As you consider starting your own real estate syndication, approach it as a career change rather than a hobby. It can be infinitely rewarding, but it requires a shift in skills and energy and the assumption of responsibility for your own financial well-being and that of your investors.
Kent Ritter is an experienced multifamily investor and operator helping you to build real wealth through real estate syndication. Learn More
Effort vs. Reward:
Why Form a Real Estate Syndication
When you are ready to flip your role from being a passive investor to gathering passive investors for a real estate endeavor, it is time to start a real estate syndication.
Taking on the role of a syndication sponsor means assuming significant financial responsibility, and not only for yourself.
The U.S. Securities and Exchange Commission (SEC) requires that you form a syndication when creating a real estate project that includes passive investors. Doing so establishes a fiduciary relationship between the syndicator and the passive investors. As a result, the syndicator assumes a heightened responsibility of defining the risks and returns to the investors and protecting the investors rather than engaging in self-dealing.
These abstract responsibilities manifest into a myriad of concrete tasks and duties in a real estate syndication operation. For example, the sponsor conducts the purchase transaction, implements and oversees the running of an income-producing property, optimizes the building’s profits, and eventually terminates the project by selling the property. And then, the process begins all over again with the next property.
Sponsors shoulder these duties to escape the traditional 8 to 5 workday, create flexibility in their schedules and regain control of their lives, all while potentially earning life-changing amounts of money. Being a sponsor isn’t easy, and it is no hobby. It requires dedication and effort.
If all this sounds appealing, here’s how to get started.
Find Your Niche
The expertise and knowledge of a syndicator draws potential investors and convinces them to contribute significant amounts of capital to your project. First, choose the type of income property you want to invest in and the market in which you want to target.
Syndications operate in many asset classes. Multifamily housing is a perennial favorite due to reliable monthly income from tenants, but syndications also invest in shopping malls, commercial spaces, storage, and more.
Obtain Training
If you lack real-world experience in the asset class you want to pursue, get some training from those with first-hand experience. One of the reasons I suggest choosing your asset class first is to facilitate effective training.
Many experienced syndicators offer one-on-one workshops or on-demand courses, as a crash course in syndications and the asset class with which they often work.
This is also an excellent time to familiarize yourself with financing options for the asset class you intend to pursue. Depending on the type of loan product you choose, the financing process can take several months. Know this as you go into the deal, in order to manage everyone’s expectations and keep the project on track.
Start Your Brand
At this point, you will want everything you do and every contact you make to connect back to your syndication company. If you haven’t already, create a consistent, cohesive brand. Most importantly, make it easy for people to find you by creating a syndication website.
Most syndicators structure their company as a limited liability company (LLC) for their flexibility and liability protection. They can have multiple types of shares, allowing you to create multiple tiers of investors with different stakes in the profit.
Once you have a name, it’s time to start marketing it.
Make Connections and Create a Database
Syndications rely on capital contributions from passive investors, so it only makes sense that finding and locking in those investors is a critical part of starting a real estate syndication. It is never too early to begin networking and creating your database of investors.
At this point, you are only creating a pool of potential investors rather than requiring a commitment. That comes later.
Form Your Team
While we often refer to the sponsor as if they single-handedly manage all aspects of the property, they work with a professional team. The makeup of that team varies based on the skills that the sponsor brings to the table.
Most syndications require the services of a real estate attorney, real estate broker, syndication attorney, mortgage broker, and property manager.
Get a Property Under Contract
Finding the right property can be a long process, so pace yourself with this step. It may take several months.
You will start by analyzing potential properties that fit your business plan. Then, when one meets your requirements, send a letter of intent. Likely, you will send out many letters of intent on different properties for months before winning the bid.
After getting the property under contract, prepare for a period of intense work. You will conduct due diligence on the property; and the information you and your property management company gather during the due diligence process will be needed to most accurately and realistically provide information to potential investors.
Work With an Attorney to Draft Syndication Documents
Now that you have a specific property to work with, it is finally time to start sharing information with potential investors and get commitments from them. To do this, you will need a collection of documents usually prepared by an attorney, specifically one knowledgeable about securities.
The right attorney does more than just draft; they also advise, helping you decide how to split profits with investors, how to structure the company, and how to remain compliant with all rules and regulations. The offering package consists of the following documents:
- The Private Placement Memorandum (PPM), which acts as a disclosure document detailing the structure of the company, risks, projected distributions, notice of liquidity of the investment, and other details that an investor needs to make an informed decision.
- The Operating Agreement is the contractual agreement between the sponsor and passive investors. It defines the rights and duties of each party and includes details like the bylaws and fees collected by the sponsor.
- The Subscription Agreement requires the investor to declare how much money they are investing. They must also certify that they meet the qualifications to participate, such as whether they are an accredited or sophisticated investor.
- The Investment Summary or Business Plan acts as the first line of marketing to entice passive investors. It explains the project and makes profit projections. Some syndications attach the purchase agreement, appraisal, and property inspection to the Investment Summary.
Search for Investors
Most likely, you started this step earlier, but this is the point that you must accelerate efforts to find investors. Now that you have a specific property and marketing materials, you have something concrete to offer.
Find investors through your professional or private connections, through real estate networking groups in-person or online, or engage a professional company to create digital marketing.
Your options for finding investors vary based on the syndication’s SEC filing stats. Syndications established under Rule 506(c) may broadly solicit and generally advertise an offering, but all investors must be accredited.
Alternatively, Rule 506(b) syndications can accept up to 35 non-accredited investors, but that comes with a prohibition against general solicitation and advertising.
Secure Financing and Close the Deal
Passive investors only contribute a portion of the purchase price, so you will have to find financing for the remainder. Again, this is where preparation in the early days of starting a syndication pays off, as this should not be the first time you are contacting brokers or applying for loans.
As part of the financing and purchase processes, you will finish due diligence and work with any discoveries that popped up along the way.
Finally, this is also the time to lock in your passive investors.
What to Expect as a Sponsor: Profits
Generally, the bulk of a sponsor’s profits come from the asset’s income, meaning that the better the property performs, the more the sponsor earns. However, syndications usually include additional fees that are not based on performance metrics. Instead, they are payments for specific tasks that would have to be outsourced to third parties if the sponsor did not perform them.
- Sponsors often collect an acquisition fee of 1 to 3 percent of the purchase price upon closing the property. This compensates the sponsor for finding the property, conducting due diligence, securing financing, and structuring the deal.
- Fees can also be collected on a monthly basis, like the asset management fee. The asset management fee is an ongoing payment for executing the business plan and may be another 1 to 3 percent of monthly revenues.
- Upon sale of the property, the sponsor may earn a disposition fee for selling the asset. Much like the acquisition fee, it compensates them for their endeavors in terminating the syndication.
- Refinancing fees and loan guarantor fees may apply if the sponsor arranges for a refinance of the property or must personally guarantee the loan.
Final Thoughts
Studying is never the wrong place to start any new venture. However, consider starting as a passive investor if you want real estate syndication to be your future. You benefit from the expertise of an experienced sponsor and get a front-row seat to the process while building your network.
Kent Ritter is an experienced multifamily investor and entrepreneur empowering you to build real wealth through real estate syndication. Learn More.
