If you’re like me, I used to think that the only way to buy real estate was to save all my money for a long time until I had enough for a down payment. The idea of purchasing a large commercial or multi-family property felt impossible…I’d have to save for 150 years to have that kind of down payment! This is why a lot of large commercial assets are actually purchased through what’s known as a syndication.
The term syndication may sound complicated but the idea is very simple: several investors pool their funds together to purchase a property they otherwise couldn’t afford individually.
There are many different ways to structure a syndication deal and each one can be unique to the investors involved in the deal. However, there are a few basic terms to understand.
General Partners (GPs)/Sponsors: The general partners, sometimes called sponsors, in the deal are the individuals who will be responsible for:
- acquiring the property
- performing due diligence
- securing financing and signing the loan
- raising capital
- Closing
- executing the business plan
- managing the day to day operations of the property.
There may be several GPs who divide these activities among themselves. Ultimately these individuals bear the responsibility ensuring that the property performs well to generate a return for investors.
Limited Partners (LPs): These individuals provide the additional capital to the deal and enjoy a healthy return on their investment without having to assume any additional liability or actively participate in the management of the asset. Yep! That’s all they have to do!
Their liability is limited solely to the amount of their initial investment. Depending on the structure of the deal, LPs may receive a preferred return and preferential equity splits. Each deal is unique, so LPs should evaluate the merits of each deal and understand their projected return structure.
This type of investment is a great option for individuals who want to take advantage of the benefits of real estate, such as passive income and tax advantages like depreciation, without having to deal with “tenants and toilets.” Limited partners generally receive a regular cash return, or distribution, as well as a share of the proceeds from the sale after the hold period, typically 5-7 years.
There are two types of syndications: a 506(b) offering and a 506 © offering.
506(b): This is commonly referred to as a “friends and family” offering, which means that investors must have a pre-existing relationship with the deal sponsors or GPs. These types of deals cannot be advertised.
506(c): This investment offering is for accredited investors only. An accredited investor is a person with an annual income exceeding $200,000 (or $300,000 jointly for married couples) for the last two years with the expectation of earning the same or a higher income in the current year or with a personal net worth exceeding $1,000,000. These investors will also need to provide proof of their accredited status. The benefit of this type of investment offering is that it can be advertised.
The syndication model has been increasing in popularity as the real estate market shows no signs of slowing down. There are several fundamental criteria limited partners should consider before investing in in this type of deal:
- Who are the GPs? Understand their track record and experience. How many deals have they taken “full cycle” (from acquisition to sale)? Do they have experience in the target market and do they understand the trends in that market as it relates to population growth and employment?
- What is the business plan? LPs should understand how the deal sponsors plan to add value to the deal, how they plan to increase the value of property. Will they be raising rents, making capital improvements or reducing expenses? Are the assumptions they have used conservative or aggressive? Conservative assumptions are best to avoid surprises.
How and when will you receive your capital back? Understand the sponsor plans to make distributions and what is their exit strategy for the property? Will you receive monthly draws? Is there a preferred return or hurdle and what is the equity split? If there is a refinance component to the deal, will you be receiving a return of capital? Remember a preferred return is NOT a guaranteed return.