What is Real Estate Syndication?
Real Estate Syndication Investing For Pilots | Photo by Tierra Mallorca
With each passing year, real estate syndication is gaining popularity in passive income circles. So what is real estate syndication, exactly? Read on to learn about the syndication model of real estate investing and how pilots in particular can take advantage of it.
Consider the difference between piloting your own small aircraft vs purchasing a ticket on a commercial airline. While a hobbyist pilot can travel great distances, the responsibilities and risks involved are considerable. In contrast, the airline passenger delegates the task of getting from A to B to a professional crew, relinquishing control, but allowing for more frequent travel to diverse destinations – all while sleeping during the flight.
A syndication is analogous to flying commercial. It is a symbiotic investment vehicle in which individuals pool funds to invest in a real estate project too large or complex for anyone individually, while a team of professionals handle all aspects of the deal and share in the profits.
The best part: since the flight crew is metaphorically "on the same aircraft" as the investors, decisions made are in mutual benefit to everyone. The syndication model heavily aligns financial incentives for all parties involved.
Let’s deconstruct the syndication model, its benefits and drawbacks, and the key players involved.
Key Players in Real Estate Syndication
General Partner: The General Partner(s) (GPs) in a real estate syndication is the team responsible for sourcing, managing, and overseeing the real estate investment, including finding the opportunity, conducting due diligence, structuring the deal, and managing the property, all with the goal of maximizing returns for all involved parties.
The GP is also often referred to as the sponsor, the sponsorship team, the operator, operating partner, manager and/ or syndicator.
Limited Partners: Limited Partners (LPs) are the investors who contribute capital to the syndication but do none of the work. LP’s liability is limited to the capital they contribute to a deal, and they play a passive role in the investment. Pilots who invest in opportunities through Turbine Capital are limited partners in real estate investments, informally called deals.
The syndication structure allows LPs to leverage a successful GP’s team, time, expertise, credit, and assumption of liability. It also allows LPs to diversify across many different types of real estate projects, operators and geographies without having to acquire hyper- specialized knowledge.
Additionally, tax benefits flow through to LP investors as if they owned the real estate directly! This feature alone is the biggest advantage of syndications over REITs.
Benefits of Real Estate Syndication
Access to Larger Projects: Real estate syndication offers investors the opportunity to participate in large-scale projects, such as apartment complexes, commercial properties, or development projects, which require significant capital investments. By pooling capital together in a fund, investors gain access to projects which would be out of reach individually because of size and complexity.
Diversification: Syndications allows investors to diversify their portfolios by investing in different property types, geographies, and investment strategies. Diversification helps spread out the risk associated with investing in a single property and reduces the impact of market fluctuations.
Zero Time Commitment: Unlike active real estate investments, where investors are responsible for property management and day-to-day operations, syndication offers a passive investment opportunity. Limited partners enjoy the benefits of real estate ownership without the burden of direct involvement.
Beyond “property management”, passive real estate investing saves you from other arduous tasks like making decisions on renovations, ensuring insurance policies are adequate and in good standing, managing the manager, staying on top of accounting, and much, much more.
By investing passively, you can focus on your primary career, personal life, and/or other investments while the syndicated investments generate income and returns without your direct involvement.
Drawbacks of Real Estate Syndication
Illiquid investments: Unlike stocks, you can't simply click a button to instantly sell your position. Syndication deals typically have a five-year hold period, meaning your cash will be tied up and inaccessible for five years.
Lack of control: As a passive investor, you have limited control over the operational aspects. Your primary role is to invest your capital and reap the benefits. Therefore, conducting thorough due diligence, prior to investing, on both the GP/operator and the investment opportunity is paramount.
Complex due diligence: As a passive investor, the moment you sign paperwork and send the money, you’re completely hands off. So, it is imperative you conduct your due diligence on the operator and on the deal itself prior to investing.
Due diligence is especially challenging at the starting line when you’re just learning the game. Large scale commercial real estate projects are inherently complex and understanding their inner workings is necessary to properly evaluate them. This doesn’t change even as you go further from the starting line. Investment projections are also driven by complex underwriting, so assessing their validity requires skill.
Even with experience, deep dives on the operating team can be difficult for individuals to accomplish. With hundreds, sometimes thousands of investors in a particular project, an operator rarely has time to meet or field questions from individual investors.
This is the value of investing through a firm such as Turbine Capital.
Our fund model provides enough economies of scale to perform robust diligence. We employ sophisticated analysis, have resources to conduct background checks, run financial modeling, make in-person site visits and more.
Individual investors, regardless of their experience, would likely have trouble the cooperation of a sponsor for this type of extensive diligence, simply because of their time constraints on offering that type of one-on-one interaction. Because we serve as a valuable capital partner, operators are far more accommodating to our extensive probing vs individual investors.
The best part: We are able to offer our investors streamlined access to the exact investment opportunities we’re investing in personally and offering the same or better terms than direct to sponsor investors.
Important Features of Real Estate Syndication
Profit Splits
The GP typically receives a minority portion of the deal’s profits (typically 20-30%) in exchange for their role in identifying the investment opportunity, conducting due diligence, securing financing, implementing the business strategy, managing tax documentation, handling profit distributions, and overseeing the property's sale or refinancing.
Ultimately, the GPs do all the work and share in a minority of profits (20-30%), while the limited partners provide the capital, and take the majority of the profits (70-80%).
Fees
In addition to the profit split (also known as the equity split), the GP is also directly compensated through fees assessed to the project and paid via limited partner capital contributed to the deal.
Here are some industry-standard fees in a syndication:
Acquisition Fee: 1-3% one-time fee based on the purchase price or total project cost, paid at closing.
Asset Management Fee: 0.5-2% per year for overseeing the project.
Miscellaneous fees: can include fees for construction management fee, developer fee, loan guarantor fee or disposition fee ranging from 1-10% depending on the project.
Keep in mind that fees are the way in which sponsors keep the lights on and the machine running, but the vast majority of a GP’s earning potential comes from the profit split; a principle which effectively aligns incentives between general partners and limited partners.
Fees should always be reasonable. Too thin, and the operator may have trouble paying their bills or retaining top talent, ultimately struggling to effectively manage the investment. Too fat, and they may be more motivated to buy more deals than focus on the ones they already have under management.
Hold Time
Most syndication deals project a 5-year hold. A project’s hold time is the expected number of years from purchase to full disposition (sale). In its simplest form, it can be thought of as how long your money will be tied up.
Remember, investors’ money is deployed into that property. Once the funds are invested in the deal, investors will not be able to sell their position not get the money back until the project is complete, and the asset sells. Once the asset sells (when the deal goes ‘full cycle’), investors’ initial principal will be returned, plus profit on sale.
Keep in mind, if the real estate market is unfavorable nearing the 5-year mark, the sponsor can elect to hold the asset until conditions improve. Conversely, if the market is booming and the sponsor can generate a quick win for investors, the deal could be sold early. We’ve seen many deals go full cycle much earlier than anticipated, generating the same return that was initially expected to take 5 years in 18 or 24 months.
Investor Distributions
Completely passive cash flow is the very best part about investing in syndications.
Some deals produce cash flow during the hold period, and some do not. If you were to invest in a 500-unit apartment complex which is 95%+ occupied on the first day of ownership, you would expect that deal throw off passive cash flow, just like a rental house.
Some other deals, like ground up development projects, do not throw off cash flow for obvious reasons. There’s nothing to rent, therefore there’s no income while the project is being built.
For deals that do cash flow, distributions occur either monthly or quarterly depending on the operator. Funds are deposited directly to your bank account via ACH.
Accreditation
Syndications are often limited to accredited investors only. What is an “Accredited Investor”? If one of the following apply to you, you are an accredited investor.
Income over $200,000 (individually) or $300,000 (with spouse or partner) in each of the prior two years, and reasonably expects the same for the current year (*note company 401k contributions count)
OR
Net worth over $1 million, excluding primary residence (individually or with spouse or partner)
By way of income, most pilots are accredited investors without even knowing it, or will be soon. Accredited investors can invest in securities which are exempt from registration with the Securities and Exchange Commission (SEC). This SEC limitation is in place to protect inexperienced investors from being taken advantage of and placing their money in investments they may not fully understand.
If a syndication is limited to accredited investors, the General Partner must obtain a 3rd party accreditation verification for each investor prior to accepting their funds. This simple step takes less than 5 minutes to complete.
It can be accomplished either by an investor’s own CPA or attorney filling out a one-page form, or by utilizing a self-service third-party verification site such as Verify Investor or Parallel Markets.
Turbine Capital covers the cost of these services, and this letter is valid for 5 years.
Summary of Real Estate Syndication
To recap, a real estate syndication is simply a pooled investment vehicle where many investors (LPs) combine their resources to acquire a property (or portfolio of properties) which would be too large or complex to acquire individually. It is a partnership with a professional real estate team (GPs) who oversees every aspect of the project.
It involves partnerships with experienced real estate professionals, such as developers, property managers, and asset managers. The collaborative approach lets investors leverage the operators’ knowledge, skills, networks and superior property management, all of which increase the likelihood of a successful investment.
If you’d like to learn more about real estate syndications including upcoming deals and webinars, consider joining Turbine Capital’s Investor Club. This is the number 1 resource for pilots interested in commercial real estate content and upcoming investment opportunities.