In its most basic form, the real estate syndication is the solicitation and pooling of multiple investor’s money to acquire an existing asset or develop a new project and distribute the profits (or losses) to the investors and the syndicators. The person organizing and syndicating the Project is commonly referred to as the sponsor. The investors are passive investors and do not participate in locating and evaluating the property, the construction or rehabilitation of the project, or the lease-up or further day-to-day operation of the project.
A sponsor of a Washington syndication is required to comply with Securities Act regulations as well as regulations of the Washington Department of Financial Institutions. Typically, a private syndication is a non-registered offering using one of the Securities Act Regulation-D exemptions that relies on what is negotiated between the sponsor and the passive investors. Non-public offerings under Rule 506(b) and (c) require filings be made within 15 days of the first sale or delivery of a signed subscription agreement.
The sponsor is required to provide the investors with all material information necessary to allow the investor to make an informed decision concerning the investment, which should include a private placement memorandum and an operating agreement for the legal entity to be syndicated. A sponsor who omits material facts or make untrue statements of material facts in connection with the offering violate state law.
The majority of real estate syndications are formed as a limited liability company, or perhaps as a limited partnership. The rights and duties of the sponsor and the investors are set forth in the LLC operating agreement or LP partnership agreement.
The sponsor will use the investor’s money as an equity investment for the Project – to acquire the real property or project, entitle the project (in the case of a new development or substantial rehabilitation), and/or to satisfy the lender’s equity requirements – in addition to the lender’s traditional financing secured by a deed of trust against the project.
As compensation for the sponsor forming the deal, the sponsor may receive fees or a promote share of the cash flow and profits. Fees may include an origination fee (0.5% to 1%), acquisition fee (1% – 3%), sales or assignment fee (1% to 2.5%), loan fees (1% to 2% of loan amount), closing fees (1% to 2% of closing costs), a cash disbursement fee (a percentage of cash flow, often between 10% and 50%), a loan guarantee fee (1%), a development fee (3% to 5%), and a property management fee if the lease-up is handled by the an affiliate property management company (2.5%), and a disposition fee (1%).
The benefits to investing in a syndication is that an investor can leverage a sponsor’s expertise into a substantial profit, own a small percentage of a project much bigger than the investor ordinarily could afford, and does not require the investor be involved in the day-to-day operation of the asset. Potential investor profits include cash distributions paid quarterly or annually (preferred or non-preferred and then according to the profit split) and upside potential paid at disposition of the asset.
Investing into a real estate syndicate requires due diligence on the part of the investor when evaluating the investment. The investor must understand the risk and reward, agree on the syndication goal (income-tax avoidance, appreciation, etc.) and accept the time-frames set for the investment to progress or mature. Some syndications are over in 6 to 12 months, while others may take up to 10 years. The potential investor also should carefully consider the individual sponsors of the syndication project, including expertise, historical performance, and individual’s background, as well as consult with their legal and financial advisors on the merits and risks of the investment.
Historically, and particularly when the real estate market is hot as it is today, fraudulent syndication schemes or sponsors without adequate experience appear, which have resulted in the investors losing large sums of money. Due diligence must be exercised in evaluating the investment as well as the history and track record of the promoters.
If you are considering syndicating a real property investment, or are evaluating the merits of a potential syndication investment, I am always happy to chat about a prospective project, offer insight about the market, and assist you in any way that I can.