Real estate syndication is an investment strategy in which multiple investors come together to purchase, manage, or sell properties. This method enables individuals and entities to participate in larger and potentially more profitable projects than they could afford independently.
Under the guidelines set by the U.S. Securities and Exchange Commission (SEC), many real estate syndications are treated as securities offerings and must adhere to specific regulations designed to protect investors. These rules help ensure transparency and accountability throughout the investment process, making it a safer and more reliable avenue for investors.
If you are a newly minted syndicator or planning to be one, this guide, written by our expert syndication attorneys will introduce you to the basics of one of the most profitable and exciting investment models in the field of real estate.
The Role of a Real Estate Syndicator
As a real estate syndicator or sponsor, your primary duties are to coordinate a group of passive investors and to guide the entire syndication process. This ranges from scouting for promising investment opportunities and organizing the syndicate to managing or selling the properties involved. Your tasks also include thorough due diligence, structuring the deal, raising capital, and overseeing the property’s operations.
In addition to identifying a suitable property or property type, you are responsible for forming a real estate investment company—either a limited liability company (LLC) or a limited partnership (LP)—to acquire it. That entity is known as a “syndicate” or “syndication.”
Effective communication and transparency are crucial as you need to build trust with investors and ensure all parties involved are informed about the investment’s progress. Never underestimate your experience and leadership because these significantly impact the syndication’s success and achieving favorable outcomes.
Various Types of Real Estate Syndication
Though varied, all syndicate models require the same corporate structure, legal compliance with securities laws, and participants—a management team (the syndicator) and passive investors. Depending on your investment goals and strategies, you can choose from these variations:
Specified Syndication Offerings
In this model, the syndicate focuses on one or more pre-identified properties. Ideal for beginner syndicators, it is the simplest way to raise money, as you will be required to manage only a few investors using an investor management platform independently.
For commercial properties, you would obtain a bank loan for a portion of the purchase price and raise the rest from private passive investors. They will own a share of the company that acquires the asset and earn a share of profits proportionate to their ownership interests.
Real Estate Investment Funds
Also called Blind Pool Fund, no specific properties are identified in this syndication before raising capital. Here, you will prepare a business plan, also known as an Investment Summary, outlining the investment criteria and desired asset classes.
Passive investors invest in the fund, which is formed as an LLC or LP. As the Fund Manager, you seek properties that meet the criteria stated in the Investment Summary for the fund to acquire, with the aim of purchasing multiple properties. Cash flow after expenses and equity realized from the eventual sale of fund properties are split between you and the investors.
When you have gained sufficient experience in profitably owning and operating the same asset class and successfully raising money, then you’re ready to handle Real Estate Funds. The administration is complex, and you would probably require professional help, which can increase costs and reduce returns available for distribution to you and your investors.
Mortgage Funds
This is an alternative way of profiting from a Blind Pool Fund using the money you gathered from private investors. You will selectively loan the pooled funds to active real estate investors. The loans are recorded against specific properties as real estate mortgages or trust deeds.
Mortgage pools are frequently used to fund borrowers engaged in single-family fix-and-flips who lack a ready source of institutional financing. They pay interest on the loans, a portion of which is passed on to your Mortgage Fund investors, and you retain the remainder.
If you are a Fund Manager with prior experience in the mortgage industry, then you’re likely to succeed in mortgage pools. Your track record should include evaluating deals and borrower qualifications and servicing loans (collecting payments and foreclosing on non-performing loans).
How it Works: The Real Estate Syndication Process
Below is a summary of the step-by-step procedure for creating a syndicate, as outlined by our securities lawyers:
- It begins with the syndicator actively searching for promising real estate investment opportunities.
- After spotting a potential property, the syndicator conducts due diligence to thoroughly evaluate the investment’s viability and potential returns. This involves analyzing financials, inspecting the property, and assessing market conditions.
- Next, the syndicator determines the deal structure, detailing the investment framework, the roles of each participant, the profit split between the syndicator and passive investors, and the projected investment terms.
- Capital raising then takes place, where the syndicator presents the deal to potential investors. Those interested will commit their capital and the funds are gathered to finance the acquisition.
- Once the property is secured, the syndicator hires and supervises local property managers to manage the day-to-day operations, ensuring the asset is maintained and operated efficiently to achieve optimal returns.
Advantages of Real Estate Syndication as an Investment
The ability to pool financial resources is a major appeal to both syndicators and investors. With a collective effort, investors can participate in larger, often more profitable properties than they could individually afford.
Another benefit is the opportunity for portfolio diversification, i.e., investing in multiple properties, which allows investors to spread their risk and potentially stabilize returns.
Partnering with experienced syndicators also brings valuable expertise to the investors’ table. These professionals conduct thorough research, manage properties efficiently, and navigate market complexities, all of which can significantly boost the chances of success.
Potential Risks in Real Estate Syndication
Like any investment, real estate syndication is not all about profit. As the syndicator, you must also carefully consider and be prepared for the unexpected, such as:
- Fluctuations in factors like economic downturns, property market crashes, and rising interest rates.
- The possibility that you will make poor decisions, potentially affecting the investment’s performance.
- Real estate investments are often less liquid than other asset classes, making it difficult to quickly convert them into cash if necessary.
- Changes in tax laws or regulations which might impact the expected returns.
Improperly structuring the syndicate or hiring a CPA unfamiliar with group investments can result in disastrous tax consequences for both you and your investors. Sometimes, these issues cannot be rectified.
Thus, it is critically important that you engage an experienced securities attorney to guarantee your earnings from fees are separate from your share of profits. This is the only way you can avoid taxation at the highest possible rate. They will also make sure the profit and loss allocations provide the greatest allowable tax benefits to all parties.
Final Thoughts: Balancing Opportunities and Risks
Real estate syndication represents a unique and collaborative investment avenue that allows individuals to engage in substantial real estate projects they might not tackle on their own. It can be a powerful strategy for diversifying an investment portfolio and accessing higher-value real estate markets.
On the other hand, while the potential for substantial returns is appealing, the importance of being well-informed and cautious cannot be overstated. By thoroughly understanding both the opportunities and risks, syndicators can make confident and strategic decisions that align with their financial goals.
This balanced approach ensures that the potential benefits of real estate syndication are maximized while minimizing exposure to potential pitfalls. Don’t miss the opportunity to get the best legal counsel in forming your real estate syndication! Shams Merchant is the leading real estate private equity and syndication lawyer, representing clients in more award-winning real estate projects. Specializing in real estate syndications, fund formations, securities law, and private placements for commercial property investments and development, Shams has been featured in national and regional publications like The Business Journals, Law360, BisNow, and The Real Deal.