Alternative Syndication Structure - 95/5

Commercial Real Estate

Alternative Syndication Structure - 95/5

We’ve earlier described sponsor-syndicated private real estate investments and some of the more typical structures used to divide the returns between the sponsor and the investors. These structures can vary, however, and here we discuss an alternative way of arranging the sponsor / investor relationship.

In most private syndications, the sponsor provides a relatively small portion of the capital for the investment, but offers the investment opportunity and the time and expertise to make the investment successful. The investors provide most of the money, but also get to take a relatively “hands-off” approach to the project. The question of how to split up the potential profits of the project is where questions of structure come into play.

The typical project often has the sponsor providing investors with a “preferred return,” often in the 5-10% range, before the sponsor gets any proceeds outside of returns on his own invested capital. Thereafter, though, the sponsor might receive a larger “promote” share in the remaining distributable cash flow and proceeds from any sale of the property. This “promote” share can be anywhere from 10% to 50% of the remaining available cash flow or sale proceeds.

The division of distributable funds varies among transactions, however, and other structures can also be utilized. One alternative arrangement is utilized simply because it is straightforward – a “95/5” split. This structure is similar to one used in venture capital fund arrangements, where the VC funds get a straight “carry” – share – of the investment returns to compensate them for their active management of projects.

With this structure, the investors are entitled to 95% of distributable cash, and the sponsor gets 5%. This straightforward arrangement eliminates lengthy negotiations between sponsors and investors over the size of any preferred return or the outline of any “promote” arrangement. It also simplifies payout and distribution schedules, and puts the sponsor on a more equal footing with investors – although investors still get the lion’s share of the deal profits.

Realty Mogul still focuses on transactions where the sponsor has some of “its own skin in the game,” and this means that the investor funds will also include whatever money the sponsor contributes. Let’s look at an example of how this would play out:

  • Investors contribute $900,000
  • Sponsor contributes $100,000
  • Sponsor gets 5% of distributable cash as his “carry” incentive

For a $10,000 distribution:

  • Investors (including the sponsor) will receive $9,500
  • Sponsor will receive $500 for his sponsorship role
  • Of the $9,500 to investors, outside investors will get $8,550, and the sponsor (in his investor capacity) will get $950, based pro rata on everyone’s invested amounts

This structure is sometimes preferred for its straightforward simplicity and perceived fairness to all the project participants. Syndicated real estate investment opportunities can be structured in many different ways; the above summary merely reflects one of the many possible alternative methods that investors and operators can use to work together.

From investors’ point of view, it is important that investments be made under a structure that helps to keep an operator’s and investors’ interests aligned. Keeping the financing and operating interests allied is important to the success of real estate projects as well as business ventures generally.

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