Inside Scoop to Multi-family Syndications
Have you ever driven by and seen large apartment complexes and wondered who owned them? Maybe wealthy individuals? Yes, some of them but not all. A lot of these large multi-unit properties are owned by regular people generating passive income through real estate syndication.
We’ve been investing in real estate for 15 years and learned about syndications through our real estate investing network. We quickly realized it was a great asset class to consider for passive investing. You’ve probably never heard of real estate syndications (we didn’t until further along into our investing) because most people would need to be an insider to be part of these deals.
What is a Real Estate Syndication?
Simply, real estate syndication is a group investment, where investors pool their money together to purchase a larger real estate asset such as multi-family apartment buildings. The group investment is a passive investment, letting others perform active management on their behalf.
It’s an opportunity for investors to pool their financial and intellectual resources to invest in properties that are much bigger than they could afford or manage by themselves.
You can think of real estate syndication like 2 people who are opening a restaurant together. As the manager and operator of the restaurant, Jack invests the sweat equity including scouting the property, raising the money, managing the day-to-day operations, accounting and financial projections. Jill provides financial equity and partners with Jack’s expertise in the restaurant industry.
How do Syndications work?
There are 2 groups in a real estate syndication, the general partners (GP) and the limited partners (LP).
General partners are the experts who put the deal together by vetting and identifying the apartment building and creating the business plan. They are the ones finding the property, securing the financing, acquiring the property, completing renovations, managing the day-to-day operations and marketing of the property.
Limited partners have a passive role. They invest their money into the deal, which allows the group to purchase the property and fund the renovations according to the business plan.
How are Syndications structured?
Together, the general and limited partners join an LLC, an entity that holds the asset. As an LLC, you receive the tax benefits of ownership of the asset and built-in protections for all parties.
The general partners are usually responsible for investing anywhere from 5-20% of the total required equity capital, while investors put in 80-95% of the total.
The LLC is structured where the sponsor is the general partner and the investors participate as limited partners or passive members. The rights of the general partner (Sponsor) and Investors, including rights to distributions, voting rights, and the Sponsor’s rights to fees for managing the investment, are set in the Operating Agreement. This creates a separate entity for management and control and protects investors from liability.
How do you make money?
A common real estate syndication deal structure looks like this.
During the investment, you will usually receive:
Preferred Returns: 6-10% of the cash invested annually. This is a cash flow distribution check, usually paid monthly or quarterly
Tax benefits: depreciation and cost segregation. (more details in another post).
At the end of the investment, you will usually receive:
Initial investment back
A share of the profits from the sale of the apartment building from the appreciation of the building. The property has been enhanced by marketing, renovations, and professional management.
A Simple Example
Real estate syndications are structured so the general partners are really motivated to make sure the apartment investment performs well for everyone involved.
Let’s say as an investor (limited partner), you invest $50k into the deal with a 10% preferred return. During the first year, the returns hit 10% so the investors get paid their returns first. The general partners only receive returns after 10%, so this motivates them to work hard to get the returns beyond 10%. You would receive $5k in cash flow that year, usually distributed quarterly or monthly.
What happens after you receive your preferred return? The remaining money is distributed between the general partners and the investors based on the syndication’s profit split structure.
Let’s say the profit split structure is 70/30. So returns above the 10% preferred return, ie. 10-15% return, investors receive 70% of the profits after receiving their preferred returns. The general partners receive 30% after the preferred return.
So let’s say the next year, the return is 15%. Since you invested $50k, you will receive the same 10% preferred return, $5k plus you will get 70% of the additional 5% returns. You get 70% of $2500 ($50k x .05%), an additional $1750. So for year 2, you would receive $6750 ($5000k + $1750).
Once you hit the first threshold, there may be another profit split structure after, let’s say 60/40. This makes sure the general partner’s interests are on the same page as the investors - achieving the highest return possible for everyone. The harder and smarter they work, the higher returns the general partner makes which translates to everyone winning in the deal.
If there are plans for the apartment to be refinanced (ie. 5-7 years), you could receive the original capital of $50k back or a majority of it when the refinance occurs. This is outlined in the business plan. Regardless, at the end of the investment when the property is sold, you can expect an additional amount to the original capital of $50k. This is the share of the profits from the sale of the apartment building from the appreciation of the building. This split structure varies depending on the specific deal structure.
What’s the Process?
What happens after a deal is identified and brought to you as an investor? Here's a very general outline.
The general partners secured a property that meets their investment goals. They made an offer, it’s been accepted, and the property is tied in an escrow period. They performed their due diligence, secured the financing, and created an investment package, referred to as a Private Placement Memorandum (PPM).
The general partners share the investment opportunity with their investors and raise money to fund the deal.
1. The general partners hold a webinar to review the project. You have an opportunity to ask questions and get more information. They will usually cover:
Background, experience of general partners
Details of the property ie. construction, units, comparable properties
Details of the location ie. job growth, trends, demographics
Business Plan
Terms, sponsor contribution, equity splits
Investment projections
Fees & general partner share
Payout & distribution details (waterfall structure)
Risks
Timeline
2. If interested in investing, you submit a soft reserve, telling the general partners how much you want to invest. They provide a timeline on when key parts of the process must be completed by. There’s a minimum investment amount and a certain number of slots available.
3. The general partner confirms your spot in the deal and provides the PPM.
4. You provide your funds after signing the PPM.
5. Once there is enough capital raised, and the financing is completed, the property is purchased. When the deal closes, the general partner informs you of the next steps.