Syndication In Real Estate
If you are looking for information on syndication in real estate, then watch this video to learn everything you need to know about syndication in real estate.
Hi folks. This is Big Mike, Mike Zlotnik, and today we’re going to talk about real estate syndication. This is a short executive summary overview of syndication in real estate.. There’s a lot more to it, but I wanted to give folks the basic framework for real estate syndication, how they work, what the benefits are, and so forth.
So typically, real estate syndication. Our form of real estate partnership is where a general partner, a sponsor, needs to raise capital for a transaction. It could be multi-family, it could be self-storage, it could be an office, and so on. And the investors of limited partners participate as passive investors in the deal providing capital to the operator. The operator is typically the manager of the transaction. So the benefits to the investors are that they take advantage of the expertise, track record, history, and abilities of the sponsor. They invest passively. They can generate passive income in the form of cash flow.
They can also benefit from the tax benefits such as depreciation. And investors can spend their time on something other than lining up a mortgage. So that’s the beauty about syndication in real estate. They participate in a baked product. They subscribe. Obviously, they need to review and make sure it meets their risk.
Other goals or objectives and risk tolerance on the other side for the operator or the. They raise the capital from investors, and they only need to bring in typically five to 10% of the total capital required for the deal, and the rest of the money comes from the investors. Most of the syndication in real estate are done on the equity side.
Now they are ready to get a mortgage lined up with the bank. What kind of mortgages typically are available? These are commercial products, and they’re typically non-recourse mortgages. So the sponsor or the operator doesn’t personally guarantee the loan? Nonetheless, they have expertise.
A track record and a value add a plan the bank is comfortable with providing financing. So normally, the bank would finance 70% of the total capital needed, and assets would bring in 30%, sometimes 75%/25%, depending. So syndication is a form of partnership that raises the capital for the deal with the general partner running the transaction, executing the value add.
And investors participating as limited partners with passive investors, as I mentioned the benefits. Now we’re going to talk about how these indications take place. From a process perspective, a sponsor gets a property on the contract. Let’s use an example of a multi-family to get the property on the contract.
They underwrite the deal. They are comfortable with the deal. With the economics, with the value add strategy, with the economic projections, and that is part of the underwriting package. Typically a sponsor or operator builds what is known as a proforma spreadsheet, where they project rent increases and renovation costs.
Projected cash flows, the ability to pay the debt, and so on. all that data is typically available to investors to review prior to making the investment decision. So once the deal is underwritten and baked, it gets presented to the bank. The bank typically underwrites the deal on their side. When they’re comfortable, they’ll approve the loan subject to the investor raising a certain amount of capital, which is required capital.
And that’s what the sponsor needs to be able to complete the deal. So they go to investors. They typically create an offering memorandum or a private place memorandum, also known as the ppm. So the offering memorandum is created by attorneys with a bunch of legal disclosures, with a bunch of projections, deal explanation, and deal details.
Effectively that document is the formal offering document to investors. So investors review the PPM or offering memorandum and decide whether they want to participate based on their objective, their conversation with their attorney, or their CPA professional. As long as this type of deal meets their objectives, meets their level of comfort, and risk tolerance, they may consider that investment.
Let’s talk briefly about the Risks and rewards of investing in syndication in real estate. So first of all, when an investor known as a limited partner takes a position in syndication, let’s use an example as a $5 million syndication. And then they write a hundred thousand dollars check.
They take a small piece of ownership, they get the benefits, and they get the cash flow and the depreciation. At the same time, they’re taking some level of risk as a partner. The risk could be that the deal could go bad. To be very clear, there’s always risk involved. Even the best-looking indications on paper, well underwritten and prepared for, can go wrong.
So I want to ensure folks understand that there’s risk in everything; strong underwritten syndication in real estate could also generate a strong ROI. The returns on syndication on a value as syndication in real estate could look like target returns, which could be between 15% and 25%.
IRR stands for internal rate of return. A compounded average annual ROI is the best way to think about the IRR. Because the IRR formula, the internal rate of return formula in Excel, considers when the cash goes into the deal and when the cash comes out in the form of cash flow, in the form of a sale, and proceeds as well.
Depending on the market, the typical rate of return on syndication could be in the mid to high teams and even in the low to mid-twenties. Now, it all depends on the type of deal, the risk profile, and the value as a strategy. So investors need to. It is cognizant of the fact that there are risks and different types of risks and understanding that it is still a single deal.
Typically, syndication in real estate is for one asset. For many investors, sometimes syndications could have two assets, but if there are many assets, the syndication becomes a fund. So fund comparing, fund syndication fund has many investments, assets, and investors. Syndication typically has one. Many investors.
This is the basic comparison. So from a risk profile, if you compare a fund to syndication, the fund spreads the risk among many investments and assets. While syndication concentrates the risk in a single property, if that property value add plan is successful, syndication can be successful.
If the plan fails, syndication can fail. So, regarding the structure of syndication in real estate, there are various structures, but the most common structure will generate a preferred return to investors. An example is a syndication offering. Documents could say investors would receive 8% cumulatively.
Non-compounded profit means 8% accumulates every year. This cash flow to pay that it gets paid. If there is no cash flow to pay that in full, it gets accumulated and co and, but it doesn’t come. So year one, it could be 8%. In year two, eight plus eight becomes 16, and so on, until there’s a sale or refinance event.
So 8% preferred return is a common number. Sometimes this number is higher, and sometimes that number is lower. But the industry average kind of gravitates around 8% per year. Then there is a return of capital, typically from a safety perspective. Investors get paid their preferred equity, then they return the capital, which happens most of the time on a property sale.
Return of capital could happen on a refinance or a partial return of capital. Let’s use an example of the sale of a property. So the preferred equity gets paid to the investors, then the return of capital takes place, and after that, there is a performance split. So there’s a split between the investors as a group. The manager, the syndicator, or the sponsor.
And the typical split, to give you a classic example, would be 70/30, 70% to investors and 30% to the manager. That’s a classic split. That’s just a basic framework for how these syndications work. So on a property sale, once investors are paid, their fee and return of capital split take place.
Investors get a portion of all the upside, and the sponsor will operate against their 30. Performance fee for executing the project? Well, that’s the general framework for how these deals are structured. There are many elements to syndication in real estate, but one of the most important elements is the value add plan.
And depending on the type of asset, sometimes the value add plan means just buying land and building from the ground up. It could be a self-storage, facility, or industrial property. A multi-family asset or value add plan could be buying an existing multi-family complex, renovating units, improving common facilities, improving the clubhouse, and increasing rents as a result of the value add work as, as a result of improvements to the property.
And that’s what creates higher ends, creates higher income, and increases the property’s value. It’s very important to understand the operator and the. Who is the leader? Who is the expert, and who’s going to execute the strategy? Strong sponsors generally have the abilities, experience, and track record of executing well.
One of the most important elements in underwriting and reviewing syndication in real estate is knowing, liking, and trusting the operator and the sponsor. There’s no easy way to do this. Sometimes it takes years to build that know, like, and trust element in a syndication in real estate. But in my opinion, that is a critical element in the underwriting, in your investment decisions, is to know, like and trust the folks you invested with, the person, the team, their communication, the ability ahead of the project themselves.
If you go with the wrong person, if you invest, you can invest with an idiot; you can invest with a shyster, right? You can invest with someone who is not able to execute. So the critical component is who is ahead of the game. Once you’re comfortable with who you’re investing with, then you look at what the deal looks like and the what.
And once you’re comfortable with that, you decide how much capital it is prudent to invest in this deal. Diversification is a critical element of one’s investment decision. So as folks decide where to put their capital, they must understand that syndication in real estate is a single deal.
And the deal can go bad, or the deal can go great, and you have to be comfortable with the risk and tolerance for, for, for the concentration of the capital, whatever you have, whatever portion of your portfolio you have in that single deal. In comparison to the funds as they mentioned. You could invest 10% of your portfolio in a single fund and be very comfortable with that because the fund diversifies the risk among many assets.
For example, putting 10% of your portfolio into a single asset may be too high of a risk concentration. So something to consider. Risk tolerance depends on the individual age, their financial situation. Consult with your real estate professional, CPA professional, or attorney professional.
This is just a general overview of how syndication in real estate works. I appreciate your time and attention. Looking forward to speaking with you again soon on the next topic. This is purely for informational, and educational purposes, not a solicitation or any commitment.
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