Real Estate Syndication: A Doctor’s Guide To Investing
I’ve written about real estate crowdfunding in the past due to the high interest of real estate investors in the online doctor community. A few years ago, I decided to diversify my portfolio and invested a certain percentage in real estate for tax benefits and to grow passive income.
As a practicing periodontist, I knew that I didn’t have time to get into property management (be a landlord) so I decided to invest in a couple of the popular crowd funding sites:
Realty Shares and Patch of Land.
My job on this site is to be as transparent as possible. There’s nothing that irks me more than someone not telling the “entire” truth when it comes to investing.
The deals I currently have with the two companies are as follows:
- Patch of Land – one debt deal that is currently paying monthly
- Realty Shares – three equity and one debt deal
Of the four Realty Shares deals, only one is currently paying. One of the equity deals in an apartment complex has yet to pay a distribution since the initial investment in 2017.
Update: The deal fell through and all investors lost their money, including yours truly.
The other two had been paying at one time but have since stopped and legal action has been taken by Realty Shares.
At the time I decided to invest in a real estate syndication, four of the five crowdfunding deals were paying. Even though they haven’t worked out quite the way I’d like them to, I’m glad I moved forward with the syndication deal.
Investing in a real estate syndication has been one of the best investments I’ve done outside of index fund investing. It’s not quite as well-known as real estate crowdfunding so that’s why I’ve decided to go into more detail so you can make an educated decision if it’s right for you.
Let’s get going…
What Is A Real Estate Syndication?
A syndication is simply the pooling of funds from a group of investors in order to purchase a property that’s more expensive than any of them could have afforded on their own.
Here’s a couple of different scenarios where this would be beneficial:
a) If you didn’t have the funds to afford a down payment on a good deal, you could syndicate it by finding others to help fund it.
b) On the other hand, if you had the down payment, but not much real estate experience, you could use syndication to get partners to help.
Who Is Involved With A Real Estate Syndication?
There are typically two to three parties involved with a real estate syndication.
This is an individual or company that’s in charge of finding, acquiring and managing the commercial real estate. They have a history of real estate experience and the ability to underwrite and do due diligence on the real estate.
The Sponsor is usually responsible for investing anywhere from 5-20% of the total required equity capital.
Depending on the legal structure of the organization created for the investment, the Sponsor is technically known as the General Partner (GP) or Manager.
Investors (Limited Partners)
The second party is the investors who invest with the sponsor and own a percentage of the real estate.
Here’s the part that got me excited about becoming an investor…
They don’t have to be involved with:
- acquiring the property
- arranging financing
- managing the property
Investors are usually responsible for investing between 80-95% of the total.
Joint Venture (JV)/Equity Partner
Occasionally, a third party is involved called the Joint Venture (JV)/Equity partner. These individuals are essentially the “middle men” between the sponsor and investors as they typically have access to a large number of investors.
They help the sponsors with such things as:
- tax documentation
How Are Syndicates Structured?
Real Estate Syndications are typically easy to set up and come with built-in protections for all parties involved.
They’re usually structured as a Limited Liability Company (LLC) or a Limited Partnership (LP) to own the property on behalf of investors.
The rights of the Sponsor and Investors, including rights to distributions, voting rights, and the Sponsor’s rights to fees for managing the investment, are set forth in the LLC Operating Agreement or LP Partnership Agreement.
How Do Investors Make Money?
The Investors (LP) in syndications are typically compensated in three ways:
1) Preferred return
The preferred return is a threshold return offered to the LP before the GP receives payment. The standard preferred return is 8% of their current capital account (capital account is initially equal to their equity investment).
That is, the LP will receive a return of up to 8% before the GP is paid. If the real estate cash flows 8%, the LP receive the 8% preferred return and the GP does not receive a profit split.
If the real estate cash flows less than 8%, the LP receives a return of less than 8%. If the real estate cash flows more than 8%, the LP receive their 8% preferred return and the remaining profits are split between the LP and GP.
Typically, the preferred return is considered a return on capital. That is, the preferred return distributions do not reduce the LP’s capital account.
2) Profit Split
If a preferred return is offered, the remaining profits are split between the LP and GP. The typical profit splits are either 50/50 or 70/30 (LP/GP).
The LP will receive their distributions from the profit split on an ongoing basis during the business plan (if the cash flow exceeds the preferred return) and/or at the sale of the real estate.
Typically, the distributions from profit splits are considered a return of capital. That is, the profit split distributions reduce the LP’s capital account and therefore the preferred return.
However, some GPs will continue to pay out an 8% preferred return based on the initial equity investment and catch-up with the profits from sale.
3) Refinance or Supplemental loan
If the GP refinances into a new loan and/or secures a supplemental loan, the LP will typically receive a distribution that is a portion of their initial equity investment.
Similar to the profit split, the proceeds from a refinance or supplemental loan are typically considered a return of capital. That is, the proceeds reduce the LP’s capital account.
Who Can Invest?
For the most part, syndications are typically open only to accredited investors.
To be considered an accredited investors by the SEC, you must either:
1) Have an income of at least $200,000 each year for the last two years, or
2) If you’re married, have a combined income of at least $300,000 each year for the last two years, or
3) Have a net worth of at least $1 million, excluding your primary residence, either individually or jointly with your spouse
An Example Of How A Syndication Works
Here’s a typical example of how a syndication works. Typically, investors will receive an email which includes the investment summary and investor webinar to review the real estate opportunity.
The deals I’ve been involved with (and are currently in) have been with sponsors with a proven track record such as Dr. Tom Black at Napali Capital. During the webinars he hosts, potential investors are allowed to ask questions pertaining to the deal as well.
Typically, investment spots are first-come, first-serve with a minimum amount to invest. The average minimum is usually 50K and there’s a deadline to close the deal.
If you decide to invest, you’ll need to complete and sign the investor documents, also known as the Private Placement Memorandum (PPM), which is a legal document as you are purchasing equity ownership in a LLC.
After you complete the PPM, you’ll send in your funds to complete your investment.
After the property closes, you should receive regular updates and financials on the investment. This is one reason I have (and continue to invest with Dr. Tom).
His company sends out monthly emails detailing what is being done with the property (renovations) and how the financials are doing.
At the end of the year, the sponsor will send out a K1 form to file with IRS.
Here’s one of the deals I’ve done in the past:
My first deal involved an apartment complex in Denton County, TX called The Avery.
- Purchase price: $40.8 million
- 350 Units
- $50 K minimum investment
- Projected annual Cash on Cash (Coc) returns: 9%
- Internal Rate of Return (IRR) of 18.6% over a 5 year hold period
So far, the syndications I’ve done with Dr. Tom have paid as promised.
Should You Invest?
When considering real estate syndications, understanding the structure and process discussed above can help you determine if it is a good fit for your portfolio.
I can’t stress enough for you to do your due diligence to know exactly what you’re potentially getting into. The majority of the work is done up front by vetting the opportunity and sponsor.
If you do invest, you must realize that your money is going to be tied up for 4-6 years on average.
Are you interested in learning more about investing in apartment syndications?
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