The question of, “what is syndication?” is often overcomplicated by many. The answer is simple. Real estate syndication is when investors effectively pool their intellectual and financial resources. Doing so enables them to place investments in projects and properties much bigger than they could either manage or afford by themselves. These syndicators have been in existence for numerous decades. The problem in the past was that it was extremely difficult for the investors to locate these groups and gain access on an individual basis. However, access became noticeably easier with the advent of crowdfunding. Real estate crowdfunding provides access to the basic fundamentals of a deal. This makes purchasing shares much easier for accredited investors because the old-fashioned approach of making small talk at a country club or paying caddy fees is no longer applicable.
Syndication Definition and Principles
The workings of a syndicated deal are relatively simple. The definition of syndication is an uncomplicated transaction between a group of investors and a sponsor. A good example would be two individuals who decide to form a partnership and open a restaurant together. One of these individuals has a lot of experience managing and working in a restaurant. The other individual has more funding to invest in the restaurant. The individual with the restaurant experience fills the role of the sponsor. This person will locate a good location for a restaurant or find a restaurant for sale and make all the arrangements. The individual with the financial backing fills the role of the investor and finances the restaurant. The individual with restaurant experience will run the restaurant. This entitles this person to a paycheck for the work they perform. Both of these individuals will receive a share or portion of the profits. This is based upon the amount of money and time that has been invested.
The Basic Role to Define Syndicate
A real estate syndicate has the same basic principles as the two individuals who opened a restaurant together. The sponsor is the operator and manager of the deal. The sweat equity is invested by the sponsor. This includes raising funds, checking out the property, acquiring and managing the property for the investment and handling the daily operations. The majority of the financial equity is provided by the investor. These individuals become the syndicators for the arrangement. The investment for the sponsor is generally in the area of 5 to 20 percent of the total equity capital required for the project. Approximately 80 to 95 percent of the remaining capital is supplied by the investor.
Setting Up a Real Estate Syndication
A real estate syndicate is very simple to set up. It is important there is proper protection built-in for all the parties involved. A real estate syndicate is usually structured for a Limited Partnership or as a Limited Liability Company. In the case of the partnership the sponsor will participate as either the manager or the general partner. The participating investors generally assume the role of either a passive member or a limited partner. Both the investors and the sponsor have clear cut rights. This includes voting rights, the rights to distribution and the fee paid to the sponsor for their management of the investment. These rights are detailed in either the LP Partnership Agreement or the LLC Operating Agreement.
The Profits of A Real Estate Syndicate
When the syndicators participate in a real estate syndication their goal is to make a profit. To define syndicate profit both property appreciation and rental income must be considered. This again encompasses the question of what is syndication. When a syndicated property’s rental income is distributed among the investors on a quarterly or monthly basis from the sponsor, this is considered a syndication definition. The syndicators receive the amount outlined in the preset terms. The value of a property usually appreciates as time passes. This means when the property is eventually sold the investors will receive much larger profits and the rents will be higher.
The Payment for The Real Estate Syndicate
When an individual asks what is syndication, it is generally because they realize this question usually involves a profit. To define syndicate profit the maturity required for the investment is critical. There are certain kinds of syndications that only require six to twelve months to reach full maturity. Other types can take as long as seven to ten years. Each individual who made an investment in the syndicate will receive a portion of the profits. When the deal is first set up the acquisition fee is determined. The average fee for the sponsor varies greatly. This fee can range from .5 percent to 2 percent and is strictly based on the details of the transaction. The average fee is 1 percent. A preferred return is received by all the investors involved with the project prior to the sponsor being paid for the work they have performed as a promotor or manager. The definition of a preferred return is a payment distributed to all the investors involved. This is generally an annual payment of 5 to 10 percent of the funding each investor initially invested in the project.
The Syndication Definition of Structure
To properly define syndicate structure the motivation of the sponsor is the key. The sponsor must be motivated to make certain the investment is properly handled and performing well. Without this motivation the investment may fail. An excellent example is a preferred return. A passive investor agrees to an investment of 50k regarding a deal offering a preferred return of 10 percent. The potential for the yearly payment is 5k. This will occur once the property has made enough money to cover the payouts. Once each investor in the project has received their preferred returns the remaining funds can be distributed. The distribution of these funds between the investors and the sponsor is based on the profit split structure originally set up by the real estate syndicate. This determines the amount received by the syndicators. An example of a profit split structure is 60/40. In this scenario the investors are entitled to 60 percent of the profits once their preferred returns have been received. The net of the sponsor would be forty percent once the preferred returns have been issued. Once all the preferred returns have been received the 60/40 deal is complete. If the amount of funds remaining is one million dollars the investors would receive 600k and 400k would go to the sponsor.
The 2012 Stats for Real Estate Syndication
The stats for syndication are important because this is where the profit comes into play. In excess of 47,000 investors took part in syndications in 2012. 2.3 million was the size of the average real estate offering. Approximately 80 to 95 percent of the initial financial investment was provided by passive investors. Between 5 and 20 percent of the initial financial investment was provided by the sponsors. The range of the preferred return for the investors was 5 to 10 percent. The amount of the average preferred return for the syndicate was 8 percent. The average acquisition fee netted by the sponsors was between .5 and 2 percent. The property management fee netted by the sponsors was between 2 and 9 percent. These yearly profits place the syndication definition prominently in the plus column.
Crowdfunding and Real Estate Syndication
In the past, when individuals asked the question “what is syndication?”, the answer was slightly different. The period of time before the internet became prominent in society is referred to by many as the dark ages. This affected the syndication definition because it was extremely difficult to locate a network of syndicate partners who were already established. To define syndicate at this time would be a group of syndicate partners offering profitable deals with a basis of trust. In the example used earlier in this article regarding the formation of a restaurant this concept is extremely important. Forming a restaurant is not possible if the individual with the experience running and managing a restaurant is unable to meet the individual interested in investing in the restaurant. The same concept is true in reverse. This is where the question of syndication has been irrevocably changed by crowdfunding. To define syndicate under current circumstances adds a different connotation. Crowdfunding is using the internet to locate a crowd of investors interested in funding large projects. When a project receives the necessary funding, it is referred to as a go. If the required funds are not received the money is returned to the individual investors. A real estate syndication employing crowdfunding has a lower minimum for investors and is much more accessible. The potential investors are additionally able to find a lot of information regarding the specifics of the project online and now have the convenience of doing their research using a PC or tablet. Ultimately making a profit is what real estate syndication is all about, and it is easily brought into the comfort of the investor’s home through the use of crowdfunding.