acquiring cash from the passive investors to cover the down payment, closing costs, any necessary renovations or other necessities;
- Closing escrow;
- Initiating the business plan.
This origination phase typically lasts for several months, starting with the investment property’s location and selection. It ends with the close of escrow.
Financing Real Estate Syndication Investment Deals
There are various ways to finance a multifamily property syndication deal. The specific financing methods available to investors are decided according to the structure of the deal and the borrower’s application and creditworthiness. Types of financing may include: conventional financing, agency loans, commercial mortgage-backed security (CMBS) loans, Small Business Administration (SBA) loans, hard money loans and real estate crowdfunding platforms.
Loan applications for financing large multi-unit property syndication projects are evaluated according to the borrower’s credit risk factors, including the following:
- The applicant’s past records of repayment;
- The borrower’s business and investing reputation;
- The borrower’s relationship with a bank;
- The borrower’s overall financial history and status (business and personal).
The lender will then decide whether this applicant has the capability to acquire more capital if the real estate investment deal is not profitable.
Phase Two: Operation Phase of Real Estate Syndication Investing
To begin the operation phase of a multi-unit property syndication deal, the sponsor initiates the business plan that was designed during the origination phase. This is often accomplished with the aid of an experienced and respected property manager and other contractors as needed.
Tasks Performed by the Sponsor During Phase Two
Tasks undertaken during this second phase of the syndicate investment include resolving any unfinished maintenance issues or repairs. Requirements for these repairs are usually decided by the lender. After all necessary renovations are planned and completed, a lease-up, renewal or rent payment increase plan is executed.
Following the completion of the first value-add period, the operation phase may continue for the next several years. For the duration of this phase, the sponsor works with the property manager to ensure that all unit rents are collected and new contracts are negotiated. Other tasks that they are responsible for include marketing and leasing unoccupied units.
The sponsor also works in collaboration with the property management to settle legal issues, such as evictions. They also pay essential expenses like insurance fees and property taxes along with repaying debt service fees. They make distributions of cash flow payments to the limited partners (passive investors).
The syndicate’s general partner (sponsor) also issues reports to the passive investors concerning the financial and physical condition of the investment asset. In addition, the sponsor prepares or approves tax returns for the investment property and supplies Form K-1 to all passive investors to include with their tax reports.
Phase Three: Liquidation Phase of Real Estate Syndication Investing
The third phase of a real estate investment through syndication is centered around an event of liquidity that results in a payment as ROI to the passive investors. This event may be the sale of the investment property or the refinancing of a loan.
Sponsor Responsibilities Concerning an Event of Liquidation
If the event of liquidation is the sale of the investment property, the sponsor’s responsibilities can involve varied tasks. These tasks include ensuring the completion of any property updates or repairs that are needed to improve the property’s sales potential. The property must then be marketed, typically with the aid of a real estate broker. The sponsor must then prepare the property financial report for the buyer’s inspection.
The sponsor must also help set up potential buyer tours and review all offers on the property. They must also negotiate the property purchase contract with the buyer and close escrow. The sponsor is also required to make payments to the passive investors equaling their share of the proceeds from the property sale. In addition, the sponsor prepares the final tax reports as well as the Form K-1s.
Sponsor Responsibilities During a Liquidation Event by Refinancing
During a liquidation event by refinancing, a syndication sponsor must locate appropriate lenders and apply for a loan. The sponsor must also secure loan guarantors and arrange a new appraisal of the property asset along with closing on the new loan.
Afterwards, the sponsor is responsible for distributing proceeds from the loan among the passive investors. Following the refinancing, this third operational phase may be in effect for several more years or until the property sale date as the final event of liquidation.
Although new investors may view real estate syndication as complex and detailed, all property investing syndicates operate according to three definite phases. These phases are the origination, operation and liquidation phases. The basic structure is rather simple and easy to understand.
The more you participate as a limited partner (passive investor) in syndication property investments, the more knowledge and understanding you will gain. The different phases, details and processes of this lucrative and relatively safe type of investing will make sense to you. As you learn more through due diligence, you will see the true value in continuing to invest in large multifamily properties through syndication.
Investors with large amounts of capital to invest in syndicated property deals typically qualify as accredited investors. However, if you only have limited funds to invest, but you have significant knowledge about syndication investing, you can qualify as a sophisticated investor. If your knowledge and understanding of this form of real estate investing is considered valuable to other investors and to the investment project, you can gain approval to participate.
Your knowledge and know-how can enable you to avoid the need to contribute a larger amount of funding than you can afford. As a new, yet valuable passive investor, you can also gain top-rated advice and expertise from the passive investors who are accredited.
Even extremely large multi-unit real estate investments have many similarities to smaller property investments. Although the numbers are significantly larger, the investment techniques and strategies used are basically the same: purchase, perform rehab, rent, refinance and sell as the final event of liquidation.
Newcomers to real estate investing may view large multifamily properties as investments for wealthy investors only. Yet the great advantage of real estate syndication investing is that virtually any investor with a moderate amount of funds to pool with other passive investors can participate in and profit from this innovative form of investing.