Hey you. Do you want to invest in a real estate project with me?
Let’s say I find a massive apartment complex for sale for $50 million. If we get a bank loan with 80% financing (borrowing $40 million), this makes our down payment only $10 million.
To get the $10 million cash down payment, we just need to find 200 people to put in $50,000 each. To keep things fair, everybody will own an equal share in the investment and receive an equal share of the profit.
I estimate that the rental profit from the building (all revenue minus all expenses) will be $60,000 per month. If we divide this between our 200 investors, this means $300 positive cash flow per person, per month. That’s about a 7.2% return per year — not bad!
Better yet, I also project that when we go to sell the building in 5-7 years, we could sell it for $60 million. That’d be a $10 million profit we can also share. So instead of giving all 200 investors their initial $50k investments back, they’d all get $100k returned after 5-7 years. Double their money!
Well, what do you think? Am I completely nuts?
If you regularly read this blog then you know that I’m definitely nuts … but deals like this are actually quite common. They are happening all around us, all the time. They are referred to as real estate syndications or private placements.
What Is a Real Estate Syndication?
A syndication is just a fancy name for a partnership. It’s when a group of investors bundle their money and resources together to invest in a real estate project — typically something larger than any one investor could tackle on her own.
In the past, these investments generally were not available to the public, and sometimes they were/are by invitation only, as with private placements. But, thanks to crowdfunding and online social networking, it’s becoming easier to find and invest in syndications.
In this post I’m going to explain the basics of how a typical syndication deal is structured. I’ll be referring back to my oversimplified and hypothetical $50 million apartment building scenario for some examples, but please keep in mind that every syndication deal is different. They come in custom shapes and sizes, like any real estate investment.
Can Anyone Invest in a Real Estate Syndication?
Let’s think about this for a second…
If you and I were seriously looking for 200 people to each invest $50,000 with us, what type of investors would we prefer to have? Would we accept money from just anyone? Or would we prefer that they meet certain investor qualifications?
If we took money from 200 novice investors, we’d probably be signing ourselves up for headaches. Not only would we be flooded with questions, but if any of them were financially unstable, they might also want to withdraw from the partnership early. They would be a time-suck and possibly a legal pain in the ass.
Instead, we would want experienced, wealthy investors who could just transfer us money –> and then leave us alone. Less time managing investors means more time working on projects and profits! To make it easier for us, we might want to find only 100 investors with $100k each. Or just 10 investors with $1 million each.
There are also strict legal guidelines we would need to adhere to. Because we are using other people’s money to buy real estate (or selling “shares” of our investment company), this is technically selling securities. We’d need either a license from the SEC or somehow be able to be exempt from SEC filings.
Most real estate syndication groups require their partners to be “accredited investors,” or at minimum “sophisticated investors.” They use syndication attorneys to structure deals to follow SEC guidelines, like these 506b and 506c rules.
Most syndication money is raised behind closed doors rather than being advertised to the general public. Real estate groups target high net worth individuals and prefer investors they have an existing relationship with.
(At the end I’ll share how you might be able to build relationships and find some syndication or crowdfunded real estate opportunities yourself.)
Syndication Objectives and Real Estate Niches
When you’re evaluating an investment, it’s important to understand the goals of the project (other than just looking at numbers). Large real estate companies usually have a specialty or niche that they work inside.
Some examples of syndication niches include:
- Commercial or office buildings
- Self-storage facilities
- Mobile home parks
- Raw land development (buying land and building something from scratch)
- Single family homes (buy packages of 50-100 homes within a certain target area)
- Residential apartment complexes
Personally, I like it when the project goals align with my personal investment goals.
That’s why I invest in “buy and hold” syndication deals with a small value-add component. I want to buy cash flow positive properties that have rent increase opportunities as well as appreciation potential. The deals I invest in must be conservatively leveraged, have a strong rental track record, and be located in a growing area.
It’s important to invest with a like-minded group of people. Common goals = better partnerships. 👍
Syndication Team and Corporate Structure:
The group that finds the deal and manages the overall investment is called the “sponsor.” They are in charge of overseeing the entire business plan, and making all major decisions on behalf of the company.
This could be just one person or a small group of highly skilled individuals that specialize in different things (like a finance guru, an investor relations person, and an operations rockstar).
The individual investors are usually called “limited partners.” These are the people putting up the money. Technically they own shares in the corporation, however they don’t really have any voting rights on what the partnership can and can’t do.
Syndication investments are not publicly traded or transferable to anyone else. So once a limited partner invests his or her funds, they are fully committed until the project is over or the company is dismantled.
TRUST plays a massive role when investing your money in a real estate syndication. It’s very important to vet out an experienced sponsor and fully research who you’re going into business with.
For our fake $50 million scenario, I might demonstrate my legitimacy as a sponsor by showing potential investors a successful track record of similar deals I’ve managed in the past, with references. Also, I could show my faith by investing $500k of my personal money in the project (buying 10 of the 200 shares myself). Good sponsors eat their own dog food.
Projected Returns for Syndications
When you’re looking at an investment proposal, the sponsor will highlight how much profit they think you can achieve for your invested capital. It’s important to note, these are projected returns, not actual returns. Nothing is guaranteed when you invest.
It does a sponsor no good to lie about these numbers or trick you into investing. I’m not saying that investment proposals are always accurate, but usually very experienced people have put the numbers together.
In my experience, most syndication sponsors will underestimate vs. overestimate. If they blow investor expectations out of the water, people are likely to invest with them again. If they overestimate and shit the bed, then people won’t trust them again.
Each real estate project has different timelines, objectives, and profit schedules. Some provide a great ongoing cash flow and passive income throughout the life of the project. Others provide a huge profit split only at the end of the investment term. Some deals pay a small amount of both.
For the residential value-add deals I am interested in, I hope to achieve a 7-8% cash on cash return every year, as well as 1.5x to 2x return on my investment when the project closes.
Going back to aligned goals, it’s a good idea to make sure the projected returns of the company suit your individual investment strategy and risk tolerance.
Syndication Sponsor Fees
In my hypothetical scenario, I said all 200 investors would split the profit “equally.” But in real world syndications, profit sharing happens *after* the sponsor collects 2 types of fees…
The first is an upfront acquisition fee. This compensates the sponsor for the enormous amount of effort it takes to find a deal, analyze it, hire lawyers, pay the deposit (personally), raise capital and create an entire business plan that everyone will be happy with. It’s not uncommon for a sponsor to evaluate 200+ properties before finding one that meets their criteria. It could be a 6 month to 1 year process, too.
The acquisition fee is usually ~2% of the total deal size. In my fake scenario, 2% of $50 million is $1 million! (Seems like a lot, but split between the team of people putting the deal together — it’s reasonable.)
The second fee is an ongoing management fee. The sponsor needs to ensure the business plan is executed properly, the investors are attended to, everyone gets their profits, the monthly reporting gets done, contractors are managed, taxes get filed, etc. If the project is large enough, they might even hire a dedicated manager for all this stuff.
The ongoing management fee is usually ~2% of incoming monthly revenue. In our scenario, let’s say the incoming total rent is around $500k per month. The sponsor would collect a $10k per month (2%) fee to cover all the management work involved for the full life of the contract.
There can be other fees (or incentives) for the sponsor included within deals. A common one I see is an acceleration bonus tied to overperformance. For example, if I end up selling our hypothetical building for $70 million instead of $60m, I might write in a clause that everyone buys me free beer for life because I just tripled their money!
Taxes and Cost Segregation
Here’s a question I hear a lot: “What about all the tax benefits of real estate investing… Can I claim things like mortgage interest and expenses in my tax filing?”
The answer is Yes, and it’s really easy!
Each year, the company files a tax return for the entire project. All deductions like depreciation, loan interest, and expenses are accounted for. Then, the total amount of income/expenses are divided exactly between the shareholders according to the proportion of their ownership. Each owner is issued an individual K1 statement, which is just a form you file in your personal tax return.
For our hypothetical scenario, an individual investor would own 1/200th (0.5%) of the overall project. Their K1 statement each year would represent 0.5% of all income, 0.5% of all deductions, etc.
Real estate syndications are very tax-efficient.
Real Estate Syndication Pros and Cons
Here are some of the goods and bads that come with investing in syndication deals:
- Passive income! Once you commit to a project as a limited partner, you don’t need to do any ongoing work.
- Expertise and experience: Many syndication sponsors have decades of real estate experience and work in elite teams.
- Private equity investment: Shares in the investment are not publicly traded or transferrable, so your share in ownership won’t fluctuate or be diluted based on market volatility.
- Diversification (within asset class): Some syndications bundle a handful of properties (like a fund), so your risk is spread across multiple properties and rental income streams.
- Very tax-efficient: The people doing the syndication taxes are experts in maximizing every real estate tax benefit available for the project.
- Limited liability: As an individual investor, you are protected from any horrible things that happen. The worst case scenario is you lose all your invested money — nobody can come after you for the rest of your assets.
Downsides to syndications:
- No control as a limited partner: You have no say in how the company operates. (This isn’t a big deal if you align well with the sponsor and trust their decisions.)
- No liquidity: Your capital is invested for the entire project and you can’t sell or “cash out” midway through.
- Hard to find and qualify: Some syndications are invite-only. It’s hard to participate when you don’t even know a deal is happening in the first place! Some syndications have a minimum $100k buy-in, and many require you to be an accredited investor.
- Risk of losing capital: There is no guarantee that the project will be a success. (This is true for any investment.) All the risks for each syndication are clearly detailed in the contract.
How to Find Real Estate Syndication Deals
Good investment opportunities don’t just fall in your lap. Well, sometimes they do, but for the most part you gotta go out and hunt for them! Here are a few ways you can find syndication deals…
First, there’s the old school networking way (this is how I learned about this stuff). I went on BiggerPockets.com and typed “syndication” into the search bar. One hundred names popped up and profiles of people who work in that arena. I clicked on all these people’s profiles and read their blog posts, comments, website links, and anything they had to offer. Then I narrowed that list down to about 20 of interest, and asked each person for a 15-minute phone call to introduce myself.
Networking is all about asking good questions (and being genuine). People in real estate love to help beginners learn. If you respect their time, they can help you learn about partnerships and deals, or at least point you in a good direction.
Next, listen to podcasts: Start with this one – The Best Ever Real Estate Podcast. This is the longest-running real estate podcast started by a syndication legend named Joe Fairless. There are more than 2,000 episodes, many of them about syndications, raising capital, and interviews with real sponsors. Not only will you learn more about the syndication ecosystem, but you’ll also hear names of people and companies to research. BiggerPockets also has a great real estate podcast yet a much wider scope on real estate investing, not just syndications.
A golden rule of investing is: “Don’t invest in things you don’t fully understand.” So take this education stuff seriously and learn about syndications at your own pace. There’s no rush to invest in deals.
Real Estate Crowdfunding
A relatively new way to find group real estate projects is via crowdfunding websites. I want to be clear before recommending these that I personally have not invested with any of these platforms (yet 😀), so please do your own research!
That being said, here are 3 platforms I know have an excellent reputation.
- Crowdsteet is one of the largest and most experienced portals, offering accredited investors direct access to individual commercial real estate deals. There’s a huge amount of deal flow, so it’s great for investors who want to use one platform to invest in many syndication deals.
- Fundrise primarily offers diversified funds in the form of eREITs, which are designed for passive income, or eFunds, which are designed for growth investing. Their unique structure makes them one of the most accessible options for non-accredited investors.
- RealtyMogul is one of the oldest investment platforms and has a pretty diverse mix of investments for both accredited and non-accredited investors.
This is one of the longest blog posts I’ve written, so bless you if you made it all the way here.
Hit me with any questions in the comments and I’ll do my best to help answer!
Joel is a 35 y/o Aussie living in Los Angeles and the guy behind 5amjoel.com. He loves waking up early, finding ways to be more efficient with time and money, and sharing what he learns with others. Rise Early | Retire Early!