The investing term “syndication” or in this case referring to “real estate syndication” makes the concept seem more complicated than it is.

Think about an airline flight. Every person buys a ticket and the proceeds from those tickets collectively go towards moving that airplane from point A to point B. You can think about a real estate syndication similarly. Investors pool their capital to, collectively, invest with a sponsor in a real estate syndication.

Syndications are now more popular than ever. Investing in commercial real estate has entered the center stage and is widely available to mainstream investors. The benefits of investing in commercial real estate are now being recognized by investors across the board. As the world economic climate continues to get worse and more sectors face economic uncertainties, commercial real estate (specifically multifamily) has proven to be resilient. The illiquidity of commercial real estate (i.e., it’s not easily purchased and sold like cryptocurrencies, stocks, and bonds) makes it less susceptible to market volatility.

With ever-changing markets, it's no wonder that even the most seasoned investors feel lost when first starting out investing in commercial real estate. The best and most lucrative deals are usually only accessible to the upper echelon, such as large private equity firms and institutional investment groups.

With the barrier to entry so high, many investors have turned their attention towards real estate syndications. This type of investing is all about a sponsor identifying profitable deals that need funding, then pooling together multiple people's capital to use as the equity investment in those opportunities. The sponsor has a crucial role in managing the deal on behalf of investors, who are otherwise passive as Limited Partners (LPs)

In this article, we explore the “ins and outs” of real estate syndications. You'll learn about what it takes to be a part of one such deal as well as how profits are distributed amongst participants! Read on to learn more.

What is Real Estate Syndication?

Real Estate Syndication is a process of pooling capital from multiple individuals to then, collectively invest in a real estate asset. The advantages are that you don't have the hassle or cost associated with owning your property outright - also known as passive investing. 

The idea behind a syndication is that many people invest in it and then the manager of this group (known as a sponsor) will leverage those funds to buy a cash-flowing real estate asset. This is the original form of real estate “crowdfunding.” A term that has become mainstream with online platforms such as Fundrise and Equity Multiple. Syndications were first introduced to provide investors with an opportunity to diversify their portfolios and maximum returns on capital without taking any significant risk themselves. Syndications are a simple and effective way to invest in assets together. They could be simple as a joint venture of two investors coming together, or more complex, with dozens, even hundreds of people investing in one deal or a large fund.

Related: Become an Investor

What Makes Participating in Real Estate Syndication so Attractive?

Investors participate in real estate syndications for a variety of reasons. As noted above, one reason is when someone does not want to or cannot afford to purchase property directly. Many people prefer to avoid dealing with the day-to-day responsibilities of managing real estate, even if they could purchase an individual asset.

Passively investing in real estate is a great way to leave all day-to-day responsibilities surrounding running that asset up to your sponsor overseeing the deal. It’s the easy “set-it-and-forget-it” way to profit from real estate investing. The sponsor is responsible for bringing all aspects of a project together and taking on responsibility during each stage. The active partner will own any legal or financial issues that arise, as well as guide the design/permitting process accordingly with financing options available at their disposal to ensure successful disposition after completion.

Oftentimes, the circumstance is that people who would like to invest in real estate but don't have sufficient funds to acquire an investment property alone. Someone who has only $100,000 to invest, for example, might find it difficult when trying to acquire, renovate, and stabilize a property. This is a perfect example of when syndication becomes advantageous.

Syndications give investors access to deals that they could only dream of before. A prime example would be when a sponsor creates a $100 million fund to invest in a portfolio of value-add multifamily deals. With leverage, this might equate to acquiring a portfolio collectively worth half a billion. Individual investors often lack access to deals of this size. By investing in a real estate syndication, you can get your hands on some historically exclusive investment opportunities that are otherwise only offered to institutions, pension funds, family offices, and other capital behemoths. To sum things up: through syndication, you can invest in larger and more lucrative deals.

The appeal of syndications for investors is that it provides them with a way to mitigate risk. Instead of making a huge investment and riding it all into one big deal, syndications provide the perfect opportunity for investors who want to diversify their investments. By investing in small denominations, you can take advantage of multiple deals with an increased return on your investment! This is a compelling approach that allows people to spread their risk across projects, product types, and geographical locations.

Who’s Involved in Real Estate Syndication?

Typically you see two parties in a Real Estate syndication: the Syndicator (generally called a "sponsor" or “developer”), and the Investors. The sponsor is the individual or company that handles all the day-to-day responsibilities related to the project. This includes drafting an execution plan and then deploying that strategy onto the property. A deal sponsor's responsibilities include analyzing markets, deals, and opportunities, negotiation, and acquisition of the property, planning, and design, permitting the building process, financing, overseeing the construction phases, marketing to prospective tenants, and lease-up. The sponsor will pave the way through to completion, which may include refinancing or disposition of the property, depending on the calculated exit strategy.

Good sponsors will take an equity stake in the deal themselves when possible if they don’t need to preserve immediate working capital to initiate other acquisitions. This practice ensures that the interests of sponsors and investors are aligned. Sponsors may also collect various acquisition or development fees along the way, as well as a share of the profits that are not usually not paid out until the investors have earned a certain degree of return first known as preferred equity.

As I mentioned above, the investors are the second party in a real estate syndication. The investors are considered "limited partners”(LP) and have a passive role in the syndication. Following a capital contribution, an LP investor widely does not have any more responsibilities related to the deal. Investors should carefully vet sponsors ahead of investing in a deal. They should ensure that they are comfortable with the sponsor's execution plan and confident that the sponsor is capable of implementing those strategies over the lifetime of the deal.

We are here to help you learn more about the costs and benefits associated with real estate syndication. Check out Groundswell Assets today to find out more.

Deciding Your Role in a Real Estate Syndication

What's the difference between being a sponsor and an investor? A lot! The roles are drastically different, depending on whether you want to be more active or passive. The sponsor is essentially an active investor. Sponsors are responsible for overseeing all the details associated with the deal, from start to finish, and ensuring the milestones are met along the way. This entails a supreme commitment and commonly equates to a full-time job for a sponsor. This is especially accurate as you become involved with larger and more complicated deals that will involve ground-up development or significant value-add repositions. When it comes to critical situations like these, the sponsor needs not only to have sufficient knowledge but also a multitude of experiences with similar projects. The LP investor, however, enjoys a passive position in the investment. They get to enjoy the fruits of their sponsors' labor without taking on as much personal risk or any responsibility themselves. The LPs investing in syndication are confiding in the sponsor by pledging their capital and allowing the sponsor to strategically deploy that capital efficiently per that syndication's execution plan. LP investors take a backseat role, with the sponsor reporting to them regularly with updates as to how the plan is unfolding including regular circulation of financial reports.

Related: Meet our Leadership

How Are The Profits Split In Real Estate Syndication?

There are many various ways that a syndication’s distribution of profits can be structured. The structure is commonly referred to as the deal’s “waterfall”. The term “waterfall” emanates from the idea that cash flow from a commercial real estate project flows through to investors. It pools at certain points until that pool is full, at which point the profits spill over to the next pool of investors in a tiered fashion.

The profits from syndication are not usually distributed evenly amongst the partners. The sponsors of the project may potentially earn a disproportionately larger share if the project exceeds forecasted expectations. This bonus cherry on top is called the “promote.” The use of a "promote" as an incentive bonus to motivate sponsors towards achieving results beyond those expected is common in the industry. 

There are many distinct types of equity waterfalls and they can vary depending on the deal. That said, it is usual for the waterfall structure to appear similarly to this:

Tier I. Preferred Return:
The first capital payment is typically paid out of cash flow to the LPs in the form of a preferred return on their investment. The 6-10% range is a pretty standard preferred return. The rate is commonly called a "hurdle rate" since it's the obstacle that a sponsor must overcome before any profits can be earned for themselves.

Tier II. Return of Capital:
After the preferred returns are paid out to the LPs, 100% of cash flow distributions will go straight to repaying investors the capital that they originally contributed upfront.

Tier III. Catch-Up:
Sometimes the waterfall has what we call a “catch-up” provision. In this case, all distributions at this stage go to the sponsor until they’ve achieved a certain percentage of the profit themselves, usually paralleling with the LPs return.

Tier IV. Carried Interest:
It is here that the profits left over are split between the LP Investors and the sponsor based on a pre-determined appropriation. The investment returns don't have to be split evenly between the sponsor and the LPs at this point. A sponsor may be rewarded with a portion of the profits relative to the equity investment they initially contributed in exchange for skillfully managing the deal.

It is common practice for sponsors to exact other fees outside of earning their share of the cash flow distributions or sale proceeds. For example, the sponsor may share a 2-3% acquisition fee for the labor of assembling the deal in preparation for the LP investors. Additionally, on new construction projects, the developer will collect a 7-10% development fee in exchange for respectively managing the deal to completion.

What Should Passive Investors Be Cautious About During Real Estate Syndications?

Investors should always do their due diligence on sponsors before they invest in a syndication. When vetting a sponsor, ensure they meet every standard of excellence before making any decisions- ask these questions!

• What is the sponsor's experience in the local market and with that asset class? How many deals are they in that are similar to the one you're considering?

• Do the sponsors spearhead and organize syndications full time, or does this appear to be their first attempt or a side hobby for them?

• What is each of the sponsor’s general partner's reputations like? Are they well-known and respected in the marketplace?

• Who’s on the sponsor's team, either internally or their third-party contractors (i.e. property management, Legal, Accounting, Construction, etc…)? What are each person or group’s roles and responsibilities? How will these players all interact to ensure seamless execution of the deal?

• How have the sponsorship team’s previous deals performed? Have they met (or exceeded) investors’ expectations? Ask to see their portfolio of deals that they are currently operating or have taken full cycle.

• How has the sponsorship team managed through periods of economic uncertainty, such as recessions or changes to the regulatory environment? How have their deals performed in these types of situations?

• What sort of fees do the sponsor charge, and are those consistent with what you are seeing elsewhere in the marketplace? (i.e. 2-3% acquisition fee, 1-2% mgmt. fee, 1-3% capital event fee.)

In addition to vetting the sponsor, proper evaluation of the deal before investing is key. You should do your best to fact-check that the local markets are as the sponsorship team has described, rent comps are accurate, the ability to reposition the property is feasible, and more. A comprehensive due diligence process is an excellent safeguard for investors looking to invest in syndication, especially if it’s your first time investing with a particular sponsorship team.

Closing Sentiments on Real Estate Syndication

Investing in commercial real estate will always come with certain risks. Ebbs and flows in the commercial real estate market are certain, but the illiquid nature of commercial real estate creates an investing platform with stability much higher than the stock or other equity markets, which can experience unruly swings—even on a daily basis. As such, those looking to hedge against market volatility and inflation will find commercial real estate to be a far superior choice.