Maybe you want to start investing in real estate, but you do not have enough capital to purchase a quality commercial property.
Alternatively, perhaps you are concerned about placing a large sum of capital into a single piece of real estate. Maybe you do not want to personally guaranty a mortgage loan—or take on the management and maintenance responsibilities of property ownership. Perhaps you have seen people renovating and flipping houses on tv, but you don’t have the time or expertise to try it yourself.
Investing in a real estate syndication enables you to acquire a single or diversified portfolio of properties with your capital, without having to undertake any managerial burdens.
A real estate syndication is an aggregation of capital from multiple participants to invest together in particular real estate opportunities.
A sponsor structures each syndicated investment, raises the capital, secures any necessary financing and manages the assets. The sponsor provides updates on the project and its finances, as well as distributions of available cash flow and proceeds from any sale or refinance of the underlying properties.
Think of syndications like a group of friends and family pooling their funds together to make an investment, however, sponsors of commercial syndications are generally real estate professionals, and the investors are typically unrelated to one another.
A syndication may be formed to acquire an individual property or a portfolio of several assets with common attributes (i.e., similar location or tenant).
Syndications often provide an opportunity to invest in larger or more exclusive properties with better credit and/or higher yields than individuals could obtain on their own.
These investment properties may be extremely difficult for you to acquire independently. One reason why is that sellers have greater confidence that a real estate company with a track record will be able to negotiate a purchase agreement and close the transaction on time than an individual. Additionally, professional syndicators typically have more equity and borrowing power than individuals, enabling them to purchase more expensive properties, or a portfolio of properties. Sponsors may also be able to obtain favorable financing terms not generally available to individual borrowers, resulting in a higher return for the same asset.
Syndications also offer a way to diversify your real estate holdings—you provide only a portion of the total equity in exchange for a corresponding fractional ownership interest in the property. So, instead of investing all of your capital in a single asset, you can spread your funds among multiple properties.
Some syndications offer a portfolio of assets for you to invest in, such as medical offices, student housing, industrial buildings or drugstores. The portfolio itself may offer some diversity, such as to geography or tenant. Other syndications pool funds to buy a single asset, often a commercial property. They enable you to deploy your capital into multiple smaller investments. Each syndication has its own requirements regarding minimum and maximum amounts to participate.
As noted above, investing in a real estate syndication will not require property management responsibilities, and there is typically no personal liability for any mortgage on the property (other than the invested capital).
The sponsor provides operational and financial reporting. The sponsor also makes periodic distributions of cash flow and/or proceeds from a sale or refinance of the underlying properties.
Syndications are generally offered through private placements. The investment should include an offering memorandum that describes:
Most importantly, the offering memorandum should disclose the risks associated with the transaction, including any potential for additional capital calls to investors. In many instances, the offerings will be limited to accredited investors who have the financial wherewithal to lose the entire principal amount of their investment if something goes wrong with the project.
The most important considerations when assessing a syndication are the experience, credibility and sophistication of the sponsor.
You will want to be comfortable that the sponsor has a track record of acquiring, managing and successfully completing similar investments. The individuals responsible for the syndication must have an excellent reputation within the real estate community. As an investor, you will be ceding control over the investment to the sponsor and the professionals it engages, and you are unlikely to have any “say” in decisions regarding the property.
If any of the sponsor’s past investments did not work out as planned, you will want to find out how the sponsor conducted itself to communicate with, and maximize value for, investors. This is particularly important for real estate syndications that are offered through crowdfunding over the Internet, or on a larger investment platform with multiple sponsors’ investments where you do not interact with the sponsor face to face.
Investors obviously should evaluate the real estate deal itself, and assess whether it is in line with their personal risk tolerance. These should be spelled out clearly in the offering memorandum, which investors should always read and understand before investing.
Answer these important questions before electing to invest in a real estate syndication.
Income from an investment with a single tenant under a net lease will be more certain than a multi-tenant property, or where the tenant is not responsible for all of the operating expenses. While a long-term lease with one tenant provides a degree of stability—assuming the tenant performs—a property with more tenants and shorter lease terms, such as apartments, allows flexibility to adjust rents frequently based on the market. It also lessens the impact of a vacancy.
If the project anticipates construction and/or significant capital improvements, consider whether the sponsor’s assumptions about the cost and timing are reasonable. Finally, you should be comfortable with the location of the investment property, its risks due to climate and any assumptions about demographic changes in the market.
While leverage can help increase your cash flow, loans often have lender-friendly covenants triggered by changes in cash flow. At some point, the loan will mature. The greater the loan amount in relation to the purchase price—and the greater the outstanding projected loan balance on the maturity date—the higher the risk. If the interest rate is floating, note whether there is a floor or a cap on the rate. Additionally, many commercial loans have prepayment penalties or swap breakage fees if the sponsor sells or refinances prior to maturity.
You should understand how long the sponsor intends to hold the property, how it will be disposed of, and the expectations for return of principal at the end of the investment period. This will typically be expressed as either an internal rate of return (IRR) or an equity multiple (EM).
As part of your exit strategy, find out what will happen if the property cannot be sold profitably at the end of the intended investment period. Evaluate whether the sponsor’s plan is realistic, and what the likely fallback position will be if market conditions change. You should also determine whether and how you can liquidate your investment if you want to exit early. Understand what will happen to your investment in the event of your death or incapacity, especially if the property is likely to be held for a long period of time.
As noted above, investors must receive a private placement memorandum describing:
Ideally, the offering materials will include an opinion from a reputable legal or financial advisor.
It is possible to lose your entire equity investment if the project does not perform as expected, and there may be obligations to contribute additional capital under certain circumstances.
It is, therefore, important for investors to review the offering materials carefully, and to consult with their own financial, legal or tax advisors before investing in a real estate syndication.
©All Rights Reserved. November, 2020. DailyDACTM, LLC d/b/a/ Financial PoiseTM
Tracy is a Principal at Syndicated Equities where she helps high net worth individuals and family offices to profitably invest in real estate. She also assists investors in identifying appropriate replacement property to complete tax-deferred exchanges under Section 1031 of the Internal Revenue Code. Drawing upon her 20 years of legal experience in the areas…
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