What is a Real Estate Syndication?

When you come across a single family home, chances are, it’s owned by a family who uses this home as a primary residence, a place they live. 

On the flip side, you do find many investors who buy single family homes as a rental property. They buy the home, get a mortgage, and their tenants pay the rent, which will cover the mortgage, taxes, and other relevant expenses. 

The main reason many people choose single family homes as an investment is because of the many benefits real estate has to offer, while also being a more affordable option for an investor with less capital. Typically, you only need about 20%-25% of the purchase price to buy a piece of real estate. If that’s a $200,000 home, that’s only about $40,000-$50,000.

But what happens if you find a great deal on a larger property, say 20 units, with a purchase price of $2,000,000. Now, that 20%-25% down payment is now $400,000-$500,000. What seemed like a great deal with great returns has now seemingly turned into a “could’ve been, if I had more money” situation. However, this couldn’t be further from the truth. Through Real Estate syndications, investors are granted access to larger, more easily-scalable assets without the limitations of capital.

Let me introduce to you a syndication:

A syndication is a partnership of multiple people who pool together resources, experience and capital to buy an asset larger than they could afford or manage on their own. 

There are two roles to a syndication: The General Partner (GP), also known as the Sponsor, and the Limited Partner (LP). 

Your skillset, amount of capital and experience will help guide your decision to either join the GP or LP of a deal.

If you are limited on capital, but have hours a day to look for deals, manage projects and raise capital, a GP role may be a fit for you. If however, you are a hard working doctor, lawyer, accountant, engineer, banker etc. with limited time to actively give time to focus on being a full-time landlord, then investing passively as an LP may suit you well. 

Generally, the LP will provide 90%-95% of the capital needed to close on the deal, while the GP will bring 5%-10% to have some “skin in the game”. (Note: It’s important to see the sponsor have their own money in the deal as it shows they have something to lose, and as a result, will want the deal to perform well. Also, if they are investing their money, they must obviously like the returns it may yield.)

Because the Limited Partners are giving most of the money, they will likely receive the majority of the cash flows that the asset produces. 

Let’s take our $2,000,000 deal as an investment.

You get this 20-unit apartment complex under contract and get a bank to provide a loan of 75%. What this means is that the bank will give a loan of 75% of the value of the property, while you as the buyer must be able to fund 25% (plus closing costs) in order to close the deal. 

$2,000,000 x .25 (AKA 25%) = $500,000 

As the sponsor, you go to your family and friends and bring 5 investors to each invest $100,000 (total of $500,000). In return for their $100K investment, you tell them that you will offer a 6% Preferred return and then the profits will be a 70/30 Split (70% to the limited partners). It is important to note that each deal offers a different preferred return and split, but this is a pretty standard range.

A preferred return is simply the agreed yield of return to be paid to the limited partner before the Sponsor gets to benefit from the cash flow.

Let me explain: Let’s say that after all of the expenses associated with running this asset, the annual Income is $45,000. This means that if somebody invested $100,000, they would receive $6000 before the sponsor got paid. So If you pay $6,000 to the five investors, this leaves us with $15,000 of cash flow to split above the preferred. 

($45,000 Income- (6% Return on $500,000 total investment)) = $15,000 paid to the LP

With this remaining $15,000 the cash flows are now split 70%/30%.

$15,000 x .70 (AKA 70%) = $10,500 paid to LP

$15,000 x .30 (AKA 30%) = $4,500 paid to GP

Adding up the $30,000 + $10,500 of total cash flows paid to the limited partners, they will receive a return of 8.1% ($40,500 of cash flows / $500,000 initial LP Investment) on their money just in year one! Not too bad of a return without taking into account appreciation of the asset, which generally will be realized at the sale or refinance of the asset.

This is a very high level overview, and one should consult with an experienced real estate professional before choosing to enter a syndication. Real Estate syndications offer many benefits including greater access to large deals with steady returns, while allowing inexperienced capital partners to invest in real estate they might have never been able to do on their own. Please feel free to contact me with any questions or concerns regarding the syndication structure.