You know when two guys open up a restaurant together, one has more money to invest and the other has a lot of experience working in and managing restaurants? The guy with the experience, usually known as the sponsor, finds a restaurant to open and arranges everything. While the other guy, the investor, simply invests his money. The guy with the restaurant experience naturally runs the place, and, as a result, gets a paycheck for his work. They both get a share of the profits based on time and money invested. Real estate syndication is no different from the two guys opening a restaurant together. Let us take a look at what is real estate syndication and how it makes you money.
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Real estate syndication
Basically real estate syndication is when you partner up with another real estate investor and invest in a property that you alone cannot afford. Both sides of the party benefit and both end up gaining a great amount of profit. They say that talent wins games, but teamwork and intelligence win championships. That is exactly the case with real estate syndication, where both the sponsor and the investor team up to create success. The sponsor invests the sweat, such as checking out the property, raising funds and managing the property’s day-to-day operations, while the investor provides most of the financial equity. The Sponsor is usually responsible for investing anywhere from 5-20% of the total required equity capital, while the investor puts in between 80-95% of the total.
Of course it can be quite frightening to go into such an investment with a partner and not grantee rights for each side of the party. Real estate syndication provides protection for each partner. These rights are usually structured as a Limited Liability Company or a Limited Partnership with the sponsor participating as the General Partner or Manager and the investors participating as limited partners or passive members. The rights of the sponsor and investors, including rights to distributions, voting rights, and the Sponsor’s rights to fees for managing the investment, are set forth in the LLC Operating Agreement or LP Partnership Agreement.
First things first: beginning syndication
- The first step in forming a real estate syndicate is to identify the type of investment and the market area. Because it is wise to invest close to home, you should first look at investments close by.
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- You should also decide on the scope of the syndicate like how many investors are going to be involved. A syndicate can consist of as few as 2-3 investors to as many as 50 investors. It can be helpful if all the investors are known personally by the organizer.
- You should be sure the organizer is someone who has knowledge and experience and is capable of raising the capital, identifying the right property to purchase, and managing the property.
- You should put great care into drafting the syndicate agreement. This is the “Constitution” which will guide the investment group no matter what happens in the future.
- If you are planning on investing a significant sum in this investment ride, you should spend a fair amount of time and money on getting legal advice on this foundational document. Investing in real estate syndication can be a savvy way to make your money grow, especially in today’s economy. As with any investment however, it is best to proceed with caution before acting too quickly.
Advantages of investing in real estate syndication
1. Superior Expertise
One of the primary advantages of syndicates is the ability of many investors to leverage expertise. Rather than relying on one person’s knowledge as is the case whenever an individual makes a self-directed investment, a syndicate can bank on the knowledge and skills of numerous real estate professionals. Nonprofessional investors who don’t have the time or inclination to learn every aspect of owning and managing real estate investment can benefit from someone else’s skills and experience negotiating purchase agreements, financing a purchase, negotiating leases and managing the property.
2. Cost savings
There are economies of scale to investing with others. By pooling funds, a small real estate syndicate can achieve cost savings as compared to an individual investor. A well-funded syndicate can make a substantial down payment on a property and leverage their capital to create improvements and increase returns.
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Another advantage of syndication is that it enables an individual investor with limited funds to diversify among a number of different properties, or to purchase a larger investment with multiple tenants. Diversification helps to safeguard against significant losses in real estate.
4. Cash Reserves
When you invest in real estate syndication you can assure that there is enough cash in reserve to help weather any economic downturns or temporary shortfalls occur.
So how do you get rich from this?
Well, if put together a series of good deals, the following happens:
- The fees on each deal, particularly when layered on top of each other, pay your living expenses. Then…
- Over time, as the deals pay off, either via sale of the assets or by re-financings and you return capital to your investors, you get into the “promote”, where you are participating in the profits.
Ideally, you avoid selling your deals and they appreciate over time. Your profits interest in them therefore grows tax-free. As the cashflow from the deals increases over time, you get to participate in regular distributions. If you do this over and over again for years, you will eventually build a portfolio of interests in good deals, each of which is sending you a stream of cash each quarter. That’s how you get really rich syndicating!