Basics
Real Estate Syndications: The Basics
In this basic overview, we’ll go over what syndications are, how you can start investing, the returns you can expect, risks involved, and more.
What is a real estate syndication?
A real estate syndication is a group of investors pooling their money together to invest in a real estate asset. This approach is beneficial for large assets like multifamily apartment buildings and self storage facilities, that cost a lot more than say, a single family home. If you’ve ever invested in single family rentals, imagine multiplying that rental income by dozens, even hundreds. This scale-ability is the one of the many advantages of commercial real estate.
A syndication is basically two groups of people:
(1.) General Partners (aka: Operators of the asset)
(2.) Limited Partners (aka: Passive Investors).
The general partners (GP’s) are those who put the syndication together. They find and vet a suitable property in the right market, put together the team to operate the asset, and create and execute the business plan. Essentially, GP’s do the work that one would be doing as the owner/landlord of a residential rental property, but on a massive scale.
The limited partners (LP’s) are those who invest their money in the deal. They have no active responsibilities in managing the asset. The LP’s invest their personal capital into the deal, which makes it possible to acquire the property and fund the renovations.
This is a true team effort that pays off for everyone involved! As we all participate in the revenue generated and the value added.
How it works
Together, the GP’s and LP’s join an entity (usually an LLC), and the entity holds the asset (apartment building or storage facility). And because the LLC is a pass-through entity, you get the tax benefits of direct ownership which we cover in more detail below.
When the deal closes, the GP’s work with the property management team to improve the asset according to the business plan, with the goal of increasing the net operating income (NOI) and property value. During this time, the LP’s receive regular ongoing distribution checks from the NOI generated.
When the renovations are complete, the GP’s will sell or perform a cash-out refinance of the property (liquidation event). In both cases, the originally invested capital is returned to the LP’s. If the asset is refinanced, everyone continues to receive those periodic distribution checks. If the asset is sold, the profits are split.
Reasons to invest in multifamily and self storage real estate
You want to invest in real estate but don’t have the time or interest in being a landlord.
You are skeptical about the performance of paper assets (like stocks) and want to invest in a stable physical asset like real estate
You want the tax benefits that come with investing in commercial real estate.
You want to receive regular cash flow distribution checks.
You want your money to make a difference in local communities.
There are two types of returns in a multifamily syndication. The details for both of these returns vary with each deal. They are determined by the deal sponsor and are spelled out in the deal structure.
(1.) A periodic cash flow return in the form of a check or direct deposit (usually quarterly) from deal close to asset sale.
(2.) A split of profits after sale or refinance of the asset.
Cornerstone looks for average cash flow returns of 8-10% per year. An example of a $100,000 investment would make an average of $8,000 per year in cash flow returns (about $667 per month). When the asset is sold, you could expect an additional 40-60% ($40,000-$60,000) in addition to receiving your original capital back.
When counting the $8,000 per year for five years, plus the ~$60,000 at the sale, you would have received a total of $100,000 (after receiving the original $100,000 investment back) in returns over the course of five years, doubling the amount of your original investment. When counting profits from the sale, your average annual return over the course of the five years would be 20%.
Side note: While some properties will perform at their target returns starting year one, others may be a heavy value-add property. That means those quarterly returns will be lower or non-existent during the first year or so while the property is being repositioned. This is usually due to higher vacancies during renovation of the units and streamlining of expenses. Once the business plan is achieved, and income of the property has increased, the returns will approach the targeted goal.
Returns
This will vary with each deal. We have seen minimums from $50,000 up to $1,000,000.
Typically, the minimum investment on a deal with Cornerstone is $50,000.
Minimum investment amount
While each syndication is different, we typically see projected hold times of 3-5 years, sometimes shorter.
Side note: Your money will be illiquid during the length of the hold time (you won’t see that money until the asset is refinanced or sold). Thus, you should only invest with funds that you don’t need to access for a while.
Length of a syndication
As mentioned above, one of the two groups in a syndication is the limited partners which include two types of investors:
(1.) Accredited investors who must meet at least one of two requirements: a minimum $1 million net worth, excluding their primary residence, and an individual income of $200,000 or joint income with spouse of $300,000 yearly, for the last two years and intend to make this amount or more the current year. A large majority of syndications are exclusive to accredited investors.
(2.) Non-accredited, sophisticated investors are people who can demonstrate that they understand real estate syndications and their risks without any of the requirements above. There are many opportunities for non-accredited investors but they are not publicly advertised (an SEC rule) so you would need to seek them out.
Types of investors
There are two main types of fees that are paid to the general partners (GP’s) in a real estate syndication:
(1.) Acquisition fee (typically 1-3% of the purchase price), which is paid out upon the deal closing. This is for the work the GP’s have put into the acquisition of the property.
(2.) Asset management fee, which is an ongoing fee (usually 1-5% depending on amount of revenues) that is deducted from the cash flow each month, for the work of managing the asset.
*Passive investors don’t pay these fees and fees are not taken out of their returns, they are already accounted for in the underwriting.
Fees
Yes! In fact, this is one way that many passive investors get started with real estate syndications.
To invest with retirement funds, you’d roll over your existing retirement funds (401k’s, IRAs, etc.) into a self-directed IRA account. Once the funds are in account, you can choose what you want to invest in. You will need to provide the self-directed IRA custodian with copies of the legal documents for the real estate syndication (private placement memorandum, operating agreement, and subscription agreement) then they will send your funds on your behalf. The returns you make on the investment go directly back into the self-directed IRA account, never into your personal accounts.
Investing with retirement funds
One of the biggest risks is in the execution of the business plan. The sponsor team must be able to execute on the business plan in the face of unforeseen circumstances. This is why you should team with sponsors who have a proven track record and who prioritize capital preservation, so you know they are reliable and will protect your investments.
Another potential risk is the unpredictability of market conditions during a project's hold time, and when the liquidation event is forthcoming. The local economy could be slowing down or the entire country could be in a recession. An important safeguard is to ensure the loan provides some buffer time. Meaning, if the projected hold time is 5 years, that the acquisition loan term is longer than the projected hold time.
As a limited partner / passive investor, your liability in the real estate syndication is limited. At worst, you could lose your monies invested, but you will not lose more than that (e.g., your house).
Just remember, a real estate syndication is an investment and no investment is a guarantee. But the more you learn about them, the better you will get at finding deals that minimize the risk potential.
Risks
As a passive investor in a real estate syndication, you are part owner of an asset which means you get to share the tax benefits.
One of the biggest tax benefits is accelerated depreciation through cost segregation (vs. straight-line depreciation). An example of straight-line depreciation is investing in a residential rental property that depreciates on a schedule of 27.5 years. When you invest in a commercial real estate syndication, the sponsors will often order a cost segregation study which takes stock of all the individual assets on the property (light fixtures, carpeting, utility systems, etc.) to create a report. The report shows which assets are eligible for accelerated depreciation (a shorter schedule).
For example, instead of depreciating the carpeting over 27.5 years, you may be able to depreciate it over 5 years. This accelerated depreciation can front load all the depreciation benefits into the first few years of ownership, which is perfect for a real estate syndication that projects a hold time of just a few years.