Commercial Real Estate Syndication for Beginners
When I first got started in commercial real estate, I thought there was only one way to go:
Save money for years and years until you finally have enough to do a deal on your own
And for some, that’s certainly a good way to go.
I thought the same way until I learned about syndicating real estate at a mastermind in Austin, TX.
It completely opened my eyes to how I could grow my investment portfolio bigger and faster while having less of my own cash, which we all know is a finite resource, in each deal.
Here’s my guide to commercial real estate syndication for beginners.
What Is a Commercial Real Estate Syndication?
A commercial real estate syndication is a way for investors to pool their funds together in order to buy a larger and more stable asset than any of them could on their own.
Since they are an investment offering, real estate syndications are governed by the Securities and Exchange Commission (SEC), so each offering must file documentation with and report to the SEC.
Now, syndications are not limited to commercial real estate.
In fact, you could syndicate just about anything you want: private jets, professional sports teams, even a Snickers bar, as Apt-Guy Bruce Petersen likes to say.
While the intent is generally to build wealth and passive income through a syndication, it doesn’t necessarily have to be for profit, but good luck finding investors to join you on your venture if it’s not.
Some of the pros of real estate syndication include:
Larger assets and projects
More stability due to higher unit counts and / or location
Less money out of your pocket if you’re the syndicator / deal sponsor
Completely passive real estate investing and cash flow if you invest with a sponsor
They can support onsite, professional management
And, all of the tax benefits, forced appreciation, and write offs just like any real estate investment
Let’s break each of those down a little bit more.
Larger Assets and Projects
Again, since you’re pooling your funds together with other investors, you will have a larger combined buying power.
Instead of just bringing your $100,000 to the table, you could team up with 9 other investors, each with $100,000, to get to $1,000,000 in buying power - really expanding your potential investment pool.
Now, instead of being limited to a $400,000 total purchase price (including debt), you could buy up to $4,000,000 - and you didn’t have to bring all of that equity on your own.
Larger assets tend to hold their value better and are more liquid than smaller properties since the buyer pool is better capitalized and seeking the confidence in income that larger assets can bring.
More Stability Due to Unit Count and / or Location
Larger projects typically mean more units - especially if you’re in the multifamily, office, and retail world.
More units inherently brings more stability. If you invest in single family homes and your tenant moves out, you now have 100% vacancy. That means that instead of your investment paying you, you will now have to cover any and all expenses on that property until you find a replacement.
If you have a tenant move out of your 200 unit apartment complex, you won’t hardly notice a hit to your bottom line since you have many other tenants paying you rent and covering those expenses.
And real estate is all about location, location, location, so if you buy a site in a premium, high-demand area, you won’t have to fight as hard to keep occupancy high as you would if your site was in the middle of nowhere.
Less Money Out of Pocket if You’re the Syndicator / Deal Sponsor
When you buy commercial real estate on your own, you’re responsible for all of the pursuit costs, which are the expenses that you have to pay in order to determine whether an investment makes sense, as well as any and all equity required to take it down.
Now, that can be quite a bit of money.
However, as the sponsor of a commercial real estate syndication, you won’t have to worry about your personal exposure to all of these costs.
While you will still be responsible for the pursuit costs, these are expenses that will be reimbursed to you by the investment group once you’ve closed on a deal. The investors are also bringing the overwhelming majority of the cash needed to close, depending on your deal structure and terms.
So, you, personally, won’t have to carry the burden alone.
Passive Real Estate Investing and Cash Flow
If you’re interested in diversifying your portfolio with commercial real estate but don’t have the knowledge, experience, or desire to find and operate these deals on your own, you could just place your capital with a sponsor you trust and let them do all of the work.
You will still benefit from the cash flow, value appreciation, depreciation of the asset, and more, but you won’t be required to tend to the day to day management of the project.
In fact, most real estate syndicators will send out quarterly reports to their investment group, so your only task could be to review and double-check those reports.
The deal sponsor will be fully responsible for distributing your cash to you and preparing K1s for tax season.
Onsite and / or Professional Management
Having a professional property management team can make or break your investment.
They’re the ones onsite each day dealing with the tenants, preventative maintenance of the building, repairs, budgeting, etc.
Since commercial real estate investments are valued based off of the net income that they bring in, it’s critical to monitor the health of the structure and keep operating expenses as low as is feasible.
A professional management team will know how to balance the well-being of the property with the costs of doing so, because while you definitely want your expenses to be as low as possible, you don’t want them to be so low that you start cutting corners and negatively impacting the site.
Properties of scale have enough income that they can justify covering the expense of a property management company so that you won’t have to deal with all of that yourself.
Other Real Estate Benefits
Just like any other real estate investment, syndications provide a multitude of benefits unlike any other investment vehicle.
Many real estate investors show far less income than they actually bring in each year thanks to depreciation. Since commercial properties are physical structures that age and experience wear and tear, the IRS allows investors to write off a piece of that against any earned income.
Not to mention that since these are not active investments (unless you’re the deal sponsor), you’re taxed as a passive investor, which offers a lower tax rate.
My favorite benefit of real estate investing?
The forced appreciation. Like I said under property management, commercial real estate is valued based off of the income you bring in. So, if you increase the income, you can substantially increase the value thanks to capitalization rates.
Roles within a Real Estate Syndication
Depending on your level of involvement, there are two different roles you can play in a real estate syndication: the deal sponsor or the investor.
Here’s what each of those parties are responsible for:
The Deal Sponsor
The deal sponsor, also called the “syndicator” or “general partner” (GP), is the active party in the investment.
Their responsibilities include:
Finding and sourcing the investment opportunity
Performing all underwriting
Putting together any renovation and operational plans
Raising capital and placing debt
Operating the day to day of the asset
And handling all investor relations, tax returns, K1s, etc.
You can see that the deal sponsor’s responsibilities are a full time job - they don’t have the ability to simply place capital and walk away. They’re responsible for ensuring that the deal comes together as planned.
Sponsors are certainly paid for their work, though, since they’re increasing investor value.
The Syndication Investor
Investors, also called the “limited partners” (LP), are the passive party in the investment.
Their responsibilities include:
Placing capital in the deal
Yep - that’s literally it.
Now, obviously they need to review the deal on their own to assess the abilities of the deal sponsor to pull off the project and whether or not they feel the project is actually viable.
Quarterly, there are reports and financials to review, as well.
But, other than that, there aren’t any true responsibilities or requirements for the limited partners in the deal outside of their initial capital placement, which is why being an investor in a real estate syndication can be so attractive.
506(c) vs. 506(b) Syndication
There are two primary types of real estate syndication: 506(b) and 506(c).
They are more commonly referred to by which investors are generally allowed to invest: accredited and non-accredited investors.
506(b)
The 506(b) offering is referred to as the “friends and family” offering.
Under the 506(b) status, you’re allowed to raise from an unlimited amount of accredited investors and from up to 35 non-accredited investors, meaning you could take capital from anyone willing to invest with you so long as you can prove that you had a pre-existing relationship.
You are also restricted from advertising the offering to the public, so you must source investors from your list or circle of influence.
506(c)
The 506(c) offering is for accredited investors only.
An accredited investor is defined as: a person having an annual income exceeding $200,000 (or $300,000 for joint income) for the last two years with the expectation of earning the same or a higher income in the current year or has a personal net worth exceeding $1,000,000.
Businesses can also be considered accredited and may invest in securities offerings but must have assets in excess of $5,000,000.
The benefit of running a 506(c) offering is that you can openly market the offering to the public, from magazines to Facebook ads.
Real Estate Syndication Structures
There are many different ways to structure real estate syndications.
And they can be as simple or as complicated as you would like for them to be.
I prefer to keep my offerings as simple as possible so that there’s complete transparency and no potential confusion at any point in the process.
Equity / Promote
Syndications can be split between the general and limited partners in many different ways. This split can be taken by the GP as straight equity or could be an earned promote, depending on the group and their goals.
You’ll typically find these splits ranging from 70/30 to 90/10 in favor of the limited partners, depending on the type of deal, the profitability, and level of risk involved. While I have seen deals in the 60/40 to even 50/50 range, it can be difficult for the GP to raise money and I likely wouldn’t invest in such an aggressive structure in favor of the deal sponsor.
Preferred Returns
Some deals will come with a preferred return to the investors.
A preferred return is a minimum return that the deal will have to hit in order for the sponsor to start making any money.
For example, if a project has a 6% return, the deal sponsor must return 6% on the investors’ capital before they can start taking a split for themselves.
I’ve typically seen these preferred returns in the 6%-8% range, but not every project will have one. They can, however, make it easier for the sponsors to raise capital since the investors know they’ll be getting a preferred return on their capital before any splits to the GP.
However, as with any aspect of investing, these are not “guaranteed” returns.
Real Estate Syndication Risks
Are there risks of investing in a real estate syndication?
Absolutely!
As I just said, nothing in the investing world is guaranteed and there is always something that could go wrong.
Savvy investors know that anything could happen - it’s the savvy deal sponsors that are able to pivot and find a way around any obstacles that may appear.
Some of the risks of investing in syndications include:
Increased vacancy due to rents being raised too high
Construction cost overruns that lead to capital calls
Project delays due to weather, political environments, etc.
The bank can call a loan
The general partner disappears into the night
And many, many more.
Some of these, like the general partner running off with investor capital and not finishing the deal, I’ve witnessed firsthand.
However, with an experienced deal sponsor that has a track record of successful projects, you likely won’t need to be worried about any of these scenarios. It’s important, however, that you perform your own due diligence and understand the risk you’re taking on, whether you’re the deal sponsor or an investor.
About The Author:
Tyler Cauble, Founder & President of The Cauble Group, is a commercial real estate broker and investor based in East Nashville. He’s the best selling author of Open for Business: The Insider’s Guide to Leasing Commercial Real Estate and has focused his career on serving commercial real estate investors as a board member for the Real Estate Investors of Nashville.
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