Edited April 2024
What Is Real Estate Syndication and Why Include It in Your Portfolio
Passive investors often look for opportunities to grow their wealth. Whether they’re extracting stock tips from a financial analyst or poring over a complicated venture capitalist proposal, the general idea is to generate passive income by entering into various ventures. While there are many different asset classes to consider, real estate syndication is often considered one of the more viable options for investors as they contemplate investments that match their investment goals and risk tolerance.
What Is Real Estate Syndication?
Real estate investing is diverse, with various available investment opportunities and strategies. Each individual has personal goals when they invest in real estate, such as creating immediate cash flow vs. long-term growth. The type of property also is an investor consideration — some prefer storage facilities, while others prefer multi-family apartment buildings.
Real estate syndication is a form of crowdfunding for the purpose of investing in residential or commercial real estate. It involves pooling capital with other individuals with a common goal. A person or group, known as the sponsor, will put together a deal consisting of a single property or multiple properties and present it to others who can invest if they determine that the opportunity meets their investment criteria.
Why Do People Engage in Real Estate Syndication?
The real estate market is very palatable to passive investors, but many don’t have a way of getting involved. For some, real estate is not within their area of expertise. Others are simply not set up to find opportunities in the real estate market.
The primary reason investors participate in real estate syndication or crowdfunding for real estate is access to deal flow. Not every investor has the access or the time to research and underwrite hundreds of properties to find the one or few that fit their mold and then buy, maintain, develop, and sell the property.
By getting involved through real estate syndication, investors have access to this deal flow and the ability to invest in real estate without the hassles of research and property management.
Who Are the Parties in a Real Estate Syndication?
The first ingredient for a real estate syndication is a “syndicator” or “sponsor.” This individual or company is responsible for finding, acquiring, and managing the real estate. They have a history of real estate experience and the ability to underwrite and do all the necessary due diligence on the real estate. They are typically referred to as the “general partner” or “sponsor” of the syndication.
The other main party is the investors. These individuals, also known as the “limited partners” of the deal, invest with the syndicator and own a percentage of the real estate as a result. They get all the benefits of property ownership but are not involved with acquiring the property, arranging for financing, and dealing with day-to-day management.
In many transactions, there is a third party — a Joint Venture (“JV”)/Equity partner. JV partners typically have access to a large number of investors and serve as a conduit between the syndicator and the investors. In addition to helping with financing, they may help the syndicator with reporting, communications, and even tax documentation.
For more details on the participants in a real estate transaction, see this article in the knowledge center Guide for CRE Investors Seeking Passive Income
How Do Investors Decide Which Real Estate Syndication To Get Involved In?
There is no single type of deal that would be considered the best type of real estate syndication to join. Every investor has their own ideas and comfort levels within the real estate market. Fortunately, there are many types of real estate syndication deals available, so each investor can find an opportunity that suits their appetite for risk, goals, and strategy. These are some examples of what investors should consider:
Investment Goals
Each real estate syndication can cater to a different set of investment goals. For some people, real estate syndication is simply a way of keeping their money out of the bank to preserve their wealth by beating inflation. Some investors look to generate monthly cash flow to supplement their income. Others might have a five-year plan for their money and don’t care as much about what happens in the short term.
Some are primarily concerned with building a nest egg for retirement. Within that category, a lot will depend on their current age, how many years they left until they retire, and their ability to recoup their money should an investment go sideways.
All of these are worthy goals and are specific to the investor. However, since no two investors are alike, each has to first determine what he or she wants to accomplish and then start researching the plethora of real estate syndication deals available.
Type of Property
There are many types of properties investors can get involved with. Some of these include:
• Residential rental property
• Strip malls
• Storage facilities
• Office space
• Industrial properties
• Shopping centers
Investors may prefer one type of real estate over the others or a mix of a few of them. There can be varying opinions and comfort levels within each of these categories. For example, some may be worried about office buildings with the recent increase in the popularity of remote work. Others might view the recent return to office as a sign that traditional office space will remain a healthy investment for the future.
Risk Factors
Every real estate syndication has risks. The offering documents for a transaction typically highlights risk factors applicable to real estate investments generally and the particular property and transaction in particular. In evaluating a transaction, investor should review these potential risks when making their investment decision.
Location
Real estate is all about location. Some investments are in prime locations with excellent resale potential but minimal short-term income. Other properties in secondary areas might produce more cash flow but won’t have as much upside when it comes to selling. Of course, there’s every option in between. There’s also the idea of buying in developing neighborhoods with the potential of the area becoming a primary location.
Access to Funds
Investors know their own financial situation best. No one can tell them when they might need access to the money they invest better than they can. Even if an investor’s primary reason for entering a real estate syndication is to grow his retirement fund, that doesn’t mean that the investor can afford to restrict his ability to access the money in between.
Say a passive investor decides they might need to use the funds before retirement. They might want to choose a particular Real Estate Investment Trust (REIT) with a lot of flexibility to sell and buy shares — even though that opportunity might not have been their first choice had they not needed access to the funds.
Minimum Investment Requirements
Real estate syndication deals often have minimum investment requirements. Investors might want to diversify their real estate portfolio. If diversification is a primary investment goal, then an investor may pass on a potentially attractive opportunity if the minimum investment amount is significantly higher than other opportunities.
What Metrics Do Investors Use to Measure Returns on Real Estate Syndications?
There are two primary numbers to look at when comparing returns on various real estate transactions: cash on cash and internal rate of return (IRR). Syndications should provide both of these numbers, and depending on an investor’s strategy and goals, he or she might use one or the other or both.
Cash on Cash
Cash on cash indicates how much an investor will earn on their money over a given period. For example, a $100,000 investment that, after accounting for all expenses, produces $5,000 in rental income, is considered to have a 5% cash-on-cash yearly return. This metric gives investors an idea of how their money will generate revenue over a projected period.
IRR
IRR is a more sophisticated method than cash on cash. It involves a formula that factors in:
• The initial cost of the property
• Current and anticipated expenses
• Current and anticipated income
• How long the group plans to hold the property
• The expected sale price of the property
The result calculates an investor’s yearly return based on the full life of an investment, including the future profit from selling the property.
This metric gives investors a clearer picture of how their money will perform overall, broken down into an annualized return percentage, but not so much what they could expect to net on a monthly or yearly basis. The formula is complicated and involves some educated speculative projections by the syndicator that are subject to market changes. However, the results are straightforward and give investors a view of the return on their money.
For more detailed information on the comparison of IRR vs cash-on-cash, take a look at this article on the knowledge center Guide for CRE Investors Seeking Passive Income
Find Your Next Real Estate Syndication Deal
This article is for informational purposes only and is not a recommendation or offer to buy or sell securities. None of the opinions expressed are the opinions of RealtyMogul. Advice from a securities professional is strongly advised, and we recommend that you consult with a financial advisor, attorney, accountant, and any other professional that can help you to understand and assess the risks and tax consequences associated with any real estate investment.