Real Estate Syndication
By Terry Painter/Mortgage Banker, Author of The Encyclopedia of Commercial Real Estate Advice – Wiley Publishers, Member of the Forbes Business Council
What is a Real Estate Syndication?
A real estate syndication is used when the sponsor of a real estate investment plans on combining the cash from multiple passive investors to raise funds for the down payment. In this case, Regulation D, of the Securities and Exchange Commission (SEC) mandates the sponsor form a real estate syndication. Because the investor’s only role is to invest their money, the SEC views the sponsor in the same way they view a stock funds manager who is essentially doing the same thing with publicly traded stock. Investors are given a preferred return specified in a private placement memorandum which also describes the investment and inherent risks.
Real Estate Syndication Example
As a commercial mortgage banker, I have closed loans on over 50 syndicated deals in the past 26 years. Last week we closed a $4 million loan on a $7 million syndicated purchase of a 36-unit apartment complex in Dallas. I would never have guessed that this was only the second deal this young sponsor had put together, as he really walked the walk and talked the talk.
Originally, he came to us intending to put 10% down of his own money with the intention of raising the balance from passive investors. Click on this link if you are wondering What Is The Highest LTV Multifamily Loan program in America. This client was not financially strong enough to qualify for the Fannie Mae Multifamily Loan Program we had in mind for him on his own. So, he took our advice and brought in a high-net-worth investor to join him as key principal on the loan. This investor, who also contributed 10%, was only able to be on the loan because it was non-recourse financing. This meant he did not have to guarantee the loan and risk losing some or all of his personal assets if there was a default. We also looked at doing a Freddie Mac Multifamily Loan and ended up doing a HUD Multifamily loan. All three of these loan programs are non-recourse and very user friendly for syndications. Click on these to learn about the Advantages of HUD Multifamily Loans and the Disadvantages of HUD Multifamily Loans.
And here’s a HUD Multifamily Loan Glossary with 74 terms defined for a fast look up.
What really impressed me was the sponsor’s ability to raise the balance of the down payment and closing costs from 18 passive investors. Some put in as little as $10,000 and one as much as $600,000. His ability to sell the potential return on investment by raising under market rents by 18% and increasing the property’s value by 20% in 5 years was very impressive. Equally impressive was that he had the chutzpah to charge a 3% acquisition fee.
Advantages of a Real Estate Syndication
The number one advantage of forming a real estate syndication is that it is much easier to raise capital from passive investors who don’t have to have any involvement in the deal beyond investing their cash, than to use active investors who will want to make decisions with you by consensus. There will always be many more potential investors that want to be passive than active, and the passive ones seem to have a lot more cash to invest.
Another advantage is the Private Placement Memorandum that all real estate syndications are required to have. This document legally states the description of the real estate, amount to be invested including renovations, projected returns, profit sharing for classes of partners, and the risks associated with the investment. PPMs install confidence in the venture and the passive investors will get comfort knowing that their investment is regulated by the government.
Disadvantages of a Real Estate Syndication
Okay, I understand the draw of being a syndicator and using other people’s money; the lure of putting the deal together, of having total control over it – from underwriting it to closing it, to overseeing management and eventually disposing of the asset. And of course earning fees for acquiring, managing, remodeling, refinancing and selling the property. Being the head of a real estate syndication gives you professional clout.
But far too often I have seen first-time sponsors get exhausted after the initial thrill of negotiating a successful purchase contract. Then there is all the grunt work underwriting the financials, and doing all the other due diligence on over 20 other items and applying for financing. And then adding on to this the fiduciary responsibility required in syndications of making safe and responsible assumptions for your investors that will be spelled out in the PPM – a legal agreement that can create a lawsuit against you down the road if you put it together too hastily.
Most often, I feel that it makes much more sense for the newbie to form a simple LLC with investors who will all take some role in overseeing the investment and management. To avoid being required by the SEC to form a syndication, you just need to spell out your partner’s active roles in the operating agreement.
And lastly, let’s not forget the cost of hiring a securities attorney to form the syndication. I certainly don’t recommend anyone doing this on their own. It’s just too complicated. And these lawyers usually charge between $400 and $1200 per hour.
How Much can a Syndicator Earn?
Sponsors usually retain at least 20% ownership even if they contribute less of the down payment than that. Keep in mind that often, most of the earnings on real estate comes from appreciation, so having as much ownership as possible is key. Sponsors charge from 1 – 2% of the project cost as an acquisition fee. They can charge a fee for managing the property if they are not going to hire professional management. Also, a fee for refinancing the property and for disposing of it. A sponsor promote or waterfall can be earned as well. This is a percentage of any excess profit over what is projected in the pro forma.
Getting Started If You Don’t Have Much Experience
Extrapolate Your Skills
To raise investors, you are going to have to have some experience that you can extrapolate from to show that you have the proven skills to pull this off. But the most important countermeasure if you don’t have much experience is finding an outstanding real estate investment – ideally one that has under market rents and doesn’t need a ton of money to get it in shape. Having a signed intent to purchase or purchase agreement is essential too. Investors won’t want to waste their time if you don’t have control of the deal.
Put At least 10% of Your Own Money In
Then it is essential that you have at least 10% of the equity in your own name to contribute. 15% is even better. Few will want to invest if you tell them you plan on just using 100% other people’s money.
Bring in a High Net Worth Experienced Investor if Needed
If you don’t have the experience or financial strength to qualify for financing, bring in a high net worth experienced partner that does. This might be the only way you can pull the deal off.
Prepare an Executive Summary
Prepare an executive summary. This will be the foundation of you future PPM. It should clearly describe the real estate and show the projected return on investment. Most importantly, state how much the investment costs at the beginning, and what you plan on selling it for in so many years. Be sure to have a strong pro forma for the duration you plan on holding the property showing income from operations increasing over the years. Be sure to show your market research that clearly verifies market rents, and the pluses of the submarket.
Be sure to rehearse your pitch to your spouse, friends, your kids, or even your dog so the delivery is smooth, and you appear confident to potential investors.