If you missed part 1 of this series, you’ll want to review How to Get Started Investing in Real Estate Syndications, Part 1 before reading this post. In it my friend, Jeff, from Debt Free Doctor started educating us on real estate syndications. We’ll continue that process today.
Today we’ll continue with Jeff’s thoughts on how to do this. I’ll pop in now and then with a few comments (which I’ll put in bold italics to differentiate them from Jeff’s writings).
Take it away, Jeff…
Two Main Syndication Roles
There are two basic roles involved in a real estate syndication:
- Sponsor/Operator/General Partner (GP)
- Investor/Limited Partner (LP)
The sponsor or General Partner (GP) plays the most critical role as they take on the largest amount of responsibility.
- Find and evaluate property
- Obtain financing
- Acquire the property
- Manage the asset
Not only does the sponsor invest their time, but most also invest their money. Typically this amount can range from 5-20% of the total equity capital for the real estate investment.
#2 Investor (LP)
Investors (you and me) are also known as Limited Partners (LPs). This group is nothing more than the passive investors that are in the deal along side the sponsor.
Remember, they have no active responsibilities in acquiring or managing the asset.
Types of Syndications
There are several different types of real estate syndications such as:
- mobile home parks
- student housing
- self storage
- land development
The majority of the syndications that I’ve invested in have been in the value-add multifamily class.
An example of this asset class would be someone that decides to invest in an apartment complex whose units haven’t been updated in 15 years. All of the kitchens and countertops are outdated. Also, the carpets are worn out and the landscaping needs to be redone.
By improving the property, the sponsor can increase the rents, which increases the income of the property. Commercial real estate is sold based on this income, specifically the Net Operating Income (NOI).
[This is exactly what I did with my units in Michigan. I bought them, upgraded the apartments, and started charging more rent. So what Jeff is talking about here is simply a larger-scale version of a strategy I’ve seen work well personally.]
How Does a Real Estate Syndication Work?
A real estate syndication starts by the sponsor forming a group together with limited (passive) partners.
Remember, the GPs are the ones that perform all of the work that you would otherwise be doing as the owner and landlord of a rental property.
The Limited Partners are you and I, the passive investors that have no active responsibilities in managing the asset. Actually, being a LP is quite easy. You simply sit back and collect a check each quarter. Not bad!
A real estate syndication can only work when both the GPs and LPs come together.
After the GP finds and purchases an asset, they put together a team in order to execute on the business plan. Next, the limited partners invest their personal capital into the deal, which makes it possible to acquire the property and fund the renovations.
The typical entity structure formed between the sponsor and limited partners is a LLC. This entity holds the underlying asset. Due to the fact that the LLC is a pass-through entity, the LPs get the tax benefits of direct ownership which is outstanding for the high-income earner.
After the deal closes, the sponsor works closely with the property management team to improve the property according to the business plan.
During this time, the passive investors receive regular and ongoing cash flow distribution checks (typically on a quarterly basis).
Most of these deals have a five to seven year hold period. If you’re going to need your money sooner than that time frame then this type of investment may not be the best for your situation.
During the hold period, all the planned renovations are completed allowing rents to be raised to increase the Net Operating Income (NOI) of the property.
At the end of the hold period, the property is sold and the limited partners receive their original investment back and split the profits with the sponsor. Typically this is a 80/20 or 85/15 split. In the latter case, 85% of the profit goes to the investors and 15% to the sponsor.
7 Steps to Invest in a Syndication
1. Make up your mind.
With all of the tremendous amounts of information available to us online, it’s hard to not occasionally suffer from paralysis by analysis.
At least once a month I connect with someone through my website that knows the ins and outs of real estate but has yet to invest due to paralysis. Unfortunately, these types of people will NEVER invest in a syndication until they make a decision then take ACTION.
You’re the main person that knows what’s best for you and your family. Simon Sinek’s book, “Start With Why” tell us that having a strong “why” you want to accomplish something is going to be the deciding factor to whether or not you’re going to pursue your goal(s) and then stick with it when times get tough.
This is the first and most important step which starts you down the path to success.
For me, it took almost getting seriously injured snow skiing to realize that only having one income stream supporting my family wasn’t enough to sleep easy at night.
I made it a point to set new goals and determined that my “why” was:
- decreasing the risk of not being able to provide for my family
- freeing up my life to spend extended vacation time with our kids
As a self-employed practice owner, I’m on the left (poor) side of Robert Kiyosaki’s Cashflow Quadrant. Even though I own the practice and don’t have to answer to anyone (unless my wife is there 🙂 ), I still trade time for money.
If I’m not treating patients, zero money is coming through the door.
I made a decision to change this by slowing moving from the left side of the quadrant to the right side in which my money will work for me instead of me working for it.
Image via CoachCarson.com
2. Develop investment goals.
Once you make the decision to become a real estate investor, one of the first questions you must answer is:
Do you want to be an active or passive investor?
After talking to several local real estate investors, I quickly realized that active investing wasn’t for me.
This would have conflicted with one of my “whys” (freeing up time to spend with kids) and caused me to continue to trade time for money.
For me, I don’t have the time (or patience) to deal with tenants, fix toilets or other management issues that goes along with being an active investor.
[Just to tell the other side of the story, this can be alleviated by hiring a property manager.]
If that’s what you want to do then great. Again, you must develop your own goals.
Other questions to ask yourself are:
- What do you plan to get out of real estate investing?
- Are you looking for a short or long-term investment?
- Are you investing for appreciation or cash flow?
- How much do you have to invest, both in terms of time and money?
On the other hand, if you’re like me and find the “set it and forget it” type of investing to be of more interest, then a real estate syndication might be a better fit.
Each new investment I make is another passive income stream I add to the mix which gets me one step closer to financial freedom.
3. Find the right investment opportunity.
From this point on, we’re going to assume that you’ve chosen to become a passive investor in a syndication. The next step is determine what asset type you’re interested in.
There are a variety of different assets that you can invest in such as:
- new construction
- value-add assets
- self storage
- mobile home parks
To help investors learn about investment opportunities, sponsors typically provide help for investors to learn about their investment opportunities via:
- Executive summary
- Full investment summary
- Investor webinar
These are the core materials that will give you a full 360-degree view of the:
- deal sponsor team
- business plan
- projected financials
Personally, when I review these materials, I’m looking first and foremost at the team who’s running the project. I want to make sure they have a solid track record and that they’re good people.
ALWAYS evaluate the sponsor THEN the property. A team with poor fundamentals and strength can take a great asset and underperform. Just one story of success does not make you strong.
Only after this should you familiarize yourself with the basic understanding of commercial real estate and underwriting.
One of the reasons that I initially lost big time on one of my first deals was that I didn’t do my part to seek out sponsors that I could trust.
After I perform due diligence on the team, it’s time to evaluate whether or not the business plan makes sense, given the:
- asset class
- where we are in the economic cycle
Some of the market research I personally perform are:
- job growth
- population growth
Most of the deals I’ve invested in have a minimum investment of $50,000 with a five to seven year projected hold time and projected returns of 15-18%.
I look to make sure that the team has multiple exit strategies in place, in case their Plan A doesn’t pan out.
Attending the investor’s webinar is another way to evaluate the sponsor as you’re able to have all of your questions answered.
If, after all my research and analysis pans out, then I consider investing in the deal.
This is the process I use to invest and encourage you to develop your own criteria as you review different investment summaries.
The more you review, the better you’ll know exactly what you’re looking for.
4. Reserve a spot.
The majority of syndication deals are set up on a first-come, first-served basis.
This can be especially important for deals in hot markets with strong deal sponsors.
It’s not uncommon for these types of opportunities to fill up in a matter of hours or days. The last deal I invested in was located in Savannah, GA. It was a $33.4 million dollar apartment complex that filled up in five days.
If you snooze, you lose.
It’s for this reason that I inform investors on our email list a week ahead of time BEFORE a deal is going to be released. This way they’re able to move money around into appropriate accounts if needed so they don’t miss out on the opportunity.
Most sponsors allow investors an opportunity to place a soft reserve amount. This is similar to raising your hand that shows you’re interested.
By doing this, you’re able to hold down a spot while you take time to review the investment materials.
If you decide to back out or change your investment amount later, you can do so with no penalty.
On the flip side, if you don’t place a soft reserve, but later decide you want to invest, there may no longer be a spot in the deal, and you’ll have to join the backup list.
5. Review the PPM.
After you’ve identified a deal that you’d like to invest in then the first step is the signing of the PPM (private placement memorandum).
This is a legal document that goes into detail about:
- the investment opportunity
- risks involved
- your role as an investor in the project
I find that most investors don’t take the time to fully review this document similar to when preparing to close on a house. The attorney flips a hundred pages in front of you making you sign your name countless times but it’s only the rare individual that will read each page.
But it’s very important that you review and understand the PPM.
It allows you to fully understand all of the aspects of the investment opportunity, including the:
- subscription agreement
- operating agreement
6. Fund the deal.
Once you’ve reviewed the PPM, the next step is to fund the investment.
Most syndication deals are reserved for accredited investors only and start with a minimum of $50,000 to invest.
Typically, you’ll have the option to either wire funds or mail a certified check.
7. Relax and reap the benefits.
After completing the six steps above, you’ve:
- performed due diligence on the investment and sponsor
- placed a soft reserve to hold a spot
- reviewed the legal documents
- funded the deal
Once the deal closes, the GP will begin updating the investors normally on a monthly basis.
After that, you can expect to receive the following from them:
- detailed quarterly reports on the financials
- monthly/quarterly cashflow distribution
- an annual K-1 for your tax returns
Here’s a handful of past investors and their thoughts about syndication investing:
#1 Mrs. S
The main barrier keeping me from investing in real estate early on in my career was knowledge. I wasn’t familiar with real estate and had only invested with a financial advisor that had us in mutual funds and a handful of annuities (ugh!).
After learning more about the FIRE movement and self-educating myself on real estate sites such as Bigger Pockets, I began to become interested in passive real estate investments.
Once I got to the point that I thought I’d expanded my knowledge enough, I jumped into syndications head first and am glad I did. So far, I’ve been very pleased with the returns, tax advantages via depreciation and especially the lack of having to deal with headaches of being a landlord.
#2 Mr. T
As someone that had the majority of our portfolio in the market, I wanted to branch out and diversify in commercial real estate. What really attracted me to real estate was the tax benefits as we’re a high income earning family.
When I learned about syndications, I was excited to be able to participate in high quality transactions without investing so much capital up front.
This allowed me to “get me feet wet” and learn the ropes before investing more of our portfolio. We now plan on investing in 2-3 deals per year.
#3 Dr. Y
My husband and I are both physicians. After we both paid off our medical school loans (yes!) we had several thousands of dollars extra freed up each month. We had already been investing in traditional retirement plans but started looking for portfolio options that provide passive income.
We started educating ourselves with books, blogs and podcasts on investment options in real estate. We first looked into single family homes and crowd funded real estate but decided on passive real estate syndications as they were more inline with helping us achieve our goal of financial freedom.
That’s it for today.
In the next post in this series, I discuss more about this process and what I’ve done.
To read it, go to My Real Estate Syndication Investing Journey.