Business Lawyers in Columbus, Ohio
By Drew Stevens - April 10, 2023 - Commercial Real Estate
Real estate syndication can be a great opportunity for people looking to fund a real estate project as well as investors interested in real estate investing. There’s a lot to know before getting started, including who can be involved in the syndicate and the responsibilities of each person during each phase. Here’s a closer look at the three phases of real estate syndication and other important aspects to consider.
Real estate syndication is when a group of investors pools their money to invest in real estate. It can be a great way for a person to invest in a property that they couldn’t afford to invest in alone. Investors can be individuals, or an investment company can partner with another investment company or companies. The syndicate then owns the property and splits the profits or losses.
A real estate syndicator – also called a deal sponsor – finds a commercial property and creates a private placement memorandum, a document with important information about the investment opportunity, including risks, business information, and how the capital is structured.
The sponsor then looks for accredited investors interested in joining the syndicate and investing capital in the project. There are multiple ways to find investors and raise funds, including through crowdfunding platforms, by registering the offer with the SEC to allow public fundraising, or by reaching out directly to people in your network who might have interest in real estate investing and pursuing an exemption with the SEC.
The investors supply the capital, and the deal sponsor is responsible for acquiring and managing the property, creating and eventually initiating the exit plan, and ensuring everyone in the group stays informed. Real estate syndications typically last 3-7 years, depending on the real estate property.
Real estate syndication can be a lucrative option for sponsors and investors looking for an investment opportunity in real estate. Assets can include commercial properties like office buildings, retail buildings, self-storage units, apartment buildings, land, multi-family homes, mobile home parks, and more. Rental properties can be a great way to generate passive streams of income on a regular basis. The specific apartment or real estate available to investors depends on the real estate market location, how the market is performing, and the properties for which sponsors are currently seeking funding.
Two parties are involved in real estate syndications: the real estate syndicator (deal sponsor) and the investors. Each party plays a different role in the group and has different responsibilities. The sponsor is the manager of the syndicate and the real estate, and the investors provide the needed funds.
The real estate syndicator, also called a deal sponsor or general partner, is in charge of planning and overseeing the investment. The sponsor is more actively involved in the investment than the passive investors. Being a sponsor involves researching the market, finding real estate, performing due diligence to ensure the property is a smart investment, and creating a business plan. For this reason, it’s helpful to have knowledge and experience in the real estate market. Being a sponsor also involves finding investors to be members of the syndication and securing funds.
The sponsor is also involved in implementing the business plan and managing the real estate. In this role, you’ll be responsible for coordinating the purchase of the real estate asset, hiring contractors for any necessary repairs or renovations, dealing with tenants or outsourcing property management tasks, and ensuring the appropriate people get their share of the income and profits. Additionally, the sponsor creates the exit strategy and a timeline for when they plan to sell or refinance the property.
The investors in a real estate syndication are passive investors and limited partners. They provide upfront capital, which is used to buy and operate the real estate asset, but otherwise don’t play an active role in the investment. Passive investors are not responsible for managing the property and other duties of the syndication sponsor. In exchange for their capital, investors receive equity in the real estate plus cash dividends distributed on a regular basis.
What does it take to become a sponsor or investor in real estate syndication? For deal sponsors, there aren’t really set requirements, but it can be helpful to have knowledge and experience in investing in real estate and managing properties. This includes knowing what makes a property a good investment, how to find those properties, the risks and rewards involved in investing in real estate, who to hire to help with property management and legal needs, and more. Percentages can vary widely, but the sponsor can provide anywhere from 5% to 20% of the capital share when purchasing the real estate, so it’s also necessary to have the proper funds for the investment.
Generally, investors in the real estate deal need to be accredited or sophisticated. To be an accredited investor, your income must be at least $200,000 per year, or $300,000 if you’re investing with a spouse. Or, you can have a net worth of more than $1,000,000. To be considered a sophisticated investor, you must have the experience and in-depth knowledge needed to determine whether or not a property is a smart investment. An investment company can also join a syndication with another investment company or companies.
A lot happens during a real estate syndication deal, and the process is divided into three phases: the origination phase, the operation phase, and the liquidation phase. Knowing what happens during these phases and your responsibilities during each phase can contribute to a successful investment for everyone involved.
The origination phase happens before the investment takes place. During origination, the deal sponsor finds a real estate investment opportunity. This process may include researching the real estate market and determining what ideal assets are like, such as the lot size, condition of the property, price, and more. Once the sponsor finds appealing real estate, they perform due diligence to learn more about it. They may also hire an inspector to look at the property and hire an accountant to review the financial records of the real estate. The sponsor is also responsible for creating a business plan.
During the origination phase, the sponsor creates a marketing plan and will market the deal to finds investors for the syndication. If you’re the sponsor, this may include using a crowdfunding platform, allowing for public fundraising, or contacting people you know personally or people in your professional network and pursuing a 506(b) or 506(c) exemption. When forming a real estate syndicate, it can be helpful to hire an attorney to ensure the contract you put together is legally sound and will properly protect your real estate syndication. The sponsor is also responsible for negotiating the price and other terms of the purchase and acquiring the property.
Once capital has been raised from investors, the syndication deal becomes an active investment and the operation phase begins. During this phase, the sponsor implements the business plan and manages the property. For a rental property, this may include renovating the property or hiring someone to do so, performing repairs or hiring a maintenance team, collecting rent, finding tenants for the units, and more, or hiring a property management company to take over the tasks you don’t want to do.
Operation also includes managing the syndication, including communicating with each member of the group to ensure everyone is up to date and on the same page. For example, you might share information about business operations, how the property is doing, and financial updates. Meetings can be in person or remote.
The sponsor is also responsible for collecting the passive income that comes in during this phase and distributing it amongst the investors. The investors are passive and don’t play an active role in the operation phase of the syndication.
During the liquidation phase, the real estate is sold or refinanced. To prepare for liquidation via sale, the sponsor makes any necessary repairs to ensure the property is appealing to potential buyers. The sponsor can also schedule and give tours of the property, review offers, and negotiate the final price and contract with the buyer. Additionally, during the liquidation phase, the sponsor prepares the tax returns for the investment and pays each passive investor their share of the profit. If the property is being refinanced rather than sold, the sponsor will need to find a lender and apply for a loan. They’ll also pay each passive investor their share of the proceeds.
Following liquidation via refinancing, the operation phase of real estate syndication can continue until eventually there is liquidation via sale of the property.
There are several passive streams of income when sponsors and investors invest in real estate through syndicates.
Equity: In exchange for their capital to fund the investment, limited partners (passive investors) gain equity in the property. Limited partners then make money through equity appreciation. As the property value increases, the syndication can sell the real estate for more money down the road.
Rental income: Many real estate syndicates invest in commercial properties and charge rent for another business to use the property. This income from rent is passive and may be divided between investors. As the property value increases, the rent can increase, bringing in more money. This income can be distributed amongst investors on a quarterly or monthly basis. Real estate syndications often last between 3 and 7 years, depending on the property, and can earn anywhere from 4% to 10% in income from rent each year.
Profit at Liquidation: When an investment property is sold or refinanced, passive investors make a profit, assuming the property sells for more than the original purchase price. The sponsor typically receives anywhere from 20% to 40% of the profit, and the remaining 80% to 60% of the profit is divided amongst each limited partner.
Fees: The sponsor collects several different fees during each real estate investment. The acquisition fee can typically be 1-2% of the cost of acquisition. This fee is collected upfront for the sponsor’s work in finding and acquiring the real estate. The sponsor may also collect an asset management fee and finance fee, which are typically between 1% and 2%, as well as a performance fee when the property is sold.
Real estate syndication offers benefits for investment sponsors and investors. It allows partners to share the risk with others and work with people who are more experienced in real estate or investing. Syndicated real estate also has the potential for high return on investment through equity and cash flow, and it also offers tax benefits. For sponsors specifically, real estate syndication gives you access to capital from several investors.
For investors, syndication allows you to invest in the real estate market and invest in properties that you couldn’t afford to invest in alone or wouldn’t be able to manage alone. It’s also a passive form of investing. Investors get the benefits of owning real estate and building wealth without having to be a landlord, as the sponsor handles the operation of the real estate and the syndication. Syndicates also offer the opportunity for investors to diversify their portfolios.
While real estate syndication has benefits, it also has risks and challenges. Since it’s a passive investment, investors don’t have much if any control over the assets and their management. This form of investing can run the risk of taking time to see a return on investment, and being subjected to unexpected changes in the market. Additionally, there’s the potential for sponsors to make money through fees even if investors don’t make any money. Another risk is the risk of expenses being higher than expected, such as the property needing unexpected repairs and costly insurance.
The two main options for structuring a real estate syndication deal are setting up a Limited liability corporation (LLC) or a Limited Partnership (LP). Each legal entity has is respective advantages and disadvantages.
There are a number of factors that will impact what legal documentation you need to setup a real estate syndication. Such factors may include the type of real estate, the type of investment, who is investing, the responsibilities and authority of the sponsor, and the overall goals of the syndication.
At minimum though, a new syndication typically involves an operating agreement, a private placement memorandum, subscription agreements, and securities filings.
Legal governance and risk factors are typically addressed in the operating agreement and the private placement memorandum. These two documents, in conjunction with one another, will cover a range of topics including sponsor authority and obligations, restrictions on transfer of equity, and right and restrictions on the limited partners.
Securities issues and compliance are the domain of the subscription agreement and the required securities filings. For example, if a syndicate is using a 506(b) or 506(c) exemption, the subscription agreement will contain certain investor representations and warranties and verification related to the investor’s accredited investor status. The extent of the securities filings that may be required will depend on a number of components, including the number of investors, the location of the sponsor and the particular target real estate, and the amount of money being raised. Securities filings may be necessary at both the federal and state levels.
If you’re sponsoring a real estate syndication investment, getting help from a business lawyer is a smart move. Business lawyers who are knowledgeable in real estate syndication understand the three phases and can help with legal aspects of these phases. They can draft, review, and revise documents related to the investment, such as operating agreements and any necessary paperwork.
If you’re interested in real estate syndication, working with a lawyer can make the process easier. Stevens Law offers a variety of legal services to help your business grow. We have experience working with companies big and small and always work with your best interests at heart.
We’re knowledgeable in business practice areas like commercial finance law, corporate and general business law, mergers and acquisitions, private equity, and other areas of business. We look forward to helping your company thrive through real estate syndication.
Want to learn more? Contact Stevens Law at (614) 826-3100 to request a consultation.