In late 2018, I changed my primary investment strategy to real estate syndications. I’ve invested $100k so far across 2 different apartment complex deals, and plan to fund another 2-3 syndication projects in 2019 also.
What the heck is a real estate syndication anyway??? To help answer this question I’ve asked Michael Bishop from Bishop Investing Group to write a guest post. Michael specializes in private partnerships, and helps investors obtain financial freedom through passive investments in alternative real estate niches.
What is a Real Estate Syndication?
Syndication is when a group of individuals pool their resources together to achieve a large common goal. In commercial real estate, this basically means a bunch of investors partner up and contribute their time, money, and/or expertise to acquire a multi-million dollar real estate asset.
How does this differ from a REIT (real estate investment trust)?
A REIT is a privately or publicly traded company that owns and manages multiple real estate holdings. When you invest in a REIT, you own shares in the overall company. When you invest in a Syndication however, you own shares in 1 specific property. It’s a much smaller, private partnership with fewer legal guidelines or restrictions.
Different Types of Real Estate Syndication:
There are several approaches to syndicate real estate. Most groups usually stay within a specific niche, and become masters of that field. Common niches are:
- New Development: Building brand new structures starting from the ground up, or tearing down old buildings to replace them with new ones.
- Unstabilized Properties: Purchasing assets that aren’t performing well and turning them around to be more profitable.
- Momentum Play: Buying in “hot” markets and following popular trends. A rising tide lifts all boats!
- Value-Add: Buying properties with a goal to increase the value via renovations, repairs, and forced appreciation.
For the purpose of this article, I will focus on value-add plays. I’ll go through the parties involved, typical strategy used, how everyone makes money, and a brief overview of common asset classes.
The main parties in a syndication include the Sponsor, Limited Partners, and the Property Management Team.
The Sponsor is more or less the work horse. They are responsible for identifying the market, underwriting the property, securing financing, overseeing the business plan/renovations, ongoing investor relations, and managing the asset it general.
Needless to say, the Sponsor is the most experienced member of the team, holding the most responsibility.
The Limited Partner, or investor, is a person (or group of people) that puts up the seed money to fund the deal. While most syndication offerings require investors to be accredited*, there are opportunities for non-accredited or sophisticated investors.
Limited Partners typically have limited decision making or voting rights. This isn’t a bad thing… because it minimizes their liability should the property fall subject to loan default or lawsuit. If either of these occurrences do happen, LPs are only at risk for their invested equity, and their personal balance sheets cannot be touched.
The Property Management Team is vitally important to the success of a deal. A good property management group knows the market/submarket intimately, and should have experience in managing similar sized properties.
The PM team manage and place new tenants, deal with leases, and oversee maintenance and renovations. For very large properties (200+ unit buildings) it is very common for the PM team to have a couple full time employees who work on-site.
Others: Many any other people work behind the scenes (brokers, attorneys, CPAs, lenders, contractors, etc.). These people typically help perform specific tasks vs. being involved as a long term partner in the deal.
Typical “Value Add” Strategy
This is the first step in any value-add syndication strategy. A good target market should be a high growth area, with these characteristics:
- Above average population growth
- Above average job growth
- Strong average household income
- Major employer diversification
- Organic rent growth (the rate at which the market rent is growing naturally without any sort of renovation or value-adds)
The ideal property should be stabilized and already performing well. This provides the least amount of risk for investors. It should also be conservatively underwritten, leaving some room for error. A good sponsor never bases their projections off of best case scenarios or statistics.
Lastly, the property should have good value-add opportunities. This is the ultimate goal. The sweet spot is a property that is old enough that renovations will achieve big rent increases, but not so old that it becomes a money pit of maintenance. Due diligence is always performed before purchasing a building, including a thorough physical inspection and a deep financial audit.
The Business Plan:
Once a property has been closed on, the sponsor and management team will immediately begin implementing the business plan. The sooner the value-add activities begin, the sooner the income increases.
Here are some core examples of value-add plans to increase income:
- Interior and exterior renovations = increase rents
- Rebranding and better advertising = fill vacancies
- Adding new amenities (eg. laundry areas, a dog park, shaded parking) = attract higher paying tenants
- Decreasing any unnecessary expenses
Whatever the means, the end goal remains the same – add value to the property by increasing Net Operating Income.
Once the business plan has been successfully implemented, it is then time to either hold or exit the deal. Typically, it is common to see 5-7 year hold periods for value-add deals.
Since nobody can foresee future market conditions, there is no guarantee of a high future sale price. If the market is in a slump, holding onto the property for a few extra years may be the best option. Conversely, if the market is in high demand, it may be best to exit the deal early and sell while the prices are high. Ultimately, this is the decision made by the Sponsor.
How Each Party Makes Money
The Limited Partners, who are majority stakeholders, receive the largest portion of the profits. They receive ongoing cash flow from the operations, and a lump sum payment at the time of sale.
Profits are all split with the Sponsors, at a percentage rate agreed upon upfront. Depending on how the sponsor operates, the structure can be a straight % split (example: 70/30) or a complex waterfall structure (example: 8% preferred to investors, after which a 80/20 split up to XX% IRR, followed by a 50/50 split). All split structures vary by whomever is putting the deal together.
The Sponsor’s main component of income is the split profit with the limited partners, explained above. Sponsors also collect a two other fees to help cover their costs:
- The acquisition fee is a percentage of the purchase price that is paid to the sponsor at the time of close. 2% is a common rate.
- The asset management fee is an ongoing fee that the sponsor collects for their daily activities in overseeing and managing the asset. 2% is common here also.
Sponsors can be, and usually are, also Limited Partners. They invest their own money in each deal which gives them some “skin in the game”.
The Property Management Team earns their piece of the pie in two ways; the construction management fee and the property management fee. The construction management fee is a percentage, typically low single digits, of the total cost of any construction. The property management fee is also a low single digit percentage of the total revenue from the properties daily operations.
Common Asset Classes
- Multi-Family: Multi-family (apartment complexes) are typically only syndicated at the commercial level, usually deals with 50+ units. Anything smaller than this doesn’t make enough money to cover all the legal fees and expenses involved.
- Self-storage: Self-storage is an asset class that has strong recession resistant properties. Like multi-family, tenants rent out the units but at a much cheaper price. Because changing storage units is a pain in the ass, tenants are less likely to leave and therefore occupancy rates remain strong.
- Mobile home parks: Mobile home parks often get a bad rap as “trailer parks.” However, most residents in “sunny state” parks own their homes and are economically more well off than class C and B multi-family residents.
If you would like to learn more about syndication, or would like to discuss investment opportunities, please visit the Bishop Investing Group website or contact me directly via email. Thanks for reading and I look forward to meeting you!
*An accredited investor is an individual who meets at least one of three requirements: (1) an income of $200K for the past two years with the expectation to make the same in the current year, (2) a net worth of $1M, excluding primary residence or (3) a married couple that has had a combined income of $300K for the past two years with the expectation to make the same in the current year.
Disclosure: I have invested $50k with Bishop Investing Group personally, and happily refer others to them also. I do not get compensated for any referrals – my recommendations are solely based on my positive personal experiences.