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Before we dive into the nitty-gritty of real estate syndication, we have to define what the term actually means. In simple terms, it’s defined as grouping together financial assets in order to invest in a real estate property. The syndication model is similar to crowdfunding, however, there are a few main differences which we’ll outline further in the article. But the primary focus of syndication is to invest in a real estate opportunity with pooled funds.
How does real estate syndication work?
The basic legal structure of real estate syndication includes a sponsor (also known as the syndicator) and the investors. These are the main roles that are involved in the process through and through. The sponsor’s job is to find the property, raise the necessary funds, and manage the property after the deal is secured. Meanwhile, the investor’s main focus is to manage the net worth of the property. They usually invest up to 95% of total capital in the property while the sponsor’s investment responsibilities are far lower. The investors are seen as limited partners while the sponsor’s official title is General Partner / Manager.
In order for successful syndication to take place, there must be a sufficient level of trust between the sponsor and investor. Since the sponsor is the one that starts off the process, they must show a tremendous level of experience and track record of previous successful real estate syndications. While the investor does take care of the majority of the investments, it is important for the sponsor to contribute as much as possible in order to establish a good reputation for any future deals.
Real estate syndication vs crowdfunding
Considering the syndication process involves pooling finances, it is often confused to be entirely interpreted as crowdfunding. While the two models are indeed interconnected, they have a few important differences that set them apart.
For example, the crowdfunding process doesn’t involve strict cooperation between a maximum of two parties in order for it to be declared a success. It’s also important to note that syndication primarily deals with extremely large sizes of investment while crowdfunding doesn’t have a typical monetary limit.
Another important difference is in the fees – while crowdfunding’s fees may include payment processing, sign-ups, and other similar elements, the syndication fees are much more upfront.
How are profits made?
Real estate syndication is often synonymous with passive income. But there are three main ways you can profit off of this process. One of them is through acquisition fees. The sponsor is in charge of creating the deals as well as finding the property. This takes a lot of time and effort and reputable sponsors can receive up to 5% of the acquisition costs. They may also charge a flat fee. However, sponsors should charge reasonable fee costs – higher fees will normally put off the investor if the rest of the deal doesn’t sound appealing.
Sponsors can also profit from asset management. As the manager, this is perhaps one of the most time-consuming functions of the role as it involves frequent communication with the property manager to ensure the property isn’t left unattended.
Normally you can receive 1% of total gross revenue as an asset management fee.
And last but not least, sponsors can also generate income through equity participation. These completely depend on the details of your deal – normally, the investor will receive a return rate, while the rest of the cash flow is split between you and the investor.
Important statistics to consider
2019 was a big year for real estate investors, with reportedly over 120,000 participating in syndications. We previously mentioned that the offering is far larger than what you would receive during crowdfunding. The average offering stood at an impressive three million dollars. Sponsors’ initial capital investment stood at up to 20% and average return stood at 8%. The average acquisition fee was 1%.
Investors frequently focus on sponsor fees and normally expect a lower fee, which is important to keep in mind when creating a deal. Therefore sponsors with a higher reputation and average fees are favorable over first-timers.
Pros and cons
Real estate syndication is a complicated process with plenty of pros and cons. If you consider investing, you should always weigh out all the necessary details that could potentially prevent you from a successful deal. However, the process has just as many financial benefits.
One of its major positives is the fact that investors know exactly what they’re investing in, which isn’t usually the case for investment trusts. Investors are also able to see the exact plan of the deal, allowing them to spot the red flags quicker. Syndication also allows for diversification of funds, meaning the investor doesn’t need to commit to just one specific property or deal.
The benefit of this type of real estate investment comes from its passive income promises. Since these deals offer regular financial returns, the parties are often guaranteed a certain amount of money after the completion of the deal. The return percentage is negotiated and, if done correctly, it could offer a huge passive income bonus for both parties.
One of the biggest cons of such investment is the lack of liquidity should the deal fail. Both parties are locked in a deal that cannot be changed, regardless of its outcome. Investors may also face a lack of control since the liquidity is entirely dependable on the syndicator – this includes selling the investor’s shares.
How to avoid common pitfalls
There are plenty of reasons why syndication deals may often fail, but the main one has to be badly structured deals. Studying the deals and making them appealing is an important step in ensuring the entire process will be successful. More than often, this part of the process is rushed, focused on the sole benefits of a single party.
Raising money in an efficient way can really make or break your syndication deal from the very start. The process of raising money has come a long way in the past few years and it no longer seems like an impossible job. The secret is to use the right tools and sometimes it means investing in a tool that will offer you the biggest fund pooling returns. Don’t forget about marketing your crowdfunding – it requires its own budget to make sure the financial pooling is successful.
Knowing every part of investment law is also extremely important in order to have a successful deal without any damaging loopholes. DIY is never the best way to handle your contracts – instead, syndicators should invest in a lawyer as well as all necessary tools to make sure the legal stuff is drafted correctly. Failing to do so could be damaging to both parties.
To ensure your deal doesn’t fail, you have to keep creating opportunities for the investors and make the whole process as attractive to do so. Again, syndicators shouldn’t focus just on themselves and a single deal. If you truly want to make a decent amount of passive income through real estate syndication, you have to create a good reputation.
How to get started in real estate syndication
Now that you understand the basics, it’s time to get down to business.
The first thing you should do is search for the property you’d like to invest in, followed by creating a solid investment strategy. This includes a mission statement, business structure, and analyzing your competitive advantage. You should dedicate a decent amount of your time to this process to truly develop your passion for your company and the industry as a whole.
Another analysis you have to develop is investment property analysis. Along with traditional real estate analysis, this also includes running various scenarios to predict any possible downsides that should be addressed. Next, it’s time to get to know your investors. This is where you’ll need to use your networking skills and introduce your full investment strategy.
Crowdfunding investment costs
The next step is to crowdfund your money. This can be done through various real estate platforms available online, including Fundrise, BrickVest, and Crowdstreet. Thorough research is needed to understand which platform works best for you.
Should any investors become interested, you then need to keep them updated on the situation throughout every step. Don’t forget to hire a solicitor to handle all legal aspects before taking it to the final stage – closing the deal.
Like every investment deal, real estate syndication involves thorough knowledge of every process. To ensure successful collaboration, both parties should take the time to get educated on everything there is to know before making their final decisions.
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