Investing in real estate is a great thing. There are so many ways to do it. We have talked about buying single family residences (houses) and apartment buildings. You can fix and flip or make a long term hold play. There is also a medium term sweet spot that takes an apartment building and rehabs it. The rehabbing is in the structure but also in the tenants. This process generally takes a few years. If done correctly, the payoff is much larger than flipping houses. It can be thought of as flipping apartments. I’ll detail the how to do this later. That medium term flip of an apartment or commercial building is generally the subject of syndication deals. They are typically larger deals that an investor cannot take down by their self. They need to work as a group. Here are the five best reasons to invest in a syndication:
Whoa now, what exactly is a Syndication anyway?
Whoops, how did I forget that? A Syndication is a strategy where a group of investors can join together to invest in a certain product or property. It is somewhere between a Partnership and a Fund.
In a Partnership each investor is a partner who assumes a share of the investment, liability (risk), and work involved. These kind of strategies involve a lot of work by each investor but each has a high degree of control in the project. Partnerships usually have a small number of partners.
A Fund is a pool of money from a large amount of investors, who trust the fund manager to look for and invest in multiple deals with a certain asset class in mind. The investors have little say in the project and have a small investment. Their liability is only up to the amount of money they put into the fund.
The Syndication is in the middle of these two deals. It is generally smaller in capital than a Fund and larger than a Partnership. The investors can have some say in the way the project is run, but typically they are passive. Their liability is limited to the amount of money they invested. It is great for the person who is interested in real estate but doesn’t have the time needed to do their own deal. The manager is called the Principal. We will talk more about this in a future post.
Behold, 5 Reasons to Invest in a Syndication
A lot of people avoid investing in real estate because they believe there is a great deal of work involved. It’s true that if you are doing all the leg-work to find a property, purchase it, rehab it, market it, and sell it, that you will spend a ton of time on the deal. While the U.S. tax man calls this type passive, I think it is anything but. I’ve done it and it is a huge amount of work. Not to mention the stress and worry about when it will sell and how much it sells for. Even if you buy and hold (rent it out) you spend time marketing, showing, and dealing with tenants. You have to respond to emergencies and fix problems with the property. It is not for everyone and it turns a lot of people away.
In a syndication, the main investor, the Principal, has already spent a lot of time and money to find and analyze the deal. He or she has found the deal and presents it to the list of investors that the Principal keeps. Once an investor selects the deal best for him, he can deposit money into the investment account, sign the syndication agreement, and sit back and watch the money come in as the Principal does the work. In this way, the syndication is much like a stock investment. There is no additional work required by the investor. It is a great way to diversify one’s investments.
2. Vet the Principal
The Principal is typically an experienced investor. She needs to be able to prove to potential investors that she knows how to do these types of deals. She will gladly produce information about her track record to the investor. The investor can decide whether to do a deal or not based in a large part on how much he believes in the Principal. The Principal also is eager to speak with potential investors, answer questions, and explain the strategy for the deal, all before ever accepting any money. That level of care is not found for the individual investing in stocks. That type of investor typically never speaks with anyone; their employer contracts with a broker and the money just flows out to the investments, the investor never knowing who is handling their money or if they are any good at it. In a syndication, the investor can be informed every step of the way. The Investor knows his Principal and can decide based on that knowledge.
3. Close observation of how the investment is doing
Very similar to #2 above, the typical syndication deals have set periods where the Principal will give updates on the health of the property and deal. The Principal is available to answer questions. If there are problems, she explains them to the investors early. She does this because she has an incentive to be on good terms with her investors; she wants them to come back for the next deal.
4. No additional liability
You could go out today, find a partner, find a deal, and create a company to operate the investment. The partner might even be doing all the work and you can be a passive investor. In a partnership each investor carries some of the liability. It usually is in responsibility for the repayment of the mortgage to the bank. Each investor may be responsible for a percentage of the mortgage or even the whole amount. It is usually greater than the investment. This creates a liability that many find undesirable. In the Syndications I do the investor is only liable for his investment, meaning he can lose all of the money he put in, but never more. In a partnership, if one partner skips town, the other has to keep paying the bills, and is responsible for much more than his initial investment.
Limited Liability Companies have decreased the legal liability that partners retain but they don’t eliminate it. Being a passive investor in a Syndication means the Investor is not making the difficult decisions in a property, the Principal is. If the Principal violates a local ordinance or state law, it will negatively affect the deal, but will be much less likely to personally affect the Investors.
5. Choose when you want your money back
Syndications have a horizon. This is the time-frame that the Principal has set forward to sell off the company and liquidate the assets. In the case of real estate it will be to sell the property. This is when the fun happens. The investors get paid back along with their share of the profits. A certain pre-determined percentage goes to the Principal for all her hard work. The predicted time between purchasing the deal and selling it is the amount of time that the investor’s money will be in the deal. He can usually find someone to buy out his share before the horizon is reached, but he may take a loss. When investing, you need to look at the horizon to determine if the investment is right for you. If you want your money back in two years, but the horizon is five, you can move on to a different deal.
Bonus: The Principal has ‘skin in the game’
This is a Bonus because it is not always the case that the Principal has some personal interest in the deal. If she doesn’t have this, you should back away. A good syndication deal has a Principal that is also an investor. The Principal must have some money in the investment to give an incentive to do well. It’s much harder for the Principal to neglect or abandon the deal if she will lose a bunch of money. Look for deals where the Principal will be investing and consider walking away from others.
The Syndication is a great way to invest in properties, and be able to have a close eye on how they are managed. They can have a tremendous upside when the property is sold. They can be a great way to learn more about this investment strategy for those looking to become a Principal in the future.