– And How Does It Work? –
Many real estate investors “get their feet wet” through some form of residential real estate. Whether those initial investments are flips, standard rental homes, or even duplexes, it can be a great way to start and has served many real estate investors very, very well. In the course of our journey, we’ve discovered and absolutely love the power of multifamily syndications. However, whenever we speak to many of our friends, family and colleagues, they may have only vaguely heard of multifamily syndications…or not at all – nothing but blank stares.
Actually, that’s pretty common. Until somewhat recently, SEC (Securities Exchange Commission) regulations did not allow for real estate syndication opportunities to be publicly advertised. This made it so that you had to be part of the “inner circle” (i.e., you had to know someone who was doing a deal) in order to invest in one. The intent of the regulation was, and is, to protect unsuspecting and ill-informed potential investors from getting involved in investments they don’t fully understand.
The SEC now however allows certain opportunities to be shared more broadly, with caveats, which opens the door for more people to learn about and invest in alternative investments, like multifamily syndications, which are actually quite common and well-structured.
But maybe you’re unfamiliar with multifamily syndications too, and are wondering things like:
Well, let’s take a look under the hood…
Let’s start with the basics.
So a multifamily real estate syndication is when a group of people pool their resources (funds, time and expertise) together to invest in a multifamily asset. Instead of buying a bunch of small properties, each individually, the group of people come together and buy a larger asset, and typically share in a larger return while de-risking the overall investment.
Let’s pretend you have $50,000 for investing, beyond other savings and retirement funds. You could invest it in an individual rental property, but that would also require time to find a property, evaluate the cost-benefit analysis, negotiate the contract, do the inspections, get the loan, find the tenants and then manage the property.
But it’s likely you don’t have the time or energy (or desire!) to deal with so many obligations. This is where most people assume real estate investing is too hard and too much work, so they stop there.
Real estate syndications are the alternative that allows you to still put your money into real estate without having to actively do the work of finding or managing the property yourself. Instead, you can invest that $50,000 into a real estate syndication as a passive investor. So you contribute $50,000, maybe a friend has another $50,000 to invest, someone else puts in $100,000, along with others until you’ve raised what’s needed to close on the property.
By pooling resources, the group now has enough to buy not just a single rental property, but something bigger, like an apartment building. And as a passive investor you don’t have to do any of the work managing the property. A lead syndicator or sponsor team does the upfront work and manages the investment (i.e. all the active work) and in return, they get a small share of the profits. Additionally, a professional property management company can be hired to run the day-to-day operations. And you, the passive investor, enjoy putting your money to work to generate nice, stable returns so that you can focus your time and energy on the things you really want to do.
When done right, real estate syndications are a win-win for everyone involved.
Ok, curiosity piqued, you’re interested in the “behind the scenes” details of a syndication to see how this all really shakes out.
First off, there are two main categories of investors who come together to form a real estate syndication:
The prior section described a team that would take care of all day-to-day management (so you don’t have to!) in exchange for a small share of the profits. That team is called the general partners (GPs). They are called the ‘active partners’ and do all the legwork of finding and vetting the property; creating the business plan; securing lender financing; putting up initial “at-risk” funds necessary to close; securing other investors for the down payment & equity; and managing the investment after closing and thereafter, until any subsequent sale. Essentially, they do the work that you would be doing as the owner and landlord of a rental property, but on a massive scale.
The limited partners (LPs) are the passive investors (others like you), who invest their money into the deal in exchange for a portion of the cash flow and/or a percentage of the asset. The limited partners have no active responsibilities in managing the asset.
A real estate syndication is designed to work best when general partners and limited partners join together and collaborate in this manner. The general partners find a great deal and put together an efficient team to execute on the intended business plan. And the limited partners invest their personal capital into the deal, which makes it possible to raise the down payment, acquire the property, and fund the renovations.
Together, the general partners and limited partners form an entity (usually an LLC), and that entity holds the underlying asset. This serves to protect the partners and investors from personal liability and formally organize the structure and responsibilities of each of the partners, along with expected compensation. Because the LLC is a pass-through entity, you also get to share in the tax benefits of direct ownership of a real estate asset.
Once the deal closes, the general partners work closely with the property management team to improve the property according to the business plan, with the intent of increasing business revenue and compounding the property’s overall value. During this time, the limited partner investors receive regular communications as to the performance of the investment and ongoing cash flow distribution checks (usually sent out quarterly).
Depending on the business plan and strategy (such as planned renovations, improved operations or simply maintaining smooth operations), there may be refinancing events and/or a planned sale of the property. A refinancing event is similar to a home equity refinancing to leverage increased value and/or better loan terms and generates a return of capital distribution to the investors. And the sale of a property is most often exercised to capitalize on improved property value, which also returns equity to the investors. When these events take place, even larger payouts are distributed among the partners. And in the case of the sale of an asset, the partnership is then dissolved and team members can work to find yet another great deal.
Okay, now that you understand the basics of how real estate syndications work, let’s talk about what’s in it for you, the passive investor. There are a number of reasons that passive investors decide to invest in real estate syndications.
Here are a few of the top reasons:
A real estate syndication is a nearly perfect way that a busy professional can invest in large-scale, physical real estate assets, without the commitment of time or excessive mental energy, while also positively impacting the community and earning interest and tax benefits. This opportunity for passive income is sounding better and better!
Okay, so you’re interested, but you’re still like, “Is this real?” Here’s an example of what a real estate syndication deal would look like.
Let’s say that Jane and John are working together to find an apartment community in Dallas, Texas. Jane lives in Dallas, so she works with real estate brokers in the area to find a great property that meets their criteria. After looking at a bunch of properties, they find one, listed at $10 million.
John takes the lead on the underwriting (a fancy term that means analyzing all the variables, costs and benefits to make sure that the deal will be profitable), and they determine that this property has a ton of potential. Greenlight!
Since Jane and John don’t have enough money to purchase the $10-million property themselves (approximately $3-million upfront costs), they decide to put together a real estate syndication to purchase the property. They create the business plan and investment summary for prospective investors and work with a syndication attorney to structure the deal.
Then, they start looking for limited partners (passive investors) who want to invest money into the deal. Each passive investor invests a minimum of $50,000 until they have enough to cover the down payment, closing costs, as well as the cost of any planned renovations and a safety net to support the transition of operations.
Once the deal closes, Jane works closely with the selected property management team to improve the property and get the renovations done on budget and on schedule.
During this time, Jane and John send out monthly updates, as well as quarterly cash flow distribution checks, to their passive investors.
When the renovations are complete, Jane and John determine that it’s a perfect time to sell and the property sells for $15 million after just 3 years. Each passive investor receives their original capital investment PLUS their split of the profits according to the original deal. In this case, a 70/30 split was agreed upon at the creation of the syndication (70% to investors, 30% to the Jane and John).
At this point, each passive investor has received regular cashflow distribution checks during the renovation and hold period, plus their initial capital investment back once the property sold, plus their portion of the profit split after the sale…a pretty sweet deal for little-to-no work!
Now that you know the ins-and-outs of a real estate syndication, including what it is, how it works, how little effort on your part it requires, and how simple it could be to begin receiving your first passive income check, definitely don’t wait 10 years to make a move.
We always recommend doing your research until you’re comfortable with how investments work in general as well as any specific investment strategies. Now that you’re armed with this knowledge about real estate syndications though, you’re miles ahead of most other investors. Keep at it! Investing in real estate has given us a huge degree of personal and financial freedom in our lives and we hope you find it just as beneficial, if not even more so! As we love to say…passive income. For Life!
And here are a few ways you can continue taking action to take back your time: