Real estate syndications have become increasingly popular as real estate investors seek to diversify their investment portfolios.
With some investors, syndications have become even more popular than Real Estate Investment Trusts (REITs) and other crowdfunding methods.
There are various ways that a real estate syndication can be organized. Below we will discuss these different structures and the pros and cons to each of them!
Once you have completed this article, you should walk away with a firm understanding of real estate syndication structures and how fit your long-term investing goals.
Introduction to Real Estate Syndications
A real estate syndication occurs when various investors pool together their resources, capital, and skills to purchase a particular real estate asset.
Real estate syndications can occur with a variety of asset classes including the below and much more.
- multifamily real estate (apartments)
- mobile home parks
For the most part, real estate syndications are either structured as limited liability companies (LLCs).
Limited liability companies or LLCs are the most popular structures for multifamily real estate syndications, especially larger investment deals, because of their flexibility.
When structuring an LLC, the managing member(s) (sponsor(s) or general partners) and the capital investors are regular members (limited partners).
The General Partners will do the work of finding the deal, raising the capital, and once the deal closes, ensuring the deal is successful by executing the business plan.
The LPs also referred to as passive investors will provide the capital for the real estate syndication. Once the deal is closed passive investors will not have active responsibilities in managing the asset.
When it comes to real estate syndications, there are many ways you can splice a deal.
The way a real estate syndication company structures its syndication will depend largely on the sponsorship team’s experience, track record, the specific deal, the market, as well as many other factors.
The way a real estate syndication is structured will affect the returns for passive investors. Which is a large reason why passive investors must understand the various deal structures available.
While conducting due diligence, investors can decide if the syndication at hand meets their investing goals.
Let’s get into a few of the most common ways that real estate syndications are structured.
Types Of Real Estate Syndication Structures
Waterfall Structure – Real Estate Syndication Structure
Waterfall structure a method for splitting profits between the parties within real estate syndication.
It allows for the uneven distribution and payout changes when certain return hurdles or thresholds are met.
The waterfall structure is an incredibly common real estate syndication structure and most often includes a preferred return.
A preferred return requires that passive investors are owed a set return rate on their investment before the general partner or sponsors earn any profit share
With this structure, the sponsor is incentivized to make the property generate as much money as possible.
Otherwise, the money will be missing from their own pockets since the preferred return must be paid to the investors first. Only after those dividends are paid does the sponsor get to enjoy the excess profits.
Let’s say a multifamily real estate syndication contains a 6% preferred return that indicates that the initial 6% of the syndication’s returns go to the limited partners/investor completely.
The sponsors/general partners will only receive income if the syndication’s return is above 6%.
While this type of structure does not guarantee that passive investors will receive 6% of returns, it does mean that you get preferential treatment for the initial 6% of the income that the syndication generates, if any.
Another great aspect of the preferred return is that they are accrued meaning that if the sponsorship team only achieved a 4% return to investors in year 1, the passive investors are owed an additional 2% in year 2 first before the sponsorship team can get paid.
After the preferred return has been reached, the next phase of the waterfall structure is activated. A waterfall structure can incur different splits based on the return thresholds met.
For example, let’s say that the syndication profits between 7% and 13% this range of profits may break into an 80/20 slit meaning 80% of the profits go to the passive investors and 20% goes to the sponsorship team.
If the deal goes above 13% the split may change and break into a 60/40 meaning 60% to passive investors and 40% to the sponsorship team.
Within a real estate syndication, there can be a variety of splits that can incur within a deal.
With a waterfall structure that incorporates a preferential return, the general partner or sponsor is incentivized to work hard on behalf of the syndication.
Essentially the better the syndication performs, the more you and the general partners are paid.
Straight Split– Real Estate Syndication Structure
One of the simplest and straightforward structures for paying out the syndication profits is called a straight split.
With a straight split, any profits are split according to the ownership percentage of the investors.
The same percentage split is used for all returns that the syndication generates. (positive cash flow, capital gains after the sale of the property, etc.).
For example, with a straight split of 70/30, if multifamily real estate syndication generates $200,000 in profits, the sponsor will take their 30% or $60,000.
The remaining $140,000 will be split evenly amongst the passive investors.
A straight split is perhaps the easiest real estate syndication structure for novice investors to understand.
A 70/30 split, as well as an 80/20 split, are common straight splits within real estate syndications.
What is the Best Real Estate Syndication Structure?
The reality is that there is no one way to invest in real estate syndications and depending on the deal, one structure may generate better returns than the other.
Various factors must be considered to decide if an investment is right for you.
Overall, investors have a preference for preferred returns as it provides safety on their return and accountability to their real estate syndication company.
Additionally preferred returns allow for passive investors to achieve more stable yearly passive income.
Whereas a straight split real estate syndication structure allows investors the opportunity to take advantage of an asset appreciation and achieve a higher ROI upon the sale of a property.
Final Thoughts on Real Estate Syndication Structures
Real estate syndications are incredibly lucrative investment opportunities and are a great way to diversify your portfolio but please keep in mind that no specific real estate syndication structure will guarantee you high returns.
However, it is incredibly important that before you invest in syndication, you understand every aspect of how the deal is split as that could have a large effect on your ROI.
When investing in a real estate syndication one of the most important aspects is picking the right real estate syndication that you like, know, and trust.
Along with partnering with the right team, before investing in a real estate syndication you want to ensure the investment aligns with your individual goals and risk tolerance.
If you looking to further your education on multifamily real estate syndications please check out the free educational resources below.