Real estate syndication is a way for investors to pool their financial and intellectual resources to invest in properties and projects much bigger than they could afford or manage on their own.
In the past, only the wealthiest and most connected individuals could participate in real estate syndications. After all, these syndications would usually invest multi-millions in commercial real estate properties around the country.
The emergence of real estate crowdfunding since the JOBS Act passed in 2012 has accelerated an individual’s access to real estate syndication. Let’s look into the basics of real estate syndication and how it works in more detail
Real Estate Syndication Basics
Real estate syndication is a transaction between a Sponsor and a group of Investors.
As the manager and operator of the deal, the Sponsor invests the sweat equity, including scouting out the property, raising funds and acquiring and managing the investment property’s day-to-day operations, while the Investors provide most of the financial equity.
The Sponsor is usually responsible for investing anywhere from 5-20% of the total required equity capital, while investors put in between 80-95% of the total.
The more the Sponsor invests in the deal, the better for the Investor as you want the Sponsor to have the most skin in the game.
Real Estate Syndication Legal Structure
Syndications are usually structured as a Limited Liability Company or a Limited Partnership with the Sponsor participating as the General Partner or Manager and the investors participating as limited partners or passive members.
The rights of the Sponsor and Investors, including rights to distributions, voting rights, and the Sponsor’s rights to fees for managing the investment, are set forth in the LLC Operating Agreement or LP Partnership Agreement.
The LLC or Limited Partnership set up is very similar to the set ups of other private funds in the Venture Capital, Private Equity, and Venture Debt space. Such legal entities are there to protect both the Sponsor and the Limited Partners if the deal goes south.
Real Estate Syndication Profits
Rental income and property appreciation 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 on a monthly or quarterly basis according to preset terms. A property’s value usually appreciates over time, so 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.
Sponsor’s 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% (although it can be anywhere from .5 to 2% depending upon the transaction).
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.
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.
Let’s look at an example of a preferred return.
If you’re 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 syndication’s profit split structure.
If, for example, 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.
Real Estate Syndication Statistics
- In 2019, over 120,000 investors participated in syndications.
- The average size of a real estate offering was $3 million.
- Passive investors came up with 80-95% of the initial capital investment
- Sponsors came up with 5-20% of the initial capital investment
- Investors received a preferred return ranging from 5-10%.
- The average preferred return was 8%.
- Sponsors netted an acquisition fee of .5 to 2%. The average acquisition fee was 1%.
- Sponsors netted a property management fee between 2 and 9%.
As time goes on, investors should expect Sponsor fees to go down and the number of deals to go up. However, as more capital chases more deals, this will put pressure on returns.
Therefore, it is imperative that investors only invest with the best real estate syndication platforms.
Real Estate Syndication and Crowdfunding
Before the JOBS Act passed in 2012, you had to be rich and connected to invest in real estate syndication. Even if you were rich, if you didn’t know anybody who invested in private real estate deals, you were out of luck.
Today, you have several major real estate crowdfunding platforms who analyze the deals before they are allowed on their platform to be open for consideration, provide the research and documentation for investors, and help make sure the investments move along as planned once funded.
Real estate crowdfunding is a way to raise money through the internet for a big project with the help of a ‘crowd’ of investors; if a project gets enough funding, it’s a “go”, and if not, the money is returned to investors.
Crowdfunded real estate syndications are more accessible, have lower investment minimums and offer a wealth of online project information available to potential investors.
Invest On The Best Platforms
With real estate crowdfunding, you don’t need to risk hundreds of thousands, if not millions to invest in commercial real estate around the country. Instead, you can invest as little as $1,000 and be much better diversified.
The best real estate crowdfunding platforms today are:
1) CrowdStreet, founded in 2014 and primarily for accredited investors. CrowdStreet is based in Portland, Oregon and is focused on investing in 18-hour cities (secondary cities) that have lower valuations, higher job growth, and higher cap rates. CrowdStreet is unique in that it allows investors to invest directly with the sponsors it screens.
2) Fundrise, founded in 2012 and available for accredited investors and non-accredited investors. I’ve worked with Fundrise since the beginning, and they’ve consistently impressed me with their innovation. They are pioneers of the eREIT product, which allows for real estate investors to gain a diversified exposure into various regions and types of real estate.
I personally think there’s a huge opportunity for investors to take advantage of real estate in the heartland of America. Valuations are much cheaper, cap rates are much higher, and there is a demographic shift by both employees and companies towards the heartland.
Google, for example, announced in 1H2019 they will be buying $13 billion worth of heartland real estate in Nebraska, Nevada, Ohio, Texas, Oklahoma, South Carolina and Virginia. A
“With this new investment, Google will now have a home in 24 total states, including data centers in 13 communities. 2019 marks the second year in a row we’ll be growing faster outside of the Bay Area than in it,” writes CEO Pichai.
If Google, one of the largest and smartest companies in the world is getting deeper into the heartland, you know other companies will follow. Apple is also making huge investments in Texas as well as of 2020.
About the Author: Sam started Financial Samurai in 2009 as a way to make sense of the financial crisis. He proceeded to spend the next 13 years after attending The College of William & Mary and UC Berkeley for b-school working at Goldman Sachs and Credit Suisse. He owns properties in San Francisco, Lake Tahoe, and Honolulu and has a total of $810,000 invested in real estate crowdfunding.
In 2012, Sam was able to retire at the age of 34 largely due to his investments that now generate roughly $250,000 a year in passive income. He spends time playing tennis, hanging out with family, consulting for leading fintech companies and writing online to help others achieve financial freedom.