What is a Syndication?
Most people have heard of crowd funding, even if they don’t exactly know what it means. Crowd funding refers to the act of raising money from a large group of people for a stated purpose, whether that be to produce a product, start a company, or fund a project. These people could be family, friends, or individual investors.
Real estate syndications are similar to crowd funding, but with a few more rules and regulations involved. A real estate syndication is simply the combining of financial resources from investors for the purpose of financing real estate property investment. This can include purchasing an existing property and/or funding the construction of a new property. The syndication can involve a few to hundreds of investors. It can be formed to purchase one single property (for a single transaction) or it can be formed for a more long term purpose to purchase multiple properties over time.
Who is involved?
Sponsor
It all starts with the sponsor, and since the success of the syndicate is largely dependent on the diligence and competence of the sponsor, it also all ends with the sponsor. The sponsor can be an individual, a company, or some other entity. The sponsor is in charge of funding the property, raising the funds from the investors to secure the property, executing the purchase of the property, managing the property’s day to day activities, reporting to the investors as expected, and paying dividends to the investors as expected. It is customary for the sponsor to contribute financially to the syndicate, generally 5 to 20 percent of the total equity. This is done to ensure the sponsor also has a financial stake in the deal.
Investor
The investor simply invests money in the deal. They are not responsible for finding, purchasing, or operating the property; that is all the responsibility of the sponsor. Dependent on how the syndication is structured, the investor may or may not have any decision making power in the day to day operations. In short, the investor has a very passive or limited role in the deal as a whole.
Joint Venture/Equity Partner
There can also be a third party in the transaction, referred to as a Joint Venture (JV) or Equity Partner. This entity isn’t required. If the sponsor doesn’t have access to the number of investors required to secure the property, a JV that has access to multiple investors can be handy. The JV can also serve as the go between for the sponsor and the investors, engaging the investors for the syndication, reporting to them after the purchase, and keeping the lines of communication open for deals in the future.
What are the rules?
There are two SEC regulations in regard to the investors in real estate syndications:
• 506(b)- Investors must have the satisfactory financial knowledge to participate in the transaction. Sponsors can only raise money from an existing client base, which means investors must establish a relationship with the sponsor ahead of the deal.
• 506(c)- Investors must be accredited. In order to become accredited, they must meet one of these requirements:
o A net worth of $1 million, not including the value of their primary residence
o An annual income of $200K or more for single individuals, with the assumption that the same amount will be earned in the present year
o An annual income of $300K or more for married couples, with the assumption that the same amount will be earned in the present year
How does one make money in the syndication?
The sponsor receives money from three possible sources: acquisition fees, management fees, and equity participation. At the purchase of the property, the sponsor may receive an acquisition fee as payment for finding the property. The management fee is a small percentage paid to the sponsor on a set schedule and represents payment for managing the day to day activities of the property and the syndication. The equity participation is the cash remaining after the two earlier fees, and is paid after the investors have been paid their preferred return. This remaining money is split among the sponsors.
In summary
Real estate syndications can be very profitably, as long as the sponsor is knowledgeable in the market, experienced at running the specific type of property, and fiscally responsible. By being part of a larger group, the investors can participate in the purchase of larger/higher class/more expensive properties, which they couldn’t have done by themselves.