By Dr. Peter Kim of Passive Income MD, WCI Network Partner
As a landlord, if waking up at 2am to fix a plumbing emergency isn’t something you want to deal with, then this passive real estate investment strategy might be the thing you’re looking for. The art of teaming up to acquire real estate isn’t new, but surprisingly enough, not many people know what it is or how it works. So, in this article, I will focus on a specific type of passive real estate investment tool known as the Real Estate Syndication.
A real estate syndication is a group of two or more investors or investment companies coming together for a common goal—to raise capital for purchasing real estate or building a new property. The advantage of pooling your money with other investors is that you can invest in a much bigger, more lucrative deal that could be otherwise too expensive for an individual investor. In addition, unlike a REIT (Real Estate Investment Trust), the asset is already identified in a syndication, and the investors raise money for that specific opportunity.
Brief History of Real Estate Syndication
Historically speaking, a real estate entrepreneur or a sponsor could publicly advertise and solicit private funding from anywhere up until the initiation of the Securities Act of 1933. After which, all new private offerings were required to be registered with the Securities Exchange Commission (SEC). The SEC passed this rule to protect the investors from fraud, but it also seemed to stall the syndication process, making it far less efficient.
However, the SEC offered a few exemptions that allowed sponsors to skip registration under specific conditions:
- Raise money through private solicitation and avoid registration or
- Register with the SEC, wait for approval, and then solicit public funding.
The first option almost always seemed more efficient to the sponsors, and despite the securities act regulating public solicitation, private syndication continued.
The general solicitation rules were further relaxed by the JOBS Act of 2012, which allowed investors to participate as long as certain criteria were met and each investor was accredited. An accredited investor is someone who has:
- An annual income of $200,000 for the past two years (or $300,000 if married)
- A net worth of at least $1 million, excluding their private residence (filing individually or jointly)
Real Estate Syndication Framework
Real estate syndication is a legal transaction between two parties—the sponsor/syndicator/general partner (GP) and the investors/limited partners (LP). Legally, a syndicate can be structured as a Limited Partnership (LP) or Limited Liability Company (LLC). A sponsor’s role is to scout out a property, seek funding, and manage day-to-day operations while the investors provide the majority of the financial support. A sponsor should have sufficient experience in real estate investing and the ability to underwrite and do due diligence on the potential investment opportunity. In addition, a sponsor usually invests between 5%-20% of the total required equity. Needless to say, the more skin a sponsor has in a deal, the better it is for the investors. A sponsor should also hire a real estate attorney to put together a contract that clearly lays out distributions, voting rights, sponsor’s right to property management fees, communication requirements, and so on to protect all parties involved, as well as consider scheduling quarterly meetings to discuss the property’s progress and next steps.
How Is a Real Estate Syndication Different from a Trust or a Fund?
On the surface, a real estate syndication might look fairly similar to a real estate trust, but there are quite a few differences between the two.
Real Estate Investment Trust (REIT)
- It is modeled after a mutual fund that owns, operates, or funds income-generating properties.
- It offers a steady income stream by paying out dividends to its investors but offers little in terms of capital appreciation.
- REITs are publicly traded like stocks which makes them highly liquid assets.
Real Estate Syndication
- This strategy invests in a physical real estate asset.
- Investors are locked in for the agreed term, and the sponsor decides on when to sell or refinance the property.
- It offers access to large, lucrative investment opportunities with property management services.
- It also offers several tax benefits like 1031 exchange, pass-through deductions, and asset depreciation.
How Does a Real Estate Syndication Make Money?
A sponsor and their limited partners make money through two primary sources—property appreciation and rental income. Rental income is distributed among the investors by the sponsor on a monthly or quarterly basis. With time, as the property’s value keeps appreciating, investors typically net higher rental income and eventually make large profits upon sale. The duration of a syndication varies per sponsor and the type of property. While some syndications are over within a year, others might run for 7-10 years. However, typically a syndication lasts for 3-7 years. And each invested party receives a share of the profits per the agreed terms and conditions.
A sponsor often takes an upfront profit share for sourcing and acquiring a deal, called the acquisition fee, and it typically averages around 1% of the property value. In addition to profit-sharing, most syndications offer what is called the “preferred return.” This means when distributions are made, an investor is in a preferred position until they meet the preferred return hurdle, meaning the real estate property isn’t producing enough cash flow to keep this promise. Preferred returns usually range between 5%-10% annually of the initial capital investment.
Final Thoughts on Real Estate Syndications
Syndication allows you to diversify your portfolio as you’re only investing a small sum at a time and might still have the ability to explore other types of investment opportunities without being tied to a single property. Moreover, as an investor, syndication is one of the most passive investment ideas that require little effort upfront for a killer return on investment.
However, it helps to understand some of the syndication disadvantages, like the lack of liquidity and control over the property as you’re locked in for a said term. Also, your sponsor chooses whether to sell or refinance. Further, unlike ownership, you don’t have the opportunity to build long-term equity in an asset.
After all, like any other investment tool, investing in real estate syndications has its pros and cons. As an investor, it’s imperative that you understand the basics to perform preliminary due diligence on your part and, more importantly, agree if this strategy will help you achieve your financial goals. Remember, you don’t have to choose one or the other; you can still invest in a syndication while already invested in a property or a trust. Investing in passive real estate with necessary due diligence is always a win in my book! Good luck!
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Have you thought about investing in a real estate syndication? If you've done it before, what was your experience like? Would you do it again? Comment below!
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How do you conduct due diligence on these deals? How do you determine whether to do one larger deal or multiple smaller deals?
There is a great book by Brian Burke, The Hands-off Investor that help you understand a syndication offering. It is a slow read because it is very detailed.
Agree, it’s the best book on the subject out there. Reviewed here: https://www.whitecoatinvestor.com/hands-off-investor-book-review/
Thanks, ordered the book!
Read books, take courses, join groups, pour over PPMs, talk to syndicators/managers.
Remember the basic principles of investing still apply: costs matter, diversification protects you against what you don’t know.
Thanks WCI! Also a big thanks for your site. Awesome content!
The offerings of syndications are often property specific but now I’m finding syndications offering funds made up of groups of properties. I’d love to see an article outlining the pros and cons between REITs, single property syndications, and syndication funds. I’m particularly interested in the advantages and disadvantages between REITs and syndication funds since both provide greater diversification than single property syndications or private ownership of a property.
REITs vs Funds: REITs send one 1099, Funds may send multiple K-1s. REITs can use depreciation to call some income return of capital, funds and syndications can actually share depreciation that can be used elsewhere. Syndications vs REITs/Funds is mostly about diversification and professional choosing of the properties.
Most important piece of advice is to Vet the sponsor. Lots of good ones, but also lots of bad ones.
I have come to the personal conclusion that if someone can’t show how they were managing other peoples money thru the global financial crises, there is a significant chance they won’t know how to navigate a downturn.
one clarification which seems to be missed in so many posts about accredited investor definition:
if you are married and your income is $200,000, and your spouse does not make any income, you meet the definition of an accredited investor. You do not have to have a $300,000 income just because you are married.
If you earn $199,000, your spouse must earn $101,000 to total $300,000 in order for you to meet a different criteria.
https://www.ecfr.gov/current/title-17/chapter-II/part-230/subject-group-ECFR6e651a4c86c0174/section-230.501
Does any of the two, REIT or Syndication, use only the funds collected from investors to buy properties? Or there is a leverage involved? I have been looking for one that does not use leverage or loans from the bank and use only investors’ money.
I think you should search for “Islamic REIT”. Here’s some:
Al-Aqar KPJ REIT
Al-Hadaharah Boustead REIT
AXIS REIT
KLCC REIT
Sabana REIT
These also tend to have some interesting prohibitions about insurance and what the properties are used for that you may or may not want. But without specifically trying to be Shariah compliant, I don’t know of any way to invest in real estate without leverage except buying the property yourself with cash or an “Islamic mortgage.”
Good luck!
Interesting! Thank you so much!
This seems akin to a fundless sponsor doing an LBO, except the target investment is real estate.
Is there adverse selection in that the better GP investors (or at least those with a track record) would prefer to raise a fund rather than raise capital on a deal-by-deal basis? In the private equity industry this is generally the case, but was wondering if it’s different in private real estate.
I think there probably is. Certainly there is some on low minimum investment crowdfunding websites.
I was hoping to see names of syndicates… Can you provide any? Or am I to Google it? What would I search for? “Real estate investment syndicate”?
How about this link (which I’m sure is in the post at least once):
https://www.whitecoatinvestor.com/real-estate-investment-companies/
Hi Dr. Dahle-
Thanks for all the great content and the podcast! Any thoughts on Arrived Homes? I think you would consider them a serial single property syndicator, with investments only in single-family homes for rent, which seems to be the area of real estate least affected by the recent downturn. Their minimum investment is quite low ($100), and you can add more as you go. Dividends are paid out quarterly.
I don’t know the company at all. When buying individual syndications, both the operator and the property need careful due diligence.
A $100 minimum investment is extremely unusual for a syndicator. I can’t think of a typical syndicator that is set up to handle such a small minimum investment due to how costly it would be to service so many tiny accounts. Thus, I suspect fees would necessarily have to be really high to do that model.
I saw this on their website:
That shows me that this is a tiny company with a lot of company specific risk. They reportedly have 245 properties funded. So that tells you that they only distributed dividends of $374,000/245 = $1,526 per property. Let’s say their cut is (random guess here) $500 per property for the quarter. That’s $122K in revenue for the company. How much payroll can that really support? Certainly less than five people once you pay for all the other expenses. I mean, that’s only $40K a month. And if somehow they’re making more than $500 per quarter on a property, how are the investors getting a fair return?
Good luck with your investing decision. Certainly isn’t going to break you to put $100 (or some other trivial amount) in and watch for a while to see what happens with this company. Could be the next great thing or could all go to pot in the next real estate downturn.