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There is no shortage of ways to invest in real estate, and there are options for just about anyone. One type of investment that has grown in popularity in recent years is multifamily syndication.
This type of investment opens up real estate to investors who have been turned off by the idea of being a landlord, or just having an asset to constantly worry about. Real estate syndication is a great option for this type of passive investor.
What is multifamily syndication?
A multifamily syndication is a real estate investment with multiple investors pooling their money to purchase the asset. There is a sponsor that locates the deal, coordinates the transaction and financing, and manages the investment once the deal has closed. This sponsor is the general partner. Passive investors supply most of the capital required in exchange for equity in the real estate.
Any type of real estate investment can be used for a syndication deal, but multifamily is currently the most popular. Multifamily investing is more attractive to a lot of investors because they usually provide consistent income and are considered one of the safer types of real estate investments.
Why invest in multifamily syndication?
The primary reason investors like syndication deals is that they are passive. The investor doesn't have to be involved with any of the property management or worry about tenant phone calls or the accounting.
Syndication has benefits over many other types of passive investments.
- The investment is protected by the real estate asset.
- Profit from cash flow, appreciation, and equity build.
- The ability to participate in larger commercial real estate deals you otherwise may not be able to.
- You can be selective of the properties you are investing in, unlike with a blind fund or a real estate investment trust (REIT).
It's hard to dispute that real estate is one of the greatest investments with all of its unique tax benefits. However, a lot of people are either too busy to be a landlord, or simply have no interest in dealing with it.
Even having a property management company doesn't make real estate investing a passive investment. There are still decisions you have to make and capital expenditures you may have to come out of pocket for.
Syndication allows investors to take advantage of the benefits of owning real estate, but without the responsibilities that normally go along with it.
How a real estate syndication deal is structured
Most multifamily syndications follow a similar structure, but they all have some differences. There are differences in the type of entity that's formed for the deal, the fees, the equity and cash flow splits, and the investment strategy.
- The deal sponsor finds a multifamily property and puts it under contract.
- The sponsor forms either a limited partnership or an LLC.
- A private placement memorandum is drafted. This outlines the specific details of the investment and how the partnership is structured, discusses risks, discloses all fees associated, and includes the subscription agreement.
- Any required SEC registrations or notices are filed.
- The syndication sponsor secures the financing on the investment. They are the one that signs on the loan and are responsible for it. The other investors aren't liable for the repayment of the loan.
- The sponsor finds potential investors for the capital requirements on the deal.
- The deal is closed once enough money is raised to cover the down payment and closing costs.
- The sponsor manages the investment. They may or may not actually manage the property. Oftentimes, a third party property management company is brought in.
- The deal sponsor distributes the cash flow to the investors based on the agreed-upon structure.
- The exit strategy typically involves selling the property at some point in the future. This is usually somewhere between five and 10 years down the road. The investors receive their share of the equity from the sale. The plan is usually for this to be more than the original investment. They should profit from any appreciation and equity built from paying down the principal balance on the loan.
How much money do investors make from a syndication investment?
Unlike a joint venture situation, investors in a multifamily syndication don't receive the full value of their investment in equity. For example, if the deal requires $1 million in capital, an investor who contributes $100,000 doesn't get 10% of the equity.
The sponsor gets a piece of the equity in exchange for putting the deal together, signing on the loan, and managing the asset. The equity splits vary from one syndicated deal to another and from one sponsor to another. You can typically expect to see an equity split of 80/20. The investors get their proportionate share of 80% of the equity, and the sponsor gets 20% of the equity.
For example, the preferred return may be set at 7%. This means that any return up to 7% has to be distributed to the investors. The preferred return rate is known as the threshold.
The sponsor in this example would start to receive a portion of the cash flow after the threshold is met. If the annual cash flow ends up being 8%, the sponsor and investors will split the difference of 1% according to the subscription agreement.
The method of how the distributions are split after the threshold is met vary depending on the deal. The waterfall method is a common structure. This is where the sponsor begins receiving a higher percentage of the profits as the return increases.
Who can invest in an apartment syndication?
There are multifamily syndications that pretty much anyone can invest in, but most are reserved for accredited investors. This means that the investor has to have an annual income of at least $200,000 for the previous two years or a net worth of at least $1 million. The minimum income increases to $300,000 for married couples.
These syndications are structured under SEC Rule 506(c). This is a securities exemption that makes it easier for real estate investors to seek capital from other people, but the investments can only come from an accredited investor.
Non-accredited investors can invest in syndication deals, but they have fewer options available. Real estate syndicators have more stringent and expensive SEC regulations to meet if they want to accept money from non-accredited investors. Even on this type of apartment deal, the real estate investor has to be considered a sophisticated investor. This means that they understand the investment, how it works, and can make an informed decision.
How to find multifamily syndication deals to invest in
You can find a multifamily syndication investment opportunity through equity crowdfunding websites or local investors or by searching for private real estate investment companies that specialize in multifamily syndication deals.
Networking with other investors is a great way to find a safe and profitable multifamily syndication deal. Talking to other multifamily investors about properties they've invested in with a syndicator and any syndicators they might know is a good option for finding multifamily investments to partner on.
Just like any other real estate investment, you want to do your due diligence on the multifamily investment that's being offered as well as the person or company sponsoring the deal. You're investing in not only the property but the sponsor as well. You have to be able to trust them with your money.
What to watch out for in a syndication investment
The private placement memorandum will likely be very long and have the disclosures on fees, splits, and any other financial matters buried throughout it. It may be daunting to read, but you should do it anyway. It would also be wise to have it reviewed by an attorney.
It's common for the deal to involve various fees paid to the sponsor. The multifamily deal having fees isn't necessarily a cause for concern on its own. The amount of fees and the number of them are important to understand. Some sponsors may try to charge so many expenses to the investors that it's difficult for them to make money.
Common fees include:
|Asset management fee||1% to 2% annually|
|Acquisition fee||1% to 3%|
|Loan guarantee fee||1% or flat fee|
|Disposition fee||1% to 2%|
Some sponsors may even require that their initial costs are paid out of the net income before any distributions are made.
There will also be a property management fee to consider. If the sponsor is acting as the property manager, they will collect this. Otherwise it will be paid to the management company.
Property management fees vary based on the type of property, the size of it, and the location. The management fee could be anywhere from 5% to 10% of the gross rental income.
You will also want to pay attention to how the equity is paid at the end. This may be paid out according to the agreed equity split, but some syndicators have been known to take an additional cut of any equity built during the investment period.
For example, let's say the split was 70/30 and the initial equity was $1 million. The apartment building is sold five years later, and the net proceeds from the sale amount to $2 million. The syndicator may take 50% of the $1 million difference, then split the remaining $1.5 million according to the 70/30 split.
In this case, the syndicator gets 50% of the $1 million made on the deal, so $500,000. Then they take 30% of the remaining $1.5 million.
The investors get 70% of the original $1 million equity back and 30% of the remaining profit from the sale.
In this scenario, the investors barely made any money from the sale. They would receive $1.05 million on the $1 million in equity they contributed.
In reality, after accounting for the acquisition and loan guarantee fees, they would have probably lost money on the equity side.
Pros and cons of investing in multifamily syndication
A lot of passive investors love multifamily syndication, but there are no perfect investments. Even the best real estate investment has its advantages and disadvantages.
Here are some of the pros and cons to consider with multifamily syndication investments.
|Passive investment.||No control over the property.|
|Managed by an experienced multifamily asset manager.||Giving up equity to the sponsor.|
|Access to bigger real estate deals.||Relying on the sponsor to manage the asset properly.|
|No tenant phone calls or other landlord headaches.||No liquidity -- money is usually tied up throughout the full investment period.|
|A simple way to add real estate into an investment portfolio.||Limited options for selling your shares in the investment.|
Does a syndication investment sound right for you?
A multifamily syndication is a great investment option for real estate investors who don't have the time or desire to manage their own investments. The ability to invest in real estate that you can essentially forget about is attractive to a lot of investors looking for passive income.
Even some active real estate investors who want to get involved with larger properties, or properties in different markets, love getting involved in syndications. On the other hand, investors who like to have more control over their investments might not like the passive structure so much.
If you're comfortable with leaving your cash tied up for three-plus years, are interested in passive investments, and can find a deal that meets your expectations, investing in a multifamily syndication may be a great option for you.
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