Syndication is the Holy Grail of real estate investing in many respects.
Passive investors consider this strategy of producing “mailbox money” from real estate to be the least labor-intensive. On the other hand, veteran real estate investors frequently lust after the position of syndication sponsor, which gives them control over a sizable project.
Syndication might be considered the Super Bowl of real estate investing, regardless of perspective. It could even start to seem threatening. There are several due diligence documents to sift through loan documentation to sign, in addition to the acquisition contract and the private placement memorandum. The procedure certainly seemed difficult.
Real estate syndication, though, is fundamentally straightforward. The only difference is that it is a far larger real estate investment. Successful real estate syndicates go through the following three stages, just like any other real estate investment:
- The Planning Stage
- The Execution Stage
- The Closing Phase
The definition of real estate syndication
Real estate syndication enables investors to aggregate their funds to buy a single property, sometimes a sizable commercial property such as an apartment building, office block, shopping mall, or industrial site.
Syndication investors own shares in a company, trust, or LLC, and that entity is the legal owner of the investment property; they do not physically own the real estate. A syndicate may be a type of real estate-backed capital fund. The fact that investor cash is pooled makes it similar to a REIT, however, syndications usually own just one property, whereas most REITs own several properties, often hundreds or thousands. Syndications are not subject to the disclosure, distribution, or tax laws that apply to REITs.
An active partner is referred to as a sponsor and often establishes and oversees a syndicate. Participants in the syndication do so as passive investors with no operational duties for the property, subscribing to (or investing money in) it.
Real Estate Syndication: Advantages and Drawbacks
Pros
Economies of scale Utilizing the economies of scale offered by bigger properties, investors can pool their finances to purchase homes they otherwise could not afford.
Diversified Risk Vacancy costs are easier to manage with larger tenant bases. Investors can also spread their funds among a larger number of assets or units by investing smaller amounts.
Leadership Structure. The sponsor takes on all of the operational duties, which eliminates the problem of “having too many cooks in the kitchen.”
Positive Financing. Syndicates sometimes have access to attractive terms from commercial lenders that smaller, independent investors operating on their behalf may not.
High Illiquidity. Investors in syndicates often are unable to sell their ownership stakes, which they are typically compensated by earning greater returns as opposed to assets that are more readily purchased and sold.
Non-correlation with the stock market. Because stocks are widely traded, their value can fluctuate minute-by-minute and are volatile. However, due to their lack of liquidity, real estate syndicate investments are typically not influenced by the mood or volatility of the market.
Cons
Lower Liquidity Syndication shares have restricted liquidity since they often cannot be exchanged on secondary markets like, for instance, stock or REIT shares.
The Control of Passive Investors is Limited. The sponsor frequently demands that cash investors cede ownership of the asset. The passive investors have limited power to request changes if the property underperforms, but they can remove the sponsor in dire situations.
Eligibility. Syndication investors must often be accredited or experienced financiers.
First stage: The planning phase
Finding the property, carrying out due diligence, securing finance, and finalizing the sale are all part of the creation step. During the initial stages, the sponsor often does the following:
- Find the best offer via marketing and networking.
- Calculate the deal’s prospective profit by underwriting (analyzing) it.
- It is advisable to draft purchase agreements.
- Put together a business strategy for the property.
- Examine the property’s financial documents.
- Conduct a visual examination of the property.
- Check the title’s validity and remove any obstacles to the transaction.
- Find the best loan for your needs by comparing real estate loans.
- Order commercial evaluations and gather loan guarantors (if required).
- Create the legal structure that will hold the asset, such as an LLC or company.
- Raise money from passive investors to cover the down purchase, closing expenses, and any immediate requirements or improvements.
- Close the escrow.
- Start putting their company idea into action.
From the time a property is identified until escrow is closed. Typically, the planning phase is several months long.
Phase 2: The Operation Phase
The origination phase’s business plan is put into action during the operation phase by sponsors, frequently with the help of a qualified property manager and other contractors.
The following may be present in the early stages of the syndication:
- Treat any unfinished maintenance.
- Complete any repairs as required by the lender.
- Put a remodeling strategy into action.
- Establish a strategy for a lease-up, renewal, or rent increase.
The operating phase might last several years beyond the first “value-add” phase. The sponsor is in charge of the following at this period, in coordination with the property manager:
- Rent collection
- Carry out periodic maintenance
- Contract negotiations
- Promoting and leasing empty properties
- Resolving legal conflicts, such as evictions
- Settling obligatory costs like insurance and property taxes
- Make payments for debt service
- Paying the passive investors from cash flow
- Updating passive investors on the asset’s financial and physical condition regularly
- Get the asset’s tax returns ready. Send Form K-1 for sponsors’ tax returns to passive investors
Phase 3: The Liquidation Phase
An occurrence is known as a “liquidation” occurs during the liquidation phase and returns money to investors. It might involve refinancing the debt or selling the asset.
The sponsor is typically in charge of the following duties in the case of asset liquidation through sale:
- Perform any improvements or repairs needed to make the asset desirable to purchasers.
- Make the financials ready for the buyer’s examination.
- Make the asset available to prospective purchasers, sometimes with the aid of a broker.
- Organize buyer tours.
- Review the deals.
- Negotiate the acquisition agreement with the successful buyer.
- Close escrow.
- Divide the earnings among the passive investors.
- Finalize your tax returns and Form K-1s.
- When a contract is refinanced and liquidated, the deal sponsor will likely:
- Compare lending institutions.
- Submit a loan application.
- Make plans for new appraisals and loan guarantors.
- Finalize the new loan.
- Payout loan money to passive investors
Before the last liquidation event (the sale of the property), the operating phase may last several years after refinancing.
Summary
To a novice, real estate syndication may appear to be confusing, yet each syndicate goes through three distinct stages:
Origination. Locate the asset, do your research, and complete the transaction.
Operation. Put the long-term and short-term company plans into action.
Liquidation. To get paid, you can sell or refinance the asset.
Conclusion
The similarities between large and small investments in commercial real estate are striking. Even when the numbers increase, the basic tactics remain the same: acquire, renovate, rent, refinance, sell, and repeat.
Only the wealthy may afford large commercial premises. However, for investors who may not have millions of dollars to spend on a single property. These investments are made possible by real estate syndications.
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