The increase in popularity of real estate investment syndications in the last few years has presented huge opportunities to investors looking to invest in commercial, multifamily, or industrial properties in a passive way. As a review, syndications are a way to pool money from multiple investors to accomplish a common investment goal. In real estate, this typically involves pooling equity to purchase a property with the intention of improving or holding it for appreciation and cash flow.
With opportunity, however, comes the need to know what to look for when comparing opportunities. I have compiled 10 of the most important factors to look for in a syndication when evaluating them in order to make the most informed investments possible.
1) Qualifications. Check and see if the syndication deal requires you to be a sophisticated or accredited investor. Syndications structured under SEC Regulation D, exemption 506(c), require investors to be independently accredited via a CPA or 3rd party service. This confirms an investor meets minimum net worth and/or income requirements in order to legally take part. 506(b) offerings, on the other hand, simply require an investor to be sophisticated which is simply a broad definition meaning an investor possesses sound financial education.
2) Track Record. Syndications are passive, so it is extremely important that the sponsors have a proven track record and knowledge of the industries and areas they are choosing to invest in. Good syndication sponsors will partner will experts when bringing new category deals to their investor pools. Due diligence is key, and sponsors should be able to clearly articulate why they like a deal and what sort of risk mitigation exists.
3) Preferred Returns. Many stabilized properties are generating revenue via rents collected from tenants, and the sponsors of these syndications will structure a preferred return to investors. This return represents an annual return on the principal amount invested by the investor (i.e. 8% returns on a $100,000 investment would represent $8000/year). This return accrues at a predetermined rate, and must be paid before any sort of profit-sharing takes place upon the sale of the property. Some deals will have a set preferred return pegged to an investor’s initial investment, while others will establish this return as a percentage of actual net cash flow received.
4) Dividends. Often confused with preferred returns, dividends differ in that they are the actual payments made during the hold period of a deal. These are often paid out monthly or quarterly. Certain value-add deals that require increasing occupancy or rehab work may delay paying dividends until cash flow of a property is sufficient to cover these payments. Dividends are ultimately paid at the discretion of a sponsor, and can be interrupted due to unexpected expenses or vacancies that arise during the course of the holding period.
5) Taxes. Good sponsors will actively work to reduce the amount of taxable income received from real estate deals. Dividends are tax reported on a K-1, which has the advantage of reducing the amount of taxable income due to the depreciation of the property. Good sponsors will perform cost segmentation studies, where they bring on a 3rd party to accelerate depreciation, further mitigating taxable obligation on dividends paid out.
6) Reporting Periods. Many sponsors elect to provide progress reports on the status and management of the property during the course of the investment. Some provide extremely detailed tenant by tenant accounting, and others simply provide a cash flow or overview of the property. It is helpful to ask a sponsor for previous reports to see what kind of reports they typically provide. Most of the time these are provided at the same interval as the dividends being paid (monthly or quarterly).
7) Profit Split. A common feature in syndication deals is for the net profits upon sale to be split with a portion going to the sponsors and the balance to the investors. These profits are what is left over after closing costs and fees are paid, preferred returns are paid, and original investor principal is returned. The percent of profits that get split among investors can vary significantly on a deal, based on risk, sponsor involvement, and overall return structure.
8) Sponsor Fees. Syndication sponsors get paid through three main ways, and investors should be aware of these when evaluating deals. Sponsors may derive compensation from one or more of these categories.
a. Upfront Fees. These fees are built into the amount of money raised and help compensate sponsors for time and money invested to get the deal secured and put together. There is no formal terminology, but this money is commonly called sponsor fees, acquisition fees, or due diligence fees. These are separate from 3rd party fees from entities such as lenders, attorneys, title companies, and inspectors.
b. Asset Management Fees. During the hold, some sponsors will take compensation for management time and costs incurred to keep the property running successfully. These are typically a percentage of rents collected or net cash flow that the syndication receives and are paid at the same time as dividends to investors.
c. Profit Splits. Typically, most of the value of a property is derived at the time of sale. A successful syndicator is incentivized by a percentage of net profits to help close a deal out and maximize profits. These will vary by deal, but should be high enough such that a sponsor is motivated to invest time and effort throughout the entire hold period to maximize returns.
9) Exit Plan. Syndications are illiquid and passive investments, meaning sponsors retain the final decision of when to sell the property. A good sponsor will have an exit plan that has a projected hold period or range of years, contingent on market forces and occupancy being favorable for a property sale. Most value-add deals will be shorter in length due to most of the value being created in early years. Many stabilized property deals will be longer in order to take advantage of increasing rents, equity build up through debt payoff, and stabilized cash flow.
10) Voting Rights. Most syndications are structured through an LLC. The LLC buys and sells the property with the sponsors being Class B managers. The Class A investors will be formally included in the company/operating agreement of the LLC that outlines their portion. Some LLCs will give members voting rights as well, which can be used for large decisions such as changing management, restructuring returns, or dealing with death or transfer of existing members. It is important to understand the type of rights you have as an investor and what types of transferability, if any, your shares have.
These are just a sampling of the many differing components of a real estate syndication savvy investors should be educated on when evaluating opportunities. Knowing how syndications are set up will allow you to make smart investment choices in the future.
Best regards to you and your investing,
Tom Wilson
CEO and Founder of
Wilson Investment Properties
