What is a syndication and how can I use one to invest passively in large commercial assets?
What is a syndication?
You’re probably familiar with an individual investor wanting to invest in real estate and using their money for a down payment on a rental property. A syndication is quite similar to that; it’s a group of people coming together to pool their money and purchase bigger properties. You often see syndications on commercial real estate assets such as a mobile home parks, retail centers, and apartment complexes.
How do syndications work?
Let’s say we have a mobile home park for $2,000,000. It requires a $400,000 down payment and another hundred thousand dollars for things like infrastructure improvements. That would mean a $500,000 all-in cost to close.
The syndication team hires a syndication attorney to handle the closing. The attorneys facilitate the group forming a Limited Liability Company (LLC) and the syndication attorney drafts the PPM (Private Placement Memorandum), which outlines items like:
- What is the investment amount each investor is making
- What percent share does each investor have in the asset
- Risks of the deal
The LLC then purchases the commercial asset. Once the deal closes, the syndication team begins executing the business plan.
Active & Passive Investors In a Syndication
There are two types of investors in syndications. There are the active investors and there are the passive investors. Check out this blog post for the difference between active and passive investing and to see which is best for you.
Active Investors
Active investors put the syndication opportunity together and manage it. This group can also be called the syndication sponsors, general partners, or “GP” for short. This sponsor team will:
- Find potential properties
- Analyze properties to determine which are potential deals
- Negotiate and handle due diligence on properties
- Bring investors together
- Handle the paperwork, closing, and administration of the investment
- Manage the property and execute the business plan
- Manage distributions to passive investors
- Facilitate the refinance and/or sale of the asset once the business plan is executed
Passive Investors
Passive investors invest money into the syndication opportunity. Passive investors can also be called limited partners or “LP” for short. Passive investors in a syndication will:
- Review an investment offering & determine if it matches their investment objectives
- Wire funds to the syndication attorney prior to closing
- Collect cash flow from the investment
- Once the property sells, recoup their initial investment and their share of the sale proceeds
Let’s take a look at an example deal
We have an investor who invests $100,000 into a syndication. This deal has an 8% cash on cash return, a 15% return on investment, and a five-year hold.
What does that really look like:
If we take the 8% cash on cash return for the $100,000 investment, that would be $8,000 per year during the five-year-hold period, or $40,000 total in cash flow. Through execution of the business plan the asset is now worth more than it was when it was purchased. The investor also gets money from the sale proceeds of the asset when it is sold. In this investor’s case, their portion of the sale proceeds is $35,000. The investor also gets their initial investment of $100,000 back.
In total, the investor gets $175,000 back for the $100,000 that was initially put into the syndication. The investor is making $75,000 over the five years hold period, which is $15,000 per year on the $100,000 initial investment. That works out to a 15% return on investment.
What money to NOT invest with
A 3 to 10 year hold is typical for syndications on real estate assets. Because of that long hold period, it’s important to know what money you should NOT invest with. We always want to make sure we’re not investing with money we need any time soon. Not money we would need to pay our mortgage or any of our bills. If we have a child in high school, we wouldn’t want to use the money we’ve earmarked for paying their college tuition, for example.
Ready to earn passive income?
Make sure you join our Investor Circle to hear about passive investing opportunities from Voyage Investing.