For individuals interested in commercial real estate investing, one of the most common ways to do so is through a deal structure known as a “syndication.”
In this article, we are going to describe what real estate syndication is, why they can benefit individual investors, and how to invest in one. By the end, readers should have the information needed to determine if a syndicated investment is a good strategy for their own individual preferences.
At First National Realty Partners, we are a deal syndicator who specializes in the acquisition and management of grocery store anchored commercial centers. If you are an accredited investor and would like to learn more about our current commercial real estate investment opportunities, click here.
What is a Real Estate Syndication?
The most logical place to start a discussion on how to invest in real estate syndications is to define what one is.
Individuals interested in a commercial real estate investment have two challenges: (1) commercial properties are very expensive (for context, the properties we purchase are usually in the $20MM – $30MM range); and (2) commercial properties are very time consuming to manage and require a lot of expertise to do so effectively. For these reasons, it is uncommon to see commercial investment properties owned by individuals. They are more commonly owned by institutional investors or “syndicates.”
For a more comprehensive article on real estate syndication, please view our article “What Is A Real Estate Syndication?”
To this point, a syndication is a commercial real estate deal structure that allows individual investors to purchase a fractional share of a commercial property in exchange for a pro-rata fractional share of the cash flow and profits that it produces.
That covers the most basic definition of a real estate syndication. Next, let’s illustrate how a syndication works with a hypothetical example.
How Real Estate Syndications Work
Suppose that we find a grocery-anchored retail center, and after significant analysis, we determine that it is a good fit for our real estate portfolio. We offer to purchase it for $30 million.
Once the offer is accepted, we will quickly work to set up a single purpose entity, an LLC, and use that as the vehicle through which to complete the purchase.
Next, we arrange debt with one of our preferred lenders and they are willing to offer a loan at 80% LTV or $24,000,000 – which means that we need to raise the additional $6 million from Limited Partners.
To do so, we put together a number of key documents such as the syndication agreement, operating agreement, subscription agreement, and offering memorandum and get to work sending them to investors who we think may be interested in our deal. Often this must be done quickly, because once the property is under contract, we have to close within 60-90 days.
Once the needed equity is closed and we have completed all of our due diligence to ensure the property has no major issues, we will get the deal closed and transfer the property into the name of the LLC.
After closing, we take over management of the asset and handle all aspects of the day to day operations including leasing, maintenance, accounting, reporting, and perhaps most importantly investor distributions – as outlined in the syndication agreement.
To accomplish this, there are two parties involved in real estate syndication; the General Partner(s) and the Limited Partner(s).
Parties Involved in a Real Estate Syndication
There are two parties involved in a typical commercial real estate syndication: (1) The General Partner or “GP” – sometimes called the Sponsor or the Syndicator; and (2) The Limited Partners or “LPs” – sometimes called the Investors. Each has an important role to play in the success of a deal.
Sponsor/Syndicator
The Sponsor/Syndicator (this is the role we play in a transaction) is the deal leader. Among other things, their responsibilities include finding attractive properties for purchase, performing due diligence on it, arranging purchase financing, and managing the investment once the transaction closes.
A real estate syndicator can be an individual, but more often it is a firm that has the expertise and experience to execute their responsibilities effectively. When they find success, they can deliver attractive returns to investors. Often, syndicators invest their own capital in each deal.
Investors
The role of the real estate investor is much simpler. It is to invest their capital with the sponsor…that’s it. In exchange, they receive a return on their capital if the property is successful. They are otherwise passive investors and have no say in the day to day management decisions for the property. This group of investors combines to make up the majority of the investment syndicate.
For individuals, this type of syndicated approach solves both of the major hurdles described above. First, it solves the cost issue because it allows individuals to purchase a fractional share of the property at a much more accessible price point, usually in the $25,000 – $50,000 range. Second, it solves the management issue because the Sponsor does all of the hard work of managing the property while the investors earn passive income.
Example
To illustrate how this real estate structure works, an example is helpful. To make it resonate, we will use an example from our own line of business.
We have an entire team of individuals responsible for finding the most attractive grocery store anchored retail center investment opportunities across the United States. As part of this effort, they look at the tenant base, financials, location, and rental amounts. They may look at 100 deals before they find one that they believe worthy of an investment. When they do, they put the wheels of purchase into motion. For example, suppose we find a property with a purchase price of $20MM.
One of the first things we do is to create a limited liability company (LLC) under which to purchase the property and manage the transaction. With the LLC as the borrower, we will leverage our existing banking relationships to arrange debt finance for the purchase and it usually makes up ~75% of the purchase price. In this example, that would be equal to $15MM, which means that we need to raise $5MM in equity from investors to complete the purchase.
To raise the needed equity, we sell shares in the LLC to individual investors where each share entitles the purchaser to their pro-rata share of the income and profits produced by the property. Each share has a minimum investment amount – usually in the $25,000 – $50,000 per share range – and individuals can purchase as many shares as they wish. In a typical deal, there could be dozens or even hundreds of individual investors.
Once the transaction closes, we handle all of the property management / asset management responsibilities such as paying taxes, renewing leases, or making the required loan payments. We also handle periodic distributions to investors. Again, for individual investors, the benefit of this structure is that they get to experience the benefits of commercial real estate ownership without the hassles of managing it.
What are the Benefits of Investing In a Real Estate Syndication?
There are many benefits to a commercial real estate syndication for accredited investors. Let’s take a look at some of the most important ones.
Passive Income
Commercial real estate investors who partner with a private equity firm are making the choice to become limited partners. The syndication is the general partner, which means it makes all investment and property management decisions. This allows the investors to achieve passive income. The private equity firm acts as the transaction sponsor and they do the hard work of finding, financing, and managing the property. Individual investors commit a certain amount of capital to an individual deal or a “fund” that entitles them to their share of proportionate cash flow produced by the underlying property.
Diversification
Suppose that an investor has $200,000 in capital to invest in the commercial real estate asset class. Instead of putting it all into one property, they could spread it across three different syndicated deals, providing their portfolio with an added layer of diversification.
In addition, price movements in real estate tend not to be closely correlated to movements in the bond and stock markets. This adds another level of diversification for investors.
Tax Benefits
A syndicated real estate investment comes with two very important tax benefits.
First, from an operations standpoint, accounting rules allow property owners to take a certain amount of depreciation each year to account for the physical deterioration in a property’s condition. Since depreciation is a non-cash expense it lowers taxable income, but does not reduce the amount of cash available to real estate investors.
Second, if the investment group manages to sell the property for a profit, they can defer capital gains taxes by reinvesting sales proceeds into a like-kind property using a transaction known as a 1031 Exchange.
For both of these reasons, commercial real estate tends to be a good fit for high income earners who are looking to reduce their tax liability.
What are the Drawbacks of Investing In a Real Estate Syndication?
Although they can come with many important benefits, a real estate syndication investment is not suitable for everyone. Potential drawbacks include:
- Liquidity: A typical real estate syndication has a required holding period of 5-10 years during which time an investor is unable to withdraw their money. Even if they are, they may have to take a significant discount to do so.
- Operational Control: Again, Limited Partners have no operational control over the properties that they invest in. They defer this responsibility to the General Partner, which highlights the need to make sure that the GP has a strong track record of performance.
- Market/Credit Risk: Market risk is the risk that market conditions will become unfavorable for the performance of the investment. For example, interest rates could rise causing a spike in vacancy and collection costs. Credit risk is the risk that a tenant can’t or won’t pay their rent, which can also impact a property’s performance.
- GP Risk: The performance of an investment is highly levered to the skill and knowledge of the General Partner leading it. Thus, it is critically important that they have a good reputation and a history of success.
Each individual investor has their own risk tolerance so it is up to them to evaluate both the risks and the benefits to determine the best real estate investment for themselves.
Finding a Real Estate Syndication
There are hundreds or thousands of real estate syndication opportunities at any given time so it can be difficult for investors to find the one that is the right fit for their own investment preferences. To do this, there are a number of methods for investors to consider.
Online Searches
Many real estate syndicators – us included – advertise their offerings widely so the first place to start is with an online search. The search can be originated through a search engine or using one of the many platforms that offer access to syndication opportunities.
The benefit of this approach is that it is quick, easy, and investors can filter them on the criteria that meet their own preferences. For example, they could filter for types of real estate (office, multifamily apartment building, grocery store anchored retail, etc.) or location.
Meeting Deal Sponsors
Many deal sponsors – us included – will offer opportunities to investors to meet them and ask questions about their investment strategy, track record, and approach. These opportunities can come through webinars, podcasts, email, or in person events. For individuals interested in commercial real estate assets, this can be a great way to take a more personal approach towards syndication investment opportunities.
Networking
Finally, another popular way to learn about syndication or private placement opportunities is to network with other real estate investors. These networking events can be organized on social media platforms or through local channels, but they can be a good way to meet both sponsors and other investors in person.
How to Invest in a Real Estate Syndication
Once the investor decides to invest in a real estate syndication and finds one that fits their investment preferences and risk tolerance, the next step is to work with the private equity sponsor to complete a number of key documents to formalize the relationship. Private equity sponsors put together a number of documents for investors such as the syndication agreement, operating agreement, subscription agreement, and offering memorandum.
The sponsor will send these documents to the investor, who should take the time to review them in detail and understand the terms on a sufficient level. Sometimes, investors choose to hire an attorney to advise them on the details spelled out in these documents. This can be a good strategy for investors who are new to real estate syndications because it reduces the risk that the investor will misinterpret the terms in the agreement.
Once the investor is comfortable with the terms of the relationship, they will get everything signed and returned to the sponsor. At this time, the investor will initiate a transfer of capital to the private equity sponsor.
Eligibility Requirements for Real Estate Syndications
It is important to note that real estate syndicated investments are not available to everyone. Under securities rules and regulations, investors must be “accredited”, which means that they have to meet certain annual income and/or net worth requirements to invest. In some cases, investors may not need to be accredited if they are “sophisticated,” but this is the exception, not the norm.
If investors have any questions about whether they qualify as “accredited” or “sophisticated”, they should work with their transaction sponsor, CPA, and/or Tax Attorney to ensure they meet the necessary criteria.
Elements of a Real Estate Syndication To Understand
Every investor is different. They have different preferences and different risk tolerances so it is important that they seek out real estate syndication deals that are most suitable for their own needs. To find these, there are a number of elements real estate investors should consider before investing in a syndication:
- Sponsor Experience & Track Record: The transaction sponsor can make or break the success of a deal. They should have the experience needed to successfully manage a deal and the track record to prove it.
- Asset Classes: Different sponsors concentrate on different asset classes. For example, we specialize in grocery store anchored retail, but others may focus on office, multifamily, or industrial property types. Investors should work with one that concentrates on the property type they are most interested in.
- Fees: All sponsors charge fees. Some may charge asset management fees, acquisition fees, debt placement fees, or refinance fees. The fees are outlined in the syndication offering documents, which should be read carefully to ensure they are understood.
- Type: There are two major types of syndications, the 506(c) and the 506(b). One allows both accredited and sophisticated investors while the other is available to accredited investors only. In addition, one type allows active solicitation, which increases the chance that investors will become aware of it.
- Holding Period: Some deals require minimum holding periods of five years or longer. These deals do not provide a high deal of liquidity and investors may be forced to sell at a steep discount, if they are able to do so at all.
- Preferred Return: Some deals pay investors a preferred return, which means that investors get 100% of the income produced by the property until they have reached a certain return threshold. Once it has been met, the sponsor’s share kicks in. This is generally favorable for investors, and is a welcome addition to the business plan.
- Minimum Investment: The initial capital requirement for every deal is different, but it is usually in the $25,000 – $50,000 range. Investors should be sure that they are comfortable with the minimum investment amount.
Again, the big takeaway here is that investors should focus less on finding the “best” syndicated investment opportunity and more on the “most suitable” given their own unique tastes and real estate preferences.
Determining if Investing in a Syndication is Right for You
Investors who are looking for a way to get started with passive real estate investing should take the time to understand how a syndication is the right type of investment to pursue. Like we mentioned earlier, the first consideration is whether the investor meets the requirements to attain accredited investor status. Investors who do not meet the requirements will probably have to pursue other options like real estate investment trusts.
For those who meet the qualifications to be accredited investors, the next step is to determine if a real estate syndication is a good fit. This is a personal decision that comes down to the investor’s objectives, risk tolerance, and investment strategy.
For investors who decide to invest with a real estate syndication, the last steps focus on due diligence. This involves speaking with representatives of the investment firm and learning about their track record and investment philosophy. For more on how to do this, check out our article on performing due diligence on a sponsor. Lastly, the individual investor will put in the time and effort to understand the specific deal they would be investing in to ensure that it fits their unique criteria and investment requirements.
Summary of Investing in Real Estate Syndications
Individuals who are interested in owning commercial real estate properties face two challenges: (1) they are very expensive; and (2) they are very time consuming to manage.
To solve these issues, a deal structure known as a syndication was created to give individual investors an opportunity to purchase a fractional share of a commercial grade property.
In a syndicated structure, there are two parties involved. The sponsor is the deal leader in charge of finding, financing and managing the property. Investors provide capital, but have an otherwise passive role.
For investors, the benefit of a syndication is that they get the benefit of rental property ownership – like income and depreciation – without the hassle of managing it.
Investors considering a syndicated real estate investment should take the time to understand how it works by reading the offering documents and studying all elements of the offering and choosing the option that is most suitable for their own investment preferences.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you are an Accredited Real Estate Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or info@fnrpusa.com for more information.
