Commercial Real Estate (CRE) Syndication: 101
Commercial Real Estate (CRE) Syndication: 101
Real estate syndication is a simple transaction between a Sponsor and a group of investors.
You know how when two guys open up a bar together, one has more money to invest and the other has a lot of experience working in and managing bars? The guy with the bar experience (the Sponsor) finds a bar to open and arranges everything, while the other guy (the investor) simply invests his money. The guy with the bar experience naturally runs the bar, and, as a result, gets a paycheck for his work. Both get a share of the profits based on time and money invested.
Real estate syndication is an effective way for investors to pool their financial and intellectual resources to invest in properties and projects much bigger than they could afford or manage on their own.
The basics of real estate syndication aren’t all that different from two guys opening a bar together. As the manager and operator of the deal, the Sponsor invests the sweat equity, including scouting out the property, raising funds and acquiring and managing the investment property’s day-to-day operations, while the investors provide most of the financial equity.
The Sponsor is usually responsible for investing anywhere from 5-20% of the total required equity capital, while investors put in between 80-95% of the total.
Syndications are simple to set up and come with built-in protections for all parties. They’re usually structured as a Limited Liability Company or a Limited Partnership with the Sponsor participating as the General Partner or Manager and the investors participating as limited partners or passive members.
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.
Real Estate Syndication Profits
How, exactly, do investors make money when participating in a real estate syndication? Rental income and property appreciation.
Rental income from a syndicated property is distributed to investors from the Sponsor on a monthly or quarterly basis according to preset terms. A property’s value usually appreciates over time, so investors can net higher rents and earn larger profits when the property is sold.
When and how does everyone get paid? Payment depends upon the time the investment needs to mature; some types of syndications are over within 6-12 months while others can take 7-10 years. Everyone who invests receives some share of the profits.
At the deal’s beginning, the Sponsor may earn an average acquisition fee of 1% (although it can be anywhere from .5 to 2% depending upon the transaction). Before a Sponsor shares in the profits for their work as manager and promoter, all investors receive what is called a ‘preferred return.’ The preferred return is a benchmark payment distributed to all investors that is usually about 5-10% annually of the initial money invested.
A Quick Example
Real estate syndications are structured so that the sponsor is motivated to ensure the investment performs well for everyone. Let’s look at an example of a preferred return.
If you’re a passive investor who invests 50k in a deal with a 10% preferred return, you could take home 5k each year once the property earns enough money to make payouts possible.
After each investor receives a preferred return, the remaining money is distributed between the Sponsor and the investors based on the syndication’s profit split structure.
If, for example, the profit split structure is 70/30 — investors net 70% of the profits after receiving their preferred returns and the sponsor nets 30% after the preferred return — here’s an example: after everyone receives their preferred return in a 70/30 deal, and there is 1 million remaining, the investors would receive 700k and the Sponsor would receive 300k. (article continues below)
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Real Estate Syndication Statistics
In 2012, over 47,000 investors participated in syndications.
The average size of a real estate offering was 2.3 million.
Passive investors came up with 80-95% of the initial capital investment
Sponsors came up with 5-20% of the initial capital investment
Investors received a preferred return ranging from 5-10%.
The average preferred return was 8%.
Sponsors netted an acquisition fee of .5 to 2%. The average acquisition fee was 1%.
Sponsors netted a property management fee between 2 and 9%.
Real Estate Syndication and Crowdfunding
Back in the dark ages (a.k.a. pre- internet), real estate syndication required that interested investors have an established network of syndicate partners to find trustworthy, profitable deals to buy shares of.
Like the two guys opening up a bar together, the guy with the bar experience had to somehow meet the guy with the money, and vice versa. Fast forward a few years and things have really changed for real estate syndications, with the help of the internet and the advent of crowdfunding.
Real estate crowdfunding gives access to the financial fundamentals of a deal and makes it easy for accredited investors to purchase shares without using the old model of country-club small talk and caddy fees.
Crowdfunding is a way to raise money through the internet for a big project with the help of a ‘crowd’ of investors; if a project gets enough funding, it’s a “go”, and if not, the money is returned to investors.
Crowdfunded real estate syndications are more accessible, have lower investment minimums and offer a wealth of online project information available to potential investors.