Syndications are a hot topic lately, especially since celebrity investor Grant Cardone has gotten into trouble for allegedly inflating potential returns and failing to disclose risks.
You have no doubt heard about syndications while listening to investing podcasts and seen posts promoting syndication deals in your social feeds. But what exactly are they?
Syndication is a method of purchasing or building property as part of a group of investors who pool capital to fund the deal, as well as any construction/value-add costs. It can be a great way to get a piece of larger projects that you likely would not be able to fund on your own, like a large condominium complex, hotel, or mobile home park.
Know the Players: Who Does What?
Any real estate syndication will include a version of these two roles:
These are the people who find and manage the deal. They are active participants in the project and will direct and supervise the project as it progresses. They are also responsible for raising capital (from investors). Sponsors set up the terms of the investment and profit structure and receive a cut of the profit themselves.
This is you. You have a passive role in the investment, contributing money alongside other investors for an ownership stake in the deal with a potential profit schedule that sponsors have predetermined.
Know the Rules and Who Can Invest
The JOBS Act of 2012 opened the doors for accredited investors to invest in real estate syndication. Being an accredited investor is a key prerequisite here. Federal securities law defines an accredited investor as a person making over $200,000 a year over the last two years, or joint income with a spouse over $300,000, with a net worth exceeding $1 million (excluding their primary home). (Read the full, official SEC definition.)
How Do You Make Money from a Syndication Deal?
Every deal is different. As you review the syndication proposal for each deal, make sure you have a crystal-clear understanding of the wealth distribution plan, especially since there may be multiple ways you can invest in a single deal.
For instance, tier 1 investors may be offered a preferred return of 10% and no equity, while tier 2 investors may be offered a preferred return of 7% but a share of the equity at sale. (And you decide whether you want to be tier 1 or tier 2.)
Pros and Cons of Real Estate Syndication
- Returns: Excellent returns in commercial real estate are possible if you align yourself with the right project and sponsor.
- Investment access: These are projects you likely wouldn’t have the cash to own were it not for the syndication opportunity to buy a piece of it.
- Completely passive: Your job is to contribute the cash and then sit back as the operators do the heavy lifting and project management.
- Illiquidity: Unlike real estate investment trusts (REITs), where you can sell your shares whenever you want, syndications are one of the most illiquid ways to invest in real estate. Once you’re in, you’re in, and you can’t move your money out for the duration of the holding period.
- No control: Don’t like how the sponsors have renovated the first 20 units? Tough. You are a passenger on this flight, not the pilot.
- Risk and inconsistent income: Like any real estate investment, there is risk. With syndication, there is no guarantee of income (true of all investments, of course), but with syndication, there is also usually a built-in income ramp-up period, especially if the plan is to spend the first part of the holding period building or doing value-add renovations. You may not see solid returns until a few years into the deal, and returns may vary from year to year. (The prospectus should lay the expected timeline out for you.)
How Should You Vet the Deal?
No doubt you’ve heard the legal caveat, “Past performance is not an indication of future success.” This is, of course, true, but it also may be your best way to evaluate the operators of the deal in front of you. Look at the track record of this sponsor. How have their past deals fared?
You’ll also want to evaluate the deal on the merit of the investment itself in all the ways you would look at a deal where you are the only investor. Make sure the syndication’s goals align with your own in terms of cash flow, equity growth, risk tolerance, and timeline. Is the investment strategy clear? How do the basic economics pencil out, and how likely is the sponsor’s plan to come to fruition at the profit levels they’re projecting? In addition to unrealistic profit claims, be very wary of any deal where the sponsor doesn’t have skin in the game and still makes money.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.