Syndications – Are they a good option for Real Estate Investment?

In my business, I have heard countless times, “I have $75,000 in the bank and I’d like to invest in commercial real estate”.   Unfortunately, in our submarket, and in many others around the nation, this is not an amount which allows for any single asset purchase. You need to take into consideration most commercial loans have a minimum 35% down payment.

What is a first-time investor to do, if they want to take advantage of a hot real estate market, but don’t have the liquidity to purchase a property for millions of dollars?  A syndication may be a vehicle which can allow a smaller investor to co-invest alongside the “big boys.”

A Real Estate Syndication is essentially structured as a limited partnership. The general partner (or managing member of an LLC) has the real estate experience, and the limited partners (or non-voting members of an LLC) having the majority of the equity.  This structure brings both positives and negatives to an investor, and each should be considered to determine whether this vehicle is right for you.

The main benefits of a syndication are: 

• Lower investment amount
• Rely on the knowledge of a seasoned investor
• Limited liability
• Diversification of risk
• Share in the profits and tax benefits
• No day to day management

Syndicators of real estate typically look for an investment from an accredited investor with a minimum between $20,000 and $100,000 depending on the syndication.   This allows for an investor with only $75,000 to invest upwards of three properties, allowing for diversification of risk.  

One of the huge benefits of a syndication is instead of jumping in, and learning about commercial property management, an investor can rely on a seasoned syndicator. This individual already has the knowledge and infrastructure to manage and/or reposition the asset.  Many investors also like the limited liability aspect of a syndication. 

In today’s commercial lending world, many banks are requiring personal guarantees for a commercial loan.  As a limited partner, the investors outside risk is generally limited to the amount they originally invested.   As a limited partner you generally also get to share in the profits and tax benefits of ownership on an equity pro-rata basis.  Lastly, as a limited partner you do not need to worry about the day-to-day management of the asset, and only need to cash your disbursement checks (typically quarterly).

Sounds great right?  There must be some downside, and yes there are some.   The main downside is you will typically not earn as much of a return than if you had purchased the property yourself, after all, the syndicator/managing member must make money as well.  The investors in a syndication typically get a preferential return, once the return is met (called a waterfall) then the profits are shared with the syndicator (typically 70% to the investor and 30% to the syndicator). Upon a second waterfall, the splits will typically change again, in favor of the syndicator. 

Another downside, is as a limited partner you have very limited say in the operations of the asset, and even when to sell (typically spelled out in the subscription documents).  This can sometimes make it hard to sell your share in the open market. Therefore, if you are considering a syndication, expect to have the initial investment tied up at least through the expected investment horizon (typically 3-5 years). 

So you’ve made the decision a syndication may be right for you, what should you be looking for in a syndicator?

• First and foremost, a track record of previous syndications, and any other experience in the asset class they are purchasing. 
• Second, ask about their fees, all syndicators have upfront fees, but many “front load” these fees and make the majority of their money by creating the syndication.  They, therefore, are not as motivated in finding a property with potential upside, and when it comes time to sell, the property may not have appreciated enough. 
• Third, ask how much of their own money they are investing alongside yours.  Most syndicators will invest at least 5.0% of the equity and sometimes more.   If they are not putting ANY money into the investment, then it may be an indication of front-loaded fees, and to possibly stay away. 

Of course, still, do your due diligence and view the property and the syndicator’s business plan for the property to determine if it seems to be a sound investment. Generally speaking, Syndications offer a first-time investor the opportunity to invest in a larger commercial property, or the ability to do so passively.  If you do your due diligence it can be a sound investment vehicle.