How To Invest In A Real Estate Syndication – Beginner’s Guide
Real estate investments offer high-income earners multiple opportunities to diversify their portfolios and generate passive income. As a periodontist, I quickly found out after a wrist injury, just how important having additional income streams was.
When I started in real estate, I thought I had to become an active investor dealing with tenants at all hours of the night.
But luckily I found out about other investment opportunities, such as real estate syndication deals, which have become very popular in recent years.
In this article, we’re going to discuss:
- What’s a syndication?
- Syndication structure and benefits
What is Real Estate Syndication?
A real estate syndication is a group investment strategy that brings together multiple investors to pool their capital to purchase a property such as a commercial asset. This arrangement allows investors to participate in deals that might otherwise be unaffordable for them as individual investors.
Syndication deals are managed by experienced real estate developers (aka general partners or sponsors) who oversee the acquisition, renovation or development, property management, and the eventual exit strategy.
In exchange for their investment, each limited partner (LP) receives equity units or shares, which entitle them to a portion of the rental income and profits when the property is sold.
I invested in my first syndication in 2017. It was an apartment syndication which paid out an 8% preferred return annually each month. That first $50k investment started to bring in $333.33 each month. This completely changed my thinking about money as now I had something (an asset) that was starting to pay my bills without me having to treat patients.
Too bad we’re never taught this in school, right?
Understanding the Real Estate Syndicate Structure
In a real estate syndicate, the general partner, or sponsor, is responsible for the day-to-day operations, including:
- property management
- implementing the business plan
The passive investors, or limited partners, provides the necessary capital for the property. The LPs receive a preferred return, which is a predetermined percentage of the rental income and profits generated by the real estate deal.
Syndication deals can be structured in various ways, such as a real estate investment trust (REIT), a limited liability company (LLC), or a limited partnership. These structures provide different degrees of legal protection and tax benefits for the investors involved.
Investment Opportunities and Benefits
There are several different asset classes available to invest in which helps you to diversify a portfolio. These include commercial properties, multifamily syndications, short-term rentals, mobile home parks, self storage and more, which can add diversity to their real estate portfolio.
They also allows investors to leverage the expertise of the general partner and property manager while enjoying the benefits of:
- passive income
- tax advantages
- property appreciation
Advantages of Real Estate Syndications
#1. Access to larger, high-value assets
As a high-income earner, you may have the financial capacity to invest in single-family rental properties or smaller commercial assets on your own. However, real estate syndication deals provide the opportunity to invest in larger, more valuable assets, such as apartment complexes, which can generate potentially higher returns.
#2. Passive investments
Real estate syndications allow you to invest passively in real estate, without having to deal with the day-to-day management of the property. This can be particularly attractive if you are a busy professional (doctor, attorney, etc.) who values your time and wants to avoid the responsibilities of being a landlord.
By participating in multiple syndication deals, you can diversify your investment portfolio across various asset classes, geographic locations, and market segments. This diversification can help mitigate risks and enhance the overall performance of your portfolio.
As a side note, I shifted from investing in single “one-off” syndication deals to syndication funds.
To learn more, check out this video:
#4. Potential for high returns
Real estate syndication deals can offer investors the potential for high returns, with annual returns often ranging from 8-12% or more.
However, as with any investment, there are risks involved, and returns are not guaranteed.
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Basics of the Syndication Process
A syndication has two main groups involved:
#1 General Partner (GPs)
This group may include real estate developers, property managers, attorneys, and accredited investors.
They’re also known as the sponsor group and typically:
- find the deal(s)
- place under contract
- arrange inspections
- evaluate the numbers
- obtain financing
- keep it leased
- manage the property
- responsible for investor relations
#2 Limited Partner (LPs)
This group is made up of those that choose to invest passively with limited risk.
Remember, they have no active responsibilities in managing the asset.
A syndication typically begins with the general partners identifying a suitable commercial property and creating a private placement offering for passive investors.
The limited partners contribute capital to the deal and receive a share of the ongoing cash flow and profits upon the sale of the asset. The minimum investment amount for syndication deals can vary, but it is typically between $50,000 and $100,000.
The investment period for real estate syndication deals can range from a few years to over a decade, with an average lifespan of 5-7 years. During this time, the property may undergo a value-add strategy, such as cosmetic improvements, renovations, or the addition of new amenities, with the goal of increasing the property’s value, raising rents, and eventually selling the asset for a profit.
Eligibility and Accreditation for Real Estate Syndication
Typically most syndication deals are available to accredited investors as defined by the United States Securities and Exchange Commission (SEC).
What is an accredited investor?
Before 2020, a United States accredited investor was anyone who satisfied the following conditions either based on income or high net worth status:
- A natural person with an annual income of at least $200,000 in each of the two most recent years or married couples making $300,000 joint income. There must be a reasonable expectation of the same income level in the current year; or
- A person or married couple with a net worth of at least $1 million which does NOT include a primary residence.
As of December 9, 2020, the SEC stated that accredited investors can also be those that can demonstrate financial literacy in the world of finance. This includes (and is limited to):
- Investors with certain professional certifications, designations, and/or credentials, including Series 7, Series 65, and Series 82 licenses while qualifying as “natural persons.” (Investors with other licenses are to be considered and added in the future.)
- “Spousal equivalents,” or spouses of accredited investors who pool their assets along with said investors to meet the previous net worth and/or income requirements for accredited investors. (Eg. If you are married to an accredited investor and share monetary resources, you are now also an accredited investor.)
- Those who are “knowledgeable employees” of a private fund.
- Limited Liability Companies (LLCs) and Family Office entities with $5 Million assets under management. SEC- and a state-registered investment adviser (but not reporting advisors) of these entities can also now be considered accredited investors.
- Entities including Native American tribes, governmental bodies, funds, and entities “organized under the laws of foreign countries” with investments over $5 million — as long as they were not formed solely to invest in a specific accredited investment.
Non-accredited investors can still participate in some real estate syndication deals through crowdfunding platforms or private offerings under the JOBS Act. However, they should conduct their due diligence and consult a financial advisor before investing in any real estate project.
Real Estate Syndication vs Other Investments
Real estate syndication offers an alternative to traditional investment options, such as the stock market, mutual funds, and individual rental properties.
While the stock market and mutual funds provide liquidity and ease of investment, syndications can offer more stable cash flow and potential for higher returns.
Additionally, syndications relieve investors from the burden of managing rental properties, as the general partner or property management company handles the day-to-day operations.
General partners make their money by charging fees for their services. These may include an acquisition fee, which is a percentage of the purchase price of the property, and asset management fees, which cover the ongoing management and oversight of the investment.
Additionally, the property management company may charge separate fees for handling the day-to-day operations.
Preferred Return and Share of Profits
Investors in real estate syndication deals often receive a preferred return (pref) on their investment, which is a predetermined percentage of the cash flow generated by the property. This return is paid to the limited partners before the general partner or sponsor receives any profits.
Most of the deals I’m currently invested in average between a 6-8% pref.
Once the pref has been distributed, any remaining profits are split between the general partner and the limited partners according to an agreed-upon ratio outlined in the operating agreement.
This distribution may be skewed in favor of the general partner, who has taken on more risk and responsibility in managing the project.
Due Diligence and Assessing Investment Opportunities
Before investing in any type of alternative investment, it’s a good idea to conduct due diligence.
- researching the general partner’s track record
- assessing the business plan
- understanding the overall risks associated with the real estate project
For more info about syndication risks, check out this video:
Self-Directed Retirement Accounts
Something you may also consider is using a self-directed individual retirement account (SDIRA) or solo 401(k) to invest in syndications.
This strategy allows you to use your retirement funds to invest in alternative assets, such as real estate, while still enjoying the tax advantages associated with traditional retirement accounts.
We use the IRA Club to set up our self-directed accounts.
Projected Returns and Hold Times
Real estate syndications can have a wide range of possible returns and hold times, depending on things like the type of property, its location, business plan, the experience of the sponsor, and the way fees are set up.
Investors can usually expect an average cash flow return of 6% – 8% per year, plus more money from selling the asset.
When the expected profit from selling the property after 4–5 years is taken into account, the average annual return on real estate syndications is between 15-20%. It’s important to remember that returns are not guaranteed and can be higher or lower than expected depending on a number of factors.
Most syndications have a hold time of 5 to 7 years, but this can vary. Before investing, it’s important to know how long the investment is expected to last so that it fits with your financial goals and investment strategy.
Tax Benefits Of Syndications
Tax breaks are one of the most important reasons to invest in real estate. When you invest in a syndication, you’re basically buying shares of an LLC that owns the property.
You can use pass-through taxation and the depreciation deduction with this structure. The tax benefits of, such as depreciation and cost segregation, are passed through to you as a passive investor because an LLC is a disregarded tax entity.
Pass-through taxation means that the income (and costs) from the real estate “pass through” to the individual investors and are only taxed at the individual level.
This is different from a C-Corp, where income is taxed both at the corporate level and again when it is distributed to shareholders.
Depreciation lets you take a tax deduction each year for the wear and tear on the asset. This is a non-cash deduction, which means you can take it even if the investment doesn’t pay any cash distributions.
You’d get a Schedule K-1 each year that showed your income and losses from the syndication. Cost segregation and accelerated depreciation can cause substantial paper losses, especially in the first year.
This means that you could show a loss on paper even though you were still receiving distributions.
And if you are eligible for Real Estate Professional Status (REPS), this could have an even bigger effect on your taxes.
Real Estate Investment Risks
When investing in a syndication, you’re putting your trust in the general partners to manage the asset on your behalf.
This is a great way to start investing without having to do all the work yourself. But it also means that byou need to carefully vet the sponsors. They’re in charge of running the property, so it’s important for them to have a lot of experience and a proven track record.
When choosing which offerings to invest in, it’s important to find a sponsor team you can trust—one whose interests align with yours, who takes a conservative approach, who communicates openly and honestly with you, and will be a good steward of your hard-earned money.
You will also want to look closely at the finances to make sure the deal makes sense and that you are okay with the risks.
When you invest in a real estate syndication, you spread your risk over several properties and markets. This can help reduce some of the risks.
To evaluate out the sponsor properly, you should:
- ask a lot of questions
- look at their track record
- read reviews
- ask for references
There are, of course, many other possible risks, but having the right team in place will protect you the most from any surprises that come up during the life of the investment.
How to Invest in a Real Estate Syndication
Here are the steps for investing in a syndication:
- The sponsor sends out a “deal offering” email that an investment is open.
- Review the offering memorandum (property description) and make an investment decision.
- Submit the amount you want to invest to the sponsor.
- The sponsor holds an investor webinar, where you can get more information and ask questions.
- The sponsor confirms your spot in the limited partnership and sends you the PPM (private placement memorandum).
- Fund the deal via wire or check.
- The sponsor confirms that your funds have been received.
- You’ll receive a notification once the deal closes and what to expect next.
As a side note, if you’re an accredited investor and want access to deals we invest in, join the Passive Investors Circle.
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What Happens After You Invest?
Investors supply the funds so the management team can perform well for tenants and investors.
You’re done investing once you wire the money. Next, your money will be held in escrow until closing. After this takes place, you’ll co-own the property with other investors. The sponsor should contact you soon after the deal closes with next actions and investment expectations.
Typically, distributions start 6 months after the deal closes. At annual investor meetings, you’re able to meet other passive members and obtain a property performance update.
Monthly occupancy, value-add, and business plan updates, quarterly financial reports, and ongoing preferred return distributions are typically given, either monthly or quarterly, depending on the deal.
You also have voting rights on any major decisions regarding the property, such as whether to sell it or refinance it.
Ready To Invest With Us?
There’s no better and more reliable way to build wealth for your family than to invest passively in real estate syndications.
To start your real estate syndication investing journey, join the Passive Investors Circle by clicking the link below.