Sounds kind of scary. A syndicate. Maybe even criminal. A syndicate is just a group of people banding together for a common interest. Could be criminal. But we aren’t going that route.
What is a Syndication Deal?
A syndication is a type of real estate deal where investors invest in the deal passively and a manager runs the deal. This strategy keeps the investors’ liability low but still gives them a large amount of the potential gains.
A syndication is a way of bringing investors and a manager together to acquire and administer a deal. The manager spends a lot of time and money finding and vetting a deal. Once it is ready, the manager presents it to their list of investors. If the investors agree to put money into the deal, they are known as subscribers to use the industry term.
The Investor Side of a Syndication
The investor typically decides how much to invest within the specifications of the offering. For instance, as a manager, I might request an investment between $50,000 and $100,000 in $25,000 increments. The investor would purchase shares, each costing $25,000, and would have to purchase between two and four shares to subscribe. The investor is given a significant amount of legal documents to read and it’s a good idea to enlist the help of an attorney for review. If the investor wants to move forward, they sign the documents and wire funds. Congratulations to them on being part of a big investment.
The investor doesn’t have any responsibility in the deal beyond the initial investment. The manager does all the work of finding the deal, finding investors, finding a bank, finding insurance, paying taxes, dealing with the property manager, looking for and negotiating with buyers, and many more.
Typically, the investor gets some form of preferred return. This is the percentage of the net income (cash flow after all expenses) before any other investor. An investor might expect from 6-8% annual preferred return. But wait! There’s more. Usually, there is an equity split as well. After investors are paid their returns, and gotten their investment money back, they get a percentage of the remaining cash flow or profit after a sale. This might be between 50% and 90%. This is where the real money is made. The remainder will go to the manager as an incentive to do a fantastic job on the deal.
Deals are usually between 5-10 years long. Investors should expect to receive very little money immediately as the new investment property is being stabilized. Then, they’ll receive modest checks for their preferred return. Usually, the deal is sold at the end of the investment period. It’ll benefit from appreciation, increased rents, and mortgage pay-down. There usually is a large chunk of money at the end.
I recently completed a syndication as manager. I got together a group of investors who trusted in me. I offered a preferred return of 8% and a 60% equity split. The apartment we bought was in rough shape and I had to evict a lot of tenants. Much of the money I rose from investors had to go to paying the mortgage as our occupancy got so low. I wasn’t able to pay any returns for the first 18 months. This money was still owed to the investors, though. I happened to find an out of state buyer two years into the deal and we agreed on a price significantly higher than we paid. Investors were paid all five years of preferred returns (even though we only held the investment for two years), their initial investment back, and 60% of the remaining profits. Investors enjoyed an 80.2% return on investment! That means for an investment of $100,000 two years ago, an investor would have received a check for $180,200. Those were the best checks I’ve ever written.
Keep in mind that for the investor, syndications have some downsides:
- No or little control over the deal
- Lots of documents to review before investing
- No broker to guide you through the process
- Deals are not registered by the SEC and there is little oversight
But importantly, syndications have some huge upsides:
- No responsibility to manage the deal
- Returns can be very, very high
- Liability is limited to the amount of money invested. The investor should be prepared to lose it all, but has no risk of losing more
- Once the investor is established with the manager, reviewing deals becomes easier