As people are looking to diversify their investment portfolio, real estate syndication is becoming more and more popular. As the saying goes, there is strength in numbers, and that saying certainly applies in the real estate syndication world.
If you’re not familiar with real estate syndication, or if you are considering getting involved, read on. We’ll cover everything you need to know below!
What Does Syndication Mean?
What is syndication? Syndication is when a group of individuals, or companies, transfer the control of something (in this example, real estate) to an individual/manager.
The word syndication does not only apply to the real estate world, but is also commonly used in the broadcasting industry.
How Does Syndication Work in Real Estate and What is Syndication in Real Estate?
Real estate syndication is a powerful investment option that has a lot of potential upside for numerous people. In its most simplest form, real estate syndication is a real estate transaction that involves sponsors and investors.
The sponsor identifies real estate deals, and the investors invest their money. The sponsor will typically collect an initial finders fee, in addition to a management fee. Whereas the investor is looking for the property to produce consistent returns, and generate free cash flow.
Syndication in real estate is when numerous parties partner together to purchase a real estate property. Real estate syndication allows individuals to combine their skills, resources, capital, and time; and use the combined force to purchase a great real estate deal.
How to Invest in Real Estate Syndication?
If you’re curious how to invest in real estate syndication, unfortunately, there is not a blueprint for investing in real estate syndication deals. There are various ways one can get involved.
There are passive income groups or websites online that promote real estate syndication. One can also network within their friends and family base to pool money together and purchase property.
Investing in real estate syndication is rather easy to do, but finding the right investment is the hard part. There are numerous variables one must consider to find a good deal. Having a mentor, or studying this investment strategy in great detail, will be critical for your success.
Is Real Estate Syndication Good?
Real estate syndication can be very good, and extremely profitable, if done correctly. Finding the right deal can generate great passive income for the investors, and the sponsor can also earn a healthy commission.
How Do You Get Paid From Real Estate Syndication?
Getting paid with real estate syndication isn’t an exact science. There is a bit of nuance that must be taken into consideration. Keep in mind, there are two parties involved; the sponsor of the deal, and the various investors.
As a deal sponsor, there are a few ways you can earn money:
- The deal sponsor often receives a ‘finders fee’ for finding the investment and dealing with all the administrative work to make the deal possible. Such work includes; negotiating the sale price, building a business plan, managing the property management team, and working on the mechanics of the deal. This fee is often 1% of the total investment.
- The sponsor can also split the profits the property generates with the investors. There are numerous ways to structure a deal. Sometimes the sponsor is entitled to the profits after a certain amount, whereas other times the profits are split evenly.
The investor invests in a real estate syndication deal to get a piece of the profit the deal generates. We’ll dive deeper into this example below.
Example of a Real Estate Syndication
To better understand real estate syndication, and how everyone gets paid, consider the following example.
A sponsor identifies a real estate deal that costs $1,000,000. The sponsor does not have the money to purchase the property themselves, so they partner with 4 investors. Each investor invests $250,000.
That property produces an annual rate of return of 10%, or $100,000. Considering the fact that each investor invested an even amount, $250,000, each investor is entitled to $25,000 (or 25% of the profit).
However, if the sponsor negotiated the right to the profit as well, that $100,000 annual profit may be split evenly between the 4 investors and the sponsor, so each individual would receive $20,000.
The sponsor would be required to manage the property, iron out the details of the deal, and raise enough capital to do the deal. The investor is hands-off, and is not responsible for managing the property.
Factors Involved with Real Estate Syndication
There are two main factors with a real estate syndication deal.
Straight Split Syndication
The first factor is a straight split syndication. This is when the profits are proportionate across each investor.
If you have four investors that all contributed the same amount of money, all four investors are entitled to the same amount of profit. If one investor contributed more money, that investor is entire to a bigger slice of the overall profit.
Waterfall Structure Syndication
A waterfall syndication deal is a bit more complex. However, the easiest way to understand a waterfall is to look at it through numerous levels. For example:
- Level 1 – the investors receive 80% of the profit if the property produces the preferred return (let’s say the preferred return is 8%)
- Level 2 – If the property produces a 12% return, the profit over the preferred return is split 70% with the investors, and 30% with the sponsor
- Level 3 – If the property produces a 16% rate of return, the profit between 12% and 16% will be split 60-40 between the investor and the sponsor
This waterfall continues, and the profit tiers and splits are entirely dependent on the structure of the deal.
A waterfall structure can be great for the sponsor. If the sponsor can figure out a way to make the property more profitable, they are rewarded a larger piece of the overall profit.
The investors are typically not upset as they are still receiving their preferred return. Anything in addition to the preferred return is just extra money!
Advantages of Real Estate Syndication
There are numerous advantages to real estate syndication!
- Investing in real estate allows you to diversify your portfolio
- Investors can own real estate without any of the hassle as the management of the property falls on the sponsor
- You can combine your money, and knowledge, with other investors to purchase a property that would typically be out of your price range
- The right property can also appreciate in value
- There are various tax benefits of owning real estate
Disadvantages of Real Estate Syndication
Now, there are always disadvantages associated with real estate syndication. Consider the following:
- The deal may not generate a profit
- Owning real estate is not nearly as liquid as other investment options
- Although working with other investors will increase your purchasing power, it can also add complications and headaches that will need to be managed and worked through
Real Estate Syndication Vs. REITs
A real estate investment trust, also known as a REIT, is a company that purchases commercial real estate with investors’ money. Although this may seem like real estate syndication, it’s not the same thing.
When you invest via real estate syndication, you directly own the investment. When you purchase a REIT, you own shares of the REIT, which generates profit through the various properties the REIT owns.
If you own a REIT, you will not have complete control over which properties the REIT invests in, whereas in real estate syndication you can specifically choose which deals you want to get involved in or invest in.
Real Estate May Be Great for Your Portfolio
Owning real estate can be a great investment. Real estate not only provides consistent cash flow, the property also has the potential to appreciate in value.
Becoming a real estate syndicator, or investor, may be the perfect option for you. However, before doing so, it’s best if you consult with a financial advisor.
Financial advisors not only exist to help you find the right stocks or mutual funds to invest in, but they will also help you manage a budget and identify ‘left over’ money that can be used for alternative investments, such as real estate. Managing your personal finances is one of the most challenging things you can do. A financial advisor helps you navigate through those challenging questions and keeps you focused on your goals.