Real Estate Syndication Profits
Property appreciation and rental income are the two main ways the Sponsor and the Limited Partners make money from real estate syndication.
Rental income from a syndicated property is distributed to investors from the Sponsor. This typically occurs on a monthly or quarterly basis according to preset terms. A propertys value usually appreciates over time. Thus, investors can net higher rents and earn larger profits when the property is sold.
Payment of rental income or profits depends upon the time the investment needs to mature some types of syndications are over within 6-12 months while others can take 7-10 years. Everyone who invests receives some share of the profits.
Sponsors often take an upfront profit at the beginning of the deal for sourcing and acquiring the property. This is call and acquisition fee. An average acquisition fee of 1% .
Before a Sponsor shares in the profits for their work as manager and promoter, all investors receive what is called a preferred return. The preferred return is a benchmark payment distributed to all investors. That is usually about 5-10% annually of the initial money invested.
Reason #2 You Have To Invest A Lot Of Money
For all the real estate syndications that we do, the minimum investment is $50,000. Which, for anyone, is a LOT of money. It could very well be an entire years salary for some folks.
Its enough to buy a car, pay for private school tuition for a year, or be a down payment on a house. My point is, $50,000 is a lot of money, and there are a lot of things you could do with that money.
Dont put that $50,000 into a real estate syndication until youre absolutely sure that its the right place for your money.
And, if youve got $51,000 in your bank account and youre thinking of investing $50,000 of that, stop right there. Remember that you wont have access to this money for the next few years, so before you invest, you should definitely have some reserves set aside for, you know, life.
This high minimum investment can definitely be a hurdle, so if youre getting sweaty palms thinking about wiring $50,000 and not seeing it for a few years, listen to your gut and pursue other investments.
Investor Or Limited Partner
The other major player within a real estate syndication is the investor or investors. They are also commonly referred to as Limited Partners. Investors provide the capital to purchase a property, but they have a mostly passive role. These real estate investors often have an interest in acquiring property to gain a percentage of profits, but will typically leave the day-to-day operations to the sponsor who has gained more direct experience. For this reason, investors will typically pay the sponsor fees for their expertise.
As passive members of the real estate syndication, they will be the source of capital and own a percentage of the real estate based on investment amount and number of potential parties.
Joint Venture Partner
Theres often a third party involved within many real estate syndications, known as a joint venture partner or equity partner. Within any massive real estate investment, its valuable to have transparency and proper communication amongst all parties, especially for a real estate syndication with numerous investors. The JV partner makes sure that there is strong communication and transparency between the syndicator and investors. Sometimes, the JV partner may assist the syndicator with reporting and taxes.
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Whos Involved In A Syndication
A real estate syndication typically involves the general partners who organize the syndication, including finding the property, securing financing and managing the property the general partners are sometimes referred to as the sponsors or operators.
The group of people who provide the cash investment are often referred to as passive investors or limited partners. In return for their investment, the limited partners receive an equity share in the syndication along with cash flow distributions and profits.
Assets Under Management Fees
The developer can also generate profits from their management of real estate syndications through the collection of assets under management fees, which is an ongoing fee paid throughout the lifecycle of a project. This is most often a fee calculated based on the total amount of equity the developer has raised and is managing, though it can also apply to the total value of all real estate that the developer controls.
In most situations, this fee is 1% of total equity or assets under management, is calculated and paid, most often, quarterly, and goes to the developer to cover the overhead of managing the intricacies of the syndicate partnership agreement. This includes facilitating communication between investors, setting goals and deadlines, and taking care of the day to day minutiae of running a property syndication.
For example, if a developer raises $10 million in equity on a project that has a total value of $30 million, they could receive an AUM fee on either of those amounts, depending on the terms that define the syndicate structure.
If the AUM fee is 1% and it is applied only to the equity under management, then in this example, the developer would receive an annual payment of $100,000 per year for managing $10 million of equity. If the fee is 1% of total asset value, then the AUM fee would be $300,000 per year.
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What Are The Challenges Of Real Estate Syndications
As you are aware, nothing in investing is certain there are always possibilities for things to go wrong.
The most common risks of investing in syndications are:
- Less liquidity: Syndication shares are typically not traded on secondary markets in the same way that shares of a company or REIT can, limiting their liquidity.
- Passive investors have little control: Cash investors must frequently relinquish control of the asset to the sponsor. If the property underperforms, the passive investors have few options for forcing improvements however, they can replace the sponsor in extreme cases.
- Property Failure: Investors who contribute most of the funds for the property are exposed to significant financial risk if the property fails. Even if they can recoup some of their money through the personal recourse guarantee, they will still lose a significant amount.
- Hidden fees: Real estate syndications come with several fees and extra costs that can be difficult to understand. Some of these charges are one-time, while others are recurring. These costs may include an acquisition fee, asset management fees, property management fees, etc.
Reason #1 You Cant Take Your Money Out At Will
When you invest passively in a real estate syndication, your money is illiquid for the length of the project hold time. That means that, if the asset is going to be held for 5 years, you should expect to have your money in the investment for the entire 5 years.
This is very different from stocks and mutual funds, where you can decide to sell right now, and you could have your money back by the time you finish this blog article. Okay, maybe not that quickly, but you get my point. When you invest in stocks, your money is liquid.
Same thing with a checking or savings account. At any moment, you can decide to spend that money, move that money, or withdraw that money, and you would have complete freedom to do so.
When you invest in a real estate syndication, however, you cant withdraw your original investment at will.
In fact, when you enter into the investment, you must sign a lengthy legal document that spells out the details of the projected length of the hold time and the illiquidity of the investment.
So you have to be super sure that you will not need access to that money in the immediate future. If you have any doubts, or the idea of having $50,000 or more locked up for 5 years is giving you hives, turn around now.
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Real Estate Syndications Are Not Liquid
Even under the best real estate syndication scenarios, its likely that youll be locked in for some period with your investment. That means that if you have an emergency or want to use that money to invest in something else, youre stuck.
You will agree to the lock-in period as part of formalizing the real estate syndication, so you have the option to push for a one-year duration as opposed to a 710-year duration. Thats an important consideration if you have any reason to believe that you might need the money sooner rather than later.
Who Can Invest In A Real Estate Syndication
A real estate investment syndicate is typically open to accredited investors. The Securities and Exchange Commission defines an accredited investor as someone who has an annual income of $200,000 or a net worth of at least $1Mnot including your primary residence. Visit the SEC website for additional information and resources.
Some syndication offerings, such as the ones designed as 506 offerings are open to unaccredited investors. Many multifamily syndications are 506 offerings, which means they are open to unaccredited investors, but these investors have to be sophisticated.
A sophisticated investor has enough knowledge and/or experience in investing in alternative investments such as real estate, oil, or precious metals. They may have made previous investments outside the stock market or perhaps they attended an investing seminar. Whether or not they have actual investing experience, the person has the ability to make an informed decision about a particular syndication offering.
Equally important to being sophisticated, the investor needs to have a pre-existing substantive relationship with the deal sponsor . While the SEC doesnt specifically define what substantive relationship means, it provided clues in this letter to a company called Citizen VC.
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The Basics Of Real Estate Syndication
Real estate syndication deals are popular for entrepreneurs because its fast and effective. You also dont really need to know very much about investing, real estate, or property management because youll have someone handle all those nitty-gritty details for you. As a commercial real estate investor, you might see the following returns:
Average annualized return: 15%
Total return: 100% in 5-7 years
Should You Invest In A Reit Or A Syndicate
Investing and risk-reward depend primarily on the individual goals and financial situation. That said, there are some fundamental differences between investing in REITs and syndicates.
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Vetting Real Estate Syndication Companies
Trust is the essential foundation upon which every business transaction depends. Therefore, you must choose real estate syndication companies that you completely trust.
It is the most significant step that any investor takes and hence requires utmost due diligence and deliberation. Who you invest with is everything, because your real estate syndication company is directly responsible for the performance of your capital.
There are a few recommended points that are essential in the process of vetting real estate syndication companies:
How To Invest In Real Estate Syndication
If youre curious how to invest in real estate syndication, unfortunately, there is not a blueprint for investing in real estate syndication deals. There are various ways one can get involved.
There are passive income groups or websites online that promote real estate syndication. One can also network within their friends and family base to pool money together and purchase property.
Investing in real estate syndication is rather easy to do, but finding the right investment is the hard part. There are numerous variables one must consider to find a good deal. Having a mentor, or studying this investment strategy in great detail, will be critical for your success.
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How To Find Real Estate Syndication Deals
There are plenty of ways to find real estate syndication deals if you are interested in adding this investment class to your portfolio.
Traditionally, the only way to find a syndication company was through networking. This means of finding real estate opportunities to invest in was a result of the Securities Act of 1933 which required both a sponsor and an investor to have a prior relationship before money could change hands. With the passing of the JOBS Act of 2012 and the legalization of crowdfunding this changed and today sponsors can actively
The JOBS Act gave birth to real estate crowdfunding platforms like CrowdStreet, RealyMogul, Fundrise and others, where you can find myriad opportunities to invest. Companies like Rising will list our projects on these sites and, common with other sponsors, we also provide direct access to our investment opportunities via our website.
Now that the laws have changed allowing for general solicitation by sponsors of investors, advertising is allowed so you will also be able to find opportunities on social media channels like Facebook or LinkedIn. Indeed, you may also find that you will see adverts on non-real estate websites as you search the web and Googles algorithm identifies you as someone interested in real estate investing.
How Do Sponsors And Passive Investors Make Money In A Real Estate Syndication Deal
Real estate syndications earn money from rental income and property appreciation. Capital is distributed according to a tiered, sequential structure, known as a waterfall.
Waterfall structures and descriptions can be quite complex. Heres a simplified example:
- Return of capital First, all distributions go to passive investors until they recover their initial capital contributions.
- Preferred return Next, all further distributions go to passive investors until a certain minimuma preferred returnis reached, for example, 7% IRR.
- Carried interest Once the preferred return is reached, the sponsor is paid in the form of a promote . In this stage, a certain percentage of the cashflow goes to passive investors and the rest goes to the sponsor, for example, 80% to the passive LPs and 20% to the GP.
In addition to performance-based compensation, sponsors also make money through fees. The most common types of fees include:
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Meet With Deal Sponsors
As incredible as the internet is, theres still nothing like face to face. When you meet a handful of vetted deal sponsors in person, it gives you the invaluable opportunity to decide if this person is someone you actually want to work with. And dont underestimate that youll potentially be giving this person a good chunk of your money, can you look them in the eye and hand it over confidently?
A Real Estate Syndication Example
Real estate syndications are structured so that the Sponsor is motivated to ensure the investment performs well for everyone. The more the Sponsor invests in the deal, the more aligned the sponsor is with Investors.
Lets look at an example of a preferred return.
Lets say youre a passive investor who invests $50k in a deal with a 10% preferred return. You could take home $5k each year once the property earns enough money to make payouts possible.
After each investor receives a preferred return, the remaining money is distributed between the Sponsor and the investors based on the syndications profit split structure.
If the profit split structure is 70/30 investors net 70% of the profits after receiving their preferred returns and the sponsor nets 30% after the preferred return.
For example, after everyone receives their preferred return in a 70/30 deal, and there is 1 million remaining, the investors would receive 700k and the Sponsor would receive 300k.
Below are some examples of various real estate syndication deals on the Fundrise platform. Today, Fundrise mostly focuses on private eREITs, diversified real estate funds. This way, non-accredited investors can invest in long-term, diversified real estate portfolios. I believe investing in a diversified eREIT is the way to go for most investors looking to gain exposure and earn income 100% passively.
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