What Is Real Estate Syndication? A Guide for Individual Investors

If you’re looking to capture the benefits of real estate investments, there are multiple ways to grow exposure—including real estate syndication. Here we’ll discuss how real estate syndication works, the potential pros and cons, and how investors can participate.

What are real estate syndications?

Syndication is a traditional way to raise money for large-scale investments. Investors form a syndicate by combining their capital to purchase a single asset, then share in the profits.

A real estate syndication is created when investors pool their capital to purchase a real estate asset, typically a single property. A wide range of real estate assets can be purchased through syndications, including single-family homes, multifamily apartment complexes, hotels, and office buildings.

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Who is involved in a real estate syndication deal?

There are two critical roles in any real estate syndication: the syndicator (commonly known as the sponsor) and the passive investors.

• Syndicator – In terms of investment strategy and execution, syndicators do the heavy lifting. They’re responsible for finding investors, structuring the deal, acquiring the asset, and managing the property. Syndicators create and implement a business plan for the asset—and they’re on the hook for delivering strong returns to investors. Syndicators are typically real estate professionals with specialized expertise in a particular niche. The syndicator often invests 5% to 10% of a deal’s total required equity.

• Passive investors – The rest of the equity capital comes from passive investors, who contribute money in exchange for ownership shares. As passive participants, these investors aren’t involved in the day-to-day operations of the property.

How does real estate syndication work?

A typical real estate syndication has four major phases:[1]

• A syndicator “ties up” a property by signing a purchase contract or having an option to purchase an asset.

• The syndicator completes due diligence on the property and organizes financing for the purchase by arranging a mortgage and raising equity from private investors.

• Once the property is purchased, the syndicator operates it on behalf of the investors.

• Investors receive distributions based on their ownership percentage. The syndicator receives additional fees and a carried interest bonus (“promote”) if the investment goes well.

How are real estate syndications structured?

Syndications are usually structured as a limited partnership (LP) or limited liability company (LLC). These legal structures help shield investors from potential liability related to owning a property.

• Limited partnerships – In this structure, investors contribute cash in exchange for interest in the entity as limited partners. The partnership is the direct owner of the real estate asset and is the borrower for the mortgage. The day-to-day decisions are made by the general partner (GP) on behalf of the passive investors.

• Limited liability companies – LLCs are structured similarly to limited partnerships but use different terms. The LLC owns the asset, and the passive investors are known as members. The decision-making entity is known as the managing member or non-member manager.

“Sponsor” is broadly used to describe the entity at the helm making active decisions. It may technically refer to a GP, managing member, or non-member manager, depending on the particular structure.

Who can invest in real estate syndications?

When companies want to raise money by selling securities, they typically need to comply with SEC registration requirements designed to protect investors. Real estate syndicates typically avoid the costs and burdens of registering with the SEC by using Regulation D, an exemption to the Investment Company Act of 1940.

Real estate syndications often use rules 506(b) and 506(c) of Regulation D. The choice determines which type of investors can participate in the deal.

• 506(b) offerings – Syndicates can raise an unlimited amount of money and can sell securities to an unlimited number of accredited investors—but they cannot make any general solicitation or advertise the securities, for example, by posting information on a company website. Furthermore, securities cannot be sold to more than 35 non-accredited investors. These are often known as “friends and family” offerings, as you’ll need to “know a guy” to find out about the deal.

• 506(c) offerings – Syndicates can broadly solicit and generally advertise as long as all purchasers are accredited investors. Non-accredited investors cannot participate. 506(c) syndicate offerings are usually more common than 506(b) offerings.

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. Here’s 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 minimum—a preferred return—is reached, for example, 7% IRR.
• Carried interest – Once the preferred return is reached, the sponsor is paid in the form of a promote (also known as carried interest). 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:[2]

• Acquisition fees – Often quoted as a percentage of the purchase price of a property. For syndicators who invest significant equity in their own deals, acquisition fees can offset their cash contribution.
• Disposition fees – Usually paid as a percentage of the property sale price, often at or below the percentage of the acquisition fee.
• Financing or refinancing fees – Calculated as a percentage of the loan balance.
• Equity placement fees – Paid to an internal or external sales team responsible for raising equity capital.
• Expense reimbursements – Usually a direct reimbursement with no markup.

For individual investors, what are the potential benefits of real estate syndication?

In general, private real estate investments offer benefits such as regular cashflow and the potential for appreciation. Specific benefits of real estate syndications include:

• Passive, hassle-free returns – Syndication investors can profit from real estate without committing their time and effort to active management. You can skip the typical headaches of being a landlord, like late-night calls from tenants and collecting rent checks.

• Ability to choose specific investments – When you put money into a syndication, you know exactly what asset is involved, enabling you to make property-by-property investment decisions. Real estate funds or REITs, on the other hand, are blind pools: you don’t know in advance what your capital is buying.

• Tax efficiency – Syndicates are usually structured as pass-through entities, which means items like depreciation and interest expense are passed through to individual investors. This can create tax benefits, allowing you to defer taxes to later years or offset income from other investments.

• Expertise of a skilled sponsor – Passive investors in a syndication can benefit from the hard-earned experience of a professional operator.

• Potential to participate in a 1031 exchange – A 1031 exchange allows investors to swap like-kind properties and defer the capital gains tax on the first property’s sale. Not all real estate investment structures are set up to allow 1031 exchanges—but syndicates often are.

• Opportunity to diversify – Syndication allows you buy just a slice of a deal, enabling you to diversify your investments across multiple sponsors, asset types, and strategies while tapping into new opportunities that may otherwise be out of reach if you had to buy the entire asset.

For individual investors, what are the potential drawbacks of real estate syndication?

Real estate syndications pose certain challenges, including:

• Choosing the right sponsor – The sponsor controls nearly every major decision related to the deal, so passive investors need to pick carefully.

• Limited liquidity – Unlike publicly-traded REITs, investments in real estate syndications are long-term and relatively illiquid. Investment periods range from two to 20 years. Sponsors may try to periodically provide liquidity events, but liquidity may not be guaranteed.

• Limited control over the investment – Passive investors have very little control over the investment. The day-to-day decisions (like tenant screening and paint colors) and the big decisions (like refinancing and selling) are made by the sponsor.

Real estate syndication and crowdfunding

In general, crowdfunding refers to online fundraising. As it pertains to real estate, crowdfunding is a way for real estate entities—including syndicators—to connect with passive investors. In other words, crowdfunding sites are intermediaries standing between investors and sponsors.

While real estate crowdfunding platforms strive to make it simple for passive investors to find and review syndication deals, it’s important to realize that the real estate crowdfunding universe is home to an array of structures and fees. Some deals are structured similarly to the traditional syndicate model, while other arrangements have added layers and fees. Some crowdfunding deals are open to accredited investors and other are not. Furthermore, there is a wide range of quality across sponsors, terms, and underlying assets.

How to invest in real estate syndication deals

Before jumping into real estate syndication deals, it’s wise to (re)consider the basic foundations of your investment approach—such as your risk tolerance, need for liquidity, and diversification goals—with an eye toward clarifying your overall objectives and specific real estate strategy.

If you’re ready to move ahead, the first step is to find syndicators and deals. Some offerings are posted on crowdfunding sites but finding deals may require an active effort given that SEC regulations limit sponsors’ ability to publicly advertise. Many individuals start by connecting with industry associations, networking with other investors, or speaking with their investment adviser, attorney, or accountant.

Once you identify a deal that could be interesting, you’ll start with an initial review. Many sponsors typically provide a tear sheet or pitch book with general information about the deal. They may also host a meeting or webinar to provide more details about the asset, market, business plan, and projected financials.

When the sponsor is ready to take final commitments, you’ll receive a full offering package with a standard suite of legal and marketing documents. Typical materials include:

• Private placement memorandum (PPM) – Thorough document that describes the investment opportunity and risks as well as the legal structure, deal terms, and economics of the investment.

• Limited partnership agreement or operating agreement – Spells out how the LP or LLC entity will operate.

• Subscription agreement – Your official commitment to invest.

At this point, many investors choose to have the offering auditedby their financial, tax, and legal advisers. If you choose to invest, you’ll complete the subscription agreement and send in your money.

[1] “Investing in Real Estate Private Equity: An Insider’s Guide to Real Estate Partnerships, Funds, Joint Ventures & Crowdfunding,” Sean Cook, 2016

[2] “Investing in Real Estate Private Equity: An Insider’s Guide to Real Estate Partnerships, Funds, Joint Ventures & Crowdfunding,” Sean Cook, 2016

About Caliber

About Caliber
Caliber – the Wealth Development Company – is a middle-market alternative asset manager and fund sponsor with approximately $1.5 billion in assets under management and development. The Company sponsors private funds, private syndications, as well as externally managed real estate investment trusts (REITs). It conducts substantially all business through CaliberCos, Inc., a vertically integrated asset manager delivering services which include capital formation and management, real estate development, construction management, acquisitions and sales. Caliber delivers a full suite of alternative investments to a $4 trillion market that includes high net worth, accredited and qualified investors, as well as family offices and smaller institutions. This strategy allows the Company to opportunistically compete in an evolving middle-market arena for alternative investments. Additional information can be found at CaliberCo.com and CaliberFunds.co.

Click here to see Caliber’s current property portfolio.

If you would like to speak to someone about diversifying your retirement accounts, contact us at [email protected] or call (480) 295-7600 to schedule a call with a member of our Wealth Development Team.

If you would like to learn more about Opportunity Zone Investing, Caliber has put together a special guide that cuts through the myths and misconceptions and outlines the benefits, the risks, and the upcoming deadlines you must know to be able to participate. Get access to the guide here.

Investor Considerations

The information contained herein is general in nature and is not intended, and should not be construed, as accounting, financial, investment, legal, or tax advice, or opinion, in each instance provided by Caliber or any of its affiliates, agents, or representatives. The reader is cautioned that this material may not be applicable to, or suitable for, the reader’s specific circumstances, desires, needs, and requires consideration of all applicable facts and circumstances. The reader understands and acknowledges that, prior to taking any action relating to this material, the reader (i) has been encouraged to rely upon the advice of the reader’s accounting, financial, investment, legal, and tax advisers with respect to the accounting, financial, investment, legal, tax, and other considerations relating to this material, (ii) is not relying upon Caliber or any of its affiliates, agents, employees, managers, members, or representatives for accounting, financial, investment, legal, tax, or business advice, and (iii) has sought independent accounting, financial, investment, legal, tax, and business advice relating to this material. Caliber, and each of its affiliates, agents, employees, managers, members, and representatives assumes no obligation to inform the reader of any change in the law or other factors that could affect the information contained herein.

Resources

• IRS: Opportunity Zones Frequently Asked Questions
• IRS: Facts About Opportunity Zones
• IRS: Tax Cuts and Jobs Act Opportunity Zones Webinar
• US Department of Housing and Urban Development (HUD) Opportunity Zone Reports
• SEC: Staff Statement on Opportunity Zones
• SEC: Spotlight on Opportunity Zones