Real Estate Syndication Structure

Real Estate Syndication Structure

In this article, you will discover that real estate syndication differs significantly from a hedge fund, as well as from syndication formation options and funding sources beyond individual investors.

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Are Real Estate Syndications Different From Real Estate Funds? 

The investors in a real estate syndication know that they are investing in a specific property. The syndicator manages the property and often receives fees from the project's revenue rather than upfront. 

Real estate funds, on the other hand, usually don't have a specific property or project in mind.  Instead, the investors contribute to a general pool of capital, empowering the General Partner (GP) in the purchase negotiations. This strategy can increase diversification since the fund can invest in different properties and asset classes. But it also means the investors must trust the GP/fund manager, as they're not as privy to the specific properties they buy. 

Real estate syndication is a proven way to package an investment opportunity, as the property is the central player. However, the syndicator must still offer proof of experience and management skills to balance out these investor concerns.

Access to Bigger Projects  

Real estate syndication gives approved investors access to major commercial projects. Think of the mega-projects, massive apartment buildings, or bustling shopping centers where individual buyers would need more resources to get involved. With real estate syndication, now they can! 

Diversification  

Investors allocate funds across properties by participating in syndications, answering the old maxim that you don't put all your eggs in one basket. 

Passive Investment  

Investors drawn to investment properties want to avoid getting involved with day-to-day management. The syndication manager uses in-house or 3rd party specialists to manage the properties daily. These experts know how to maintain a smooth operation, build tenant relations, and lower vacancies.

Stability and Reduced Risk  

Commercial multi-tenant investments are stable because of the diverse tenant mix, which can shield investors from the volatility of less diverse investments and provide more stable incomes. 

Tax Advantages  

Investors may benefit from specific tax code incentives depending on the property type and location. Creative improvements that increase rent cash flow also raise the property basis for even better tax-efficient returns. 

Real Estate Syndication Manager Responsibilities

The first duty of a syndicator is to locate investment-grade properties. The syndicator designs a tailored investment model; once the due diligence yields a promising property, the syndicator brings in a real estate attorney. They'll create the syndication agreement and the PPM (Private Placement Memorandum), which contains all the critical details, such as property information, the management team, estimated income, and risks. 

Upon Property Acquisition  

The syndicator then takes over the building management with their team. At times, they might enlist an outside property manager to assist. When it comes to leasing, the syndicator takes the reins. They decide on rental terms and conditions and ensure the prospective tenant has the financial wear-with-all to maintain the lease.

With the help of an accounting firm, the syndicator keeps all the financial documents (profit & loss statements) current and makes them available to the investors on a regular schedule. Transparency is key! Last but not least, the syndicator focuses on the exit plan. They keep a close eye on the market to know the right time to sell, orchestrate the sale, and ensure that the transfer of ownership goes off without a hitch.

Structuring a Real Estate Syndication

Like a hedge fund, a real estate syndication must have a legal structure that complies with securities laws and regulations. Below are two of the most popular.

Limited Partnership (LP)

A Limited Partnership comprises one General Partner (GP) and one or more LPs. 

General Partner (GP)

GPs are in charge of the syndication. They find and vet the properties to purchase, raise the money from Limited Partners, and manage the property. 

Limited Partners (LPs)

LPs are passive contributors to the project. They are minimally liable; in other words, they can only lose what their capital investment is worth. LPs are not the owners or managers of the property and are not responsible for the entity's debts or obligations beyond the amount invested. 

Limited Liability Company (LLC)

An LLC can be the owner and the manager of a real estate syndication. LLCs have flexibility and are cheap to create and run. 

Members: 

In an LLC, all members enjoy limited liability. In a limited partnership, only the LPs have limited liability. The members of the LLC could be people, partnerships, or other LLCs. 

Taxation:

LLCs have pass-through taxation, just like LPs, which means profits and losses carry over to individual members' tax returns. Choosing one of these entities depends on the level of liability protection, hands-on management, and the tax treatment desired, as well as the needs and requirements of the syndication.

Syndication Capital Stack

Unlike a hedge fund, a real estate syndication can secure financing from various sources. A capital stack refers to the different sources and seniority of funding that constitute the entire capital expenditure (stack) needed to fund a transaction.

Senior Debt  

Position: Senior debt is the least risky and highest priority at the top of the capital stack.

Source: Most often provided by banks or financial institutions in mortgages or loans.

Description: Backed by a mortgage on the property, senior debt is paid before other lending sources.

Mezzanine Debt  

Position: Mezzanine debt is subordinate to senior debt but in a senior position to preferred equity and common equity shareholders.

Source: Offered by mezzanine lenders, this debt bridges senior debt and equity.

Description: Mezzanine debt also has a guarantee but is a higher interest than senior debt due to the increased risk.

Preferred Equity

Position: Preferred equity holders are secondary to both senior and mezzanine debt. Preferred equity holders receive returns before the ordinary equity holders.

Source: Provided by investors looking for a stable return

Common Equity  

Position: Common equity is the most risky at the bottom of the stack. 

Source: From GPs and LPs who invest capital in the project.

Description: Common equity holders share the property's positive cash flow and capital returns.

Waterfall Structure  

The capital stack is a waterfall-based payout structure, with compensation going out in order of seniority.

1. Senior debt is first.
2. Next comes mezzanine debt.
3. Then, preferred equity holders.
4. Finally, holders of common stock.

Investors must understand the capital stack structure to know how much their inherent risk is and when and how they'll receive a return. This information is available in the Private Placement Memorandum (PPM). 

Raising Capital for Syndication From Investors

Creating a compelling syndication plan to attract investors involves several key components that demonstrate your opportunity's viability and potential profits. Yes, the property is central, but the experience of the GP and team members will be the deciding factor, especially if this is the GP's first syndication.

Your business plan should include:

Management Team and Organization

Include bios of your key team members, where they have relevant experience, and why their skills fit with your business mission. Investors put their money into people as much as they put their money into concepts, so this section should receive your serious attention, as this is where you build trust and confidence. 

Investment Strategy

Communicate precisely why investors should put money into your syndication, how the property will make money, and what they will receive in return. Highlight why your syndication is a solid investment candidate and why now is a good time to invest. 

Include projections from an accounting firm regarding how much capital is needed, how the syndicator will use the capital, and the anticipated ROI. 

• Sales Forecast: Estimated revenue for a specific period, like 3-5 years. 
• Cash Flow Statement: Monthly or quarterly forecast of cash flow coming and going. 
• Forward-Looking Statement: Projected profit and loss, expenses, and net income. 
• Balance Sheet: Estimated assets, liabilities, and equity balance sheets. 
• Break-Even Analysis: When you expect the property to make money.

NOTE: Only Accredited Investors are invited to the Party. The SEC created the accredited investor requirement to shield private investors from exposures in unregistered private securities offerings by ensuring that only financially sophisticated and able investors engage in riskier investments. 

A syndicator must have reasonable grounds to believe that the investor qualifies as an accredited investor. The investor's income, net worth, or employment history is typically confirmed.

Individuals and legal entities become accredited investors when they satisfy these standards. They can invest in securities not registered with the SEC – including private placements, hedge funds, and venture capital funds.

A syndicator should not view this as a hindrance but as a protection, as those who qualify as an accredited investor accept greater liability for the financial decision to invest.

Income Requirements

A person qualifies as an accredited investor if, for two consecutive years, they earned more than $200,000 per year or if married, their combined income was more than $300,000 per year in the last two years. 

Net Worth Requirements 

A spouse or a single person whose net worth at the purchase date is more than $1 million, less the value of the primary residence, is also considered an accredited investor.

The Securities Act of 1933, also known as the Truth in Securities Act, mandates that all securities offerings be registered with the Securities and Exchange Commission (SEC) unless they are subject to certain exemptions. This Act requires issuers to disclose all material facts about the securities offered in detail so that investors can make decisions based on the information they need.

[Exemption] Real estate syndications, where multiple parties agree to fund a property together, are securities offerings and, as such, fall under the 1933 Act. Syndicators must either register their offerings with the SEC or rely on exemptions, including Regulation D, that permit private placements to involve qualified investors without complete registration.

If a syndicator can operate under an exemption, it in no way excludes them from operating in the best interests of their investors. These are the key facts concerning disclosure, fiduciary duty, and dispute resolution.

Disclosure Requirements  

Private Placement Memorandum

You must provide this document to explain the investment opportunity, risks, and disclosures. It offers an in-depth business plan analysis, estimates, and investment commitments. 

Accredited Investor Questionnaire

Syndicators need to assess whether investors are accredited investors by verifying the investor's financial details. 

Property Documents

This would include title deeds, appraisals, environmental reports, and other documents relevant to the property under consideration. They provide transparent disclosure about the property's condition and potential liabilities. 

SEC Filings

A Form D is necessary if syndications are subject to SEC rules. This form notifies the SEC about the private securities offering and details the amount of capital to be raised.

Fiduciary Duties  

Responsibility

Syndicators should exercise reasonable, prudential action to protect investors' funds. 

Disclosure Obligation

Syndicators have a fiduciary obligation to fully and accurately disclose to investors the syndicator's project, risks, fees, and compensation.

Loyalty

Syndicators must look out for the best interests of the investors and not engage in self-dealing or other conflicts of interest. If the syndicator has a conflict of interest, it should be disclosed in the PPM to ensure trust and openness. 

Dispute Resolution Options  

Operating Agreement Provisions 

The Operating Agreement should include options for dispute resolution. Those could include mediation, arbitration, or alternative dispute resolution mechanisms to avoid lengthy and costly litigations. 

Mediation

The third-party mediator helps the disputants reach a settlement agreement that is acceptable to them. In most circumstances, this is typically the preferred approach, as parties can agree without a definitive decision from a third party. 

Arbitration 

Arbitration may be the next option if mediation doesn't work. In arbitration, an impartial third party settles the matter based on the facts.

Clear Communication and Documentation 

Having complete documentation (the Operating Agreement and PPM) helps to prevent conflicts by clarifying who is responsible for what. Communication and transparency are also essential to keep conflicts at bay. 

By following these disclosure requirements, fiduciary duties, and dispute resolution processes, real estate syndicators can ensure that their investments are managed transparently, legally, and fairly, keeping investors in the loop and ensuring the long-term success of the syndication.

Acquiring and Managing Properties

Since syndication is single-project-centric, multiple analyses and due diligence steps are needed to determine if a property can spin off positive tenant cash flow and future equity appreciation. 

The Income Capitalization Method (ICM) 

This entails estimating the value of a property based on net operating income (NOI) divided by the capitalization rate (cap rate). This approach works exceptionally well for properties with predictable rental income, like office buildings and multi-family units. Deeper due diligence is warranted if this analysis confirms the properties' income and equity potential.

Property Documents and Financials 

Checking property records, financial documents, leases, and other legal agreements to ensure the property is up to par. The GP will enlist the services of accounting and legal professionals to corroborate the findings.

Property Audits and Environmental Assessments 

Performing a thorough property audit and environmental assessments to evaluate the physical condition of the property and any existing or future liabilities.

Real Estate Syndication Fee Structure

In real estate syndication, several fees are typically charged to compensate the syndicator for their efforts and to cover various expenses associated with the investment.

The syndicator receives this payment when the property is purchased. It pays the syndicator for the effort and cost of sourcing, screening, raising funding, and concluding the transaction. 

Amount

An acquisition fee usually amounts to between 1% and 3% of the property purchase price or its value. Example: If a property has 10 million in value and a 2% acquisition fee, this would total $200,000. 

‍Asset Management Fee

Purpose

It is a regular payment to the syndicator for managing the day-to-day business activities, such as bookkeeping, K-1 preparation, and investor communications. 

Amount

A management fee between 1% and 2% of the property's gross operating income. 

Example

If a property has $500,000 in gross operating income and an asset management fee of 2%, the cost is $10,000 a year.

Promotion Fee

Note: Promotion fee is not commonly used to describe syndication fees. But it could be called by another term in the PPM when it discusses property disposition efforts.

Refinance Fee

Purpose

This fee is incurred when the syndicator refinances the asset to get a better return on the investment or draw down cash. It reimburses the syndicator for refinancing efforts such as running proformas, conducting financial analysis, and shopping lenders.

Amount

Refinance charges usually range between 0.5% and 2% of the new loan amount. 

Example

Refinancing a property valued at $5 million, with a refinance fee of 1%, would equal $50,000.

Disposition Fee 

Purpose

Paid to the syndicator at the time of selling the property. It pays the syndicator for the time spent preparing the property to sell, advertise, and close.

Amount

The dissolution fee usually amounts to 1 to 3 percent of the selling price of the property. 

Example

If the property sells for $10,000,000 and the disposition fee is 2%, the cost would be $200,000.

In this article, you've read about real estate syndication and how it is funded and managed. Here is a quick summary of the main points.

What is Real Estate Syndication? 

• Real estate syndication enables investors to pool resources to fund a real estate investment they cannot take down independently. 

Syndication vs.Hedge Fund: 

• Investors in a real estate syndication know what property they are investing in. Real estate hedge fund investors contribute to a shared pool of capital, enabling the General Partner to buy and sell more freely. Syndications target one property; hedge funds focus on several properties and asset classes. 

Pros of Real Estate Syndication: 

• There are numerous benefits to real estate syndication, such as greater scope, portfolio diversification, passive investment, stability and low risk, and potential tax advantages. 

Syndication Manager Responsibilities:

• Syndicators are responsible for finding properties, developing an investment model, getting legal support, running the property, renting, being financially transparent, and engineering an exit strategy. 

Structuring a Real Estate Syndication: 

• Property syndications are generally structured as Limited Partnerships (LP) or Limited Liability Companies (LLC). The LPs comprise a GP, who manages the firm, and Limited Partners (LPs), who are non-voting, limited-liability investors. 

Syndication Capital Stack: 

• Property syndications have a capital stack that lists the source of funds and where they sit within the stack, i.e., senior debt, mezzanine debt, preferred equity, and common equity. 

Raising Capital for Syndication: 

• Syndicators develop a business model to raise capital. Typical elements of this plan are a detailed description of the management team, an investment approach, and financial projections. 

Accredited Investor Requirements: 

• Property syndications are generally limited to qualified investors. The SEC developed these requirements to ensure that only experienced people invest in these assets. Investors can be accredited based on income, net worth, or experience. 

Legal and Regulatory Compliance:

• Securities laws and regulations govern real estate syndications. Syndicators are required to disclose all material facts about the investment to investors. And they are also obligated to act in the best interests of investors.

Fee Structure:

• Syndicators charge various fees for their work. Acquisition, asset management, refinance, and disposition fees are standard fees. 

In conclusion

Planning, creating, and launching a real estate syndication fund can be a fantastic way to build wealth for yourself and the investors. The goal of this article was to make it evident that there are numerous details to ensure it is completed correctly and with full legal compliance; anything less is unacceptable. 

You now have three choices:

1. Visit our website at www.fundlaunch.com for more information
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3. Do nothing and take whatever your future gives you..