What is a Syndication?
A real estate syndication pools money from many investors to buy a property none of them could buy alone. The general partner finds and runs the deal. Limited partners put in capital, share in the cash flow and profits, and have no landlord duties.
We use syndications to get into opportunities to get away from the mom and pop chaotic and highly competitive space of under $1M-$2M deals.
In addition, we try to stay under $10M-$20M purchase price sizes so we do not compete with larger institutions or hedge funds who are mostly interested in capital preservation not optimizing equity growth.
You can syndicate anything from a shave-ice store or pizza store to a multi-million dollar development. I just try to stay in my lane and focus on cash flowing real estate where the tenant demand is high.
By Lane Kawaoka, PE. Track record: $2.1B in past real estate acquisitions, 65+ projects and 10,000+ units acquired.
This content is a sample of our comprehensive Syndication eCourse, available for FREE to club members.
What are the Various Roles in a Syndication?
Whenever you are learning something new like ballroom dancing for example its best to learn the definitions first. Then once you understand those we will build up on the concepts. Remember mastery only happens with the right Mastermind and actually jumping into deals.
I use an airplane analogy when I explain these syndications.
In an airplane, there are the General Partners (GPs) who act as the pilots and fly the airplane (find deal, negotiate, find investors, line up lending, manage the 3rd party property management, operate the investment).
They are interchangeably known as the Sponsor, Lead, Manager, Operator, or Syndicator. Being in over a dozen different arrangements I can tell you that sometimes there can be a lot of dead weight in a GP however if you are looking to be in the GP you need to help with the deal with 1) finding it, 2) doing the grunt work, 3) bringing in a lot more capital than a typical Limited Partner.
Here is what the GP does and why they deserve the extra compensation:
- Source and identify assets
- Underwrite and discover hidden value
- Pursue, negotiate and win deals
- Develop asset business plans
- Negotiate purchase and sale agreements
- Conduct thorough due diligence
- Secure financing
- Close deals
- Manage assets
- Lease to new tenants
- Renew leases with existing tenants
- Perform and manage capital expenditure projects
- Execute asset business plans
- Dispose of assets; and
- Deliver investment returns
In coach, you have the passive investors or Limited Partners (LPs) who come on the plane and go to sleep. LPs provide most of the money to finance the deal and in return they receive equity, a monthly or quarterly cash distribution off cashflow, and receive profit shares when the property is sold (based on their equity shares).
Why Invest as an LP in Syndication?
1. Minimizing Headaches: No more managing tenants, vacancies, maintenance and managing an on-site manager whose pay is not tied to your results.
By passing the control of the day to day operations to true experts who are literally partners (direct alignment of compensation and motivations), you can assure the investment is being optimized while you spend your time on what you want which is 1) making more money at your day job, 2) spending time with your family or 3) finding that one off deal that you want to do one your own while pairing with a Limited Partner strategy.
2. Asset Diversification: Many commercial real estate investments have high acquisition prices (think $10M+) where most people don’t have access to. You want to get away from these other Mom and Pop invests like these 1-40 units. When I was new to syndications, I thought I could do everything myself and did not trust anyone. I then realized in a few months that 1-40 unit deals had horrible pricing because all the amateurs were involved and the ones that looked good from a per unit price prospective were under 80% occupied and had ISSUES.
Investing passively in a group can allow you to invest in multiple asset classes (apartment/mobile home/assisted living), in multiple locations and with varying business plan duration.
3. Avoid Credit and Liability Risk: Investing passively allows one to avoid being exposed to credit or liability risk. Documented W-2 income is not required. You do not need to personally guarantee multi-million dollar loans. Your credit also stays free for other uses, such as credit cards and tradelines.
What is an Accredited Investor?
An accredited investor is defined by the United States Securities & Exchange Commission as someone who:
- Made a minimum of $200,000 ($300,000 if filing jointly) in the previous two years
- Have a net worth of 1 million dollars excluding personal residence.
The significance of being an accredited investor is that you can invest in things that those with less money, cannot. You can also be something called “a sophisticated investor” which has a much more nebulous definition but essentially says you know what you are doing even if you don’t have that much money. These laws were put in place long ago to “protect” the average person from predatory activity.
The 2012 JOBS act made it easier for Main Street America to participate in “alternative” investments via crowdfunding and made it easier for sponsors to advertise previously unknown opportunities. However, we have a long way to go. I would advise you that you need to know the lead syndicator personally. None of this “we met at a local REIA and he pitched me his deal”. A sponsor without a list of solid investors likely lacks the track record.
How Does a Non-Accredited Investor Get Into Private Deals?
Most private offerings, including ours, are open to accredited investors only. If you are not there yet, use the free courses on this site to prepare.
Some tips for getting into 506B – Deals that accept non accredited investors.
- Understand that many syndicators will have a no Non-Accredited policy
- Be serious and get educated so when you build a relationship with a syndicator you separate yourself from investors who are only browsing
- Always give a reason for not investing, always close the communication gap
- Be forthcoming if you are only exploring
- Add value to the syndicator, respect their time. They are interviewing you as much as you are interviewing them.
Two Types of Syndications
A single (of finite number of assets) that are going to be put into the ownership entity. For example we are going to syndicate the purchase and rehab of a 200-unit apartment complex at 123 Main Street. The assets are identified before capital is raised. This allows sophisticated investors to vet the deals on an individual basis.
A Blind Pool Fund (like a real estate fund) where capital is raised based on the sponsor’s vision, track record, and reputation. The capital is raised first the sponsors will then go out and acquire properties.
Generally speaking, I recommend investing in a specific property.
A blind pool allows a syndicator a lot of freedom to go out and find an asset. I have seen more scams in blind pools partly because its hard to track the dollars.
I like to invest in a specific property that you can vet the asset’s past performance and understand the business plan before the team picks it up.
Syndication Property Types and Deal Structure
Location: They are bought in growing cities that have diverse economies and large populations. The properties and locations are typically Class B which attracts the largest group of potential working class tenants.
Price: Deal prices can range from $5-$75 million. 20% of the deal price plus a little extra for those “value adds” needs to be raised to fund these deals.
Equity Split: The common share in ownership between LPs and GPs is a 70/30 split. LPs get 70% of the total equity for providing most of the money to fund the deal while the GPs get 30% for finding, executing, and maintaining the deal.
Timeline: The typical investment time frame is 5 years.
Property Type: Most commonly bought are large “multifamily” rental properties (apartments). They have “value-add” opportunities (adding amenities, remodeling unit interiors, fixing up exteriors, or improving management). These “value-adds” are intended to raise the property’s income and value, though results depend on execution and the market.
Property Size: These deals can range from 100-500+ apartment units that have amenities such as pools, gyms, management offices, etc.
What are the Returns for Syndications?
In terms of returns, being the direct operator normally produces higher gains. However with my track record I consistently lost money on 3 out of every 10 rentals, but overall I hit my anticipated $200-$300 per month cashflow per property. Throw in the chance of a disaster tenant in there like my $30,000 repair bill and a few months of vacancy and you can see how you can quickly go into the red.
The only way you can protect from this volatility is to get more properties.
Something to think about in a correction if you are buying turnkey/retail properties is that you will likely be in the red with equity as unlike being a passive in a syndication you are not buying with forced appreciation.
Returns vary widely by deal, sponsor and market, and past results don’t predict future ones. In terms of risk you are putting a lot of risk that the General Partners will uphold their fiduciary roles.
Many LPs invest from the executive summary alone, without reading the trailing 12-month profit and loss statement or the rent roll.
A spreadsheet is a starting point. To vet a deal properly you also need to vet the people, which takes a network.
What is Preferred Equity?
Preferred equity in real estate investing refers to a form of ownership interest that has certain preferences or privileges over common equity. It’s a hybrid security that combines features of both debt and equity. Investors who hold preferred equity in a real estate deal have a priority claim on the property’s cash flows and proceeds in the event of a sale or liquidation.
Here are some key characteristics of preferred equity in real estate:
Priority in Distributions: Preferred equity investors typically receive distributions before common equity investors. This means that, in the distribution of profits generated by the property, preferred equity holders are entitled to their share first.
Fixed or Stated Return: Unlike common equity, which participates in the property’s performance, preferred equity often comes with a fixed or stated return. This could be a percentage of the invested amount or a specific annualized return.
Limited Upside Participation: While preferred equity investors may enjoy a fixed return, their upside participation in the property’s appreciation is often limited compared to common equity holders. Common equity investors have more potential for higher returns but also bear more risk.
Seniority in Liquidation: In the event of a property sale or liquidation, preferred equity holders have a senior claim on the proceeds after satisfying any outstanding debt obligations. This means they are ahead of common equity investors in receiving their share of the remaining funds.
Risk Mitigation: Preferred equity is considered less risky than common equity because of its priority in cash flow distributions and liquidation proceeds. However, it is still riskier than debt, as preferred equity investors do not have the same level of security as lenders.
Investors in preferred equity are essentially taking a position between debt and common equity in the capital stack. They receive certain protections and a preferred return, making their investment more secure than common equity but with potentially higher returns than debt.
It’s important for investors to carefully review the terms of preferred equity investments, as these can vary significantly between different deals. Understanding the specific rights, preferences, and potential risks associated with preferred equity is crucial for making informed investment decisions in real estate.
Things we look for when we tour properties:
- An entrance sign or logo that looks dated. It should look current to attract good residents.
- A logo too small or the wrong color to be seen from the street.
- Landscaping and garden strips that are not maintained.
- Exterior paint colors that do not match across buildings.
- Stains on exterior walls.
- Tenant furniture left out in front of units.
- Tenant barbecue grills in front of units, which are a fire hazard.
- Interior light fixtures that do not match, such as a mix of white and yellow bulbs.
- Kitchens and bathrooms that look fine but need a deep clean.
- Mismatched appliances, such as a white refrigerator next to a black oven.
- Cabinet stain that does not go with the appliances.
- Private backyards that are not fenced. A fenced yard can support higher rent.
- Pool areas with few touches such as umbrellas, a gazebo or arranged chairs.
- Too few benches, or picnic tables that could be reused elsewhere on the property.
- Public grills that are rusty or placed too close to seating.
The Numbers
Asset Types for Multifamily Offering
These assets are located in prime, urban areas (e.g. Downtown Chicago, Manhattan) and are most currently built. They are not difficult to maintain and do not require any renovation. They can provide steady income with low risk.
Here, location can be either in the city or submarkets within the city that gives liquidity. Properties are still new so very few renovations are necessary. Leverage can be about 45% to 60% in these real estate properties.
Most often, there are maintenance problems or operational issues with these investment properties. These have higher leverage than Core Plus properties which is 60% to 75%.
Unfortunately, these properties provide the most uncertainty of all and also the riskiest yet can provide the highest return capacity. Located mostly in newly developed areas and possibly on highly distressed sites. They have very high leverage of approximately 75% to 90%.
Essential Steps of Multifamily Investing
Discover Sponsors and Review Deals
- Assess the General Partner’s (GP) background, team, and track record.
- Inquire about challenges faced and problem-solving strategies.
- Verify communication methods, availability of quarterly reports, and reinvestment rates.
- Evaluate GP’s contribution to deals using personal capital and their market and investment strategy.
Evaluate and Determine Market Location
- Scrutinize market metrics: population, job diversity, income advancement, property value growth, tax laws, and crime rates.
- Request market-specific data from the GP, such as vacancy rates, rent growth, and market cap rates.
- Be cautious of marketing tactics and seek additional information about property details.
Evaluate the Multifamily Property
- Understand the risks by evaluating property class (A, B, C, D) based on construction, amenities, and location.
- Consider potential cash flow and necessary improvements based on the property’s class.
Comprehend Deal’s Structure
- Understand equity ownership split (commonly 70/30), preferred return (6%-10%), and profit split structures.
- Know the holding period (3-10 years) and various fees (acquisition, asset management, disposition).
- Be wary if sponsors do not charge any fees.
Grasp Underwriting Principle
- Compare projected and existing operations.
- Verify purchase price with sales comps, rent increase projections, and accurate tax calculations.
- Examine purchase and exit cap rates for conservatism.
- Assess refinance predictions, break-even occupancy rate, and reserves availability.
Be Critical With The Legal Documents Needed
- Familiarize yourself with legal documents like Subscription Agreement, Operating Agreement, and Private Placement Memorandum (PPM).
- Consult with an attorney to understand obligations, expectations, and implications of entering the contract.
Multifamily investments are complex. Careful due diligence and a clear reading of the legal documents help you judge whether a deal fits you.
About the author
Lane Kawaoka, PE, is the founder of The Wealth Elevator and the author of two Amazon bestselling books, The Wealth Elevator and Simple Passive Cashflow. He spent 12 years as an engineer, bought his first rental in 2009, and left his job in 2019. He built his base in real estate and today is a general partner, operator and fund manager working with a community of accredited investors across real estate, oil and gas, and private companies. His track record: $2.1B of past real estate acquisitions, 10,000+ units acquired, 65+ projects, and $230M+ raised.
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