WHAT IS A REAL ESTATE SYNDICATION?
REAL ESTATE SYNDICATION is simply the pooling of funds from numerous investors (sometimes referred to as “Equity Partners,”) and channeling those funds into real estate projects. These funds can be used to acquire a property in its entirety, or they can be used as an equity contribution to the project in addition to a commercial mortgage, which would fund the majority or the projects costs.
What is multifamily commercial syndication?
1) Syndication is really Crowdfunding, where a number of investors join together to purchase a high quality, in our case Class A investment property, like an Apartment Complex, Mixed-use Building and Commercial Office Building.
2) These investments are passive because the Management Company performs the necessary day-to-day decisions, while the investors sit back and collect their share of the rental income and profits at sale, usually in 3-5 years.
3) During the “Holding Period,” the property’s income from tenants is distributed as a “Preferred Return.” (A Preferred Return is paid to Investors before the Sponsor is paid anything – Investors get “Preferred” treatment).
4) Upon sale of the asset, the profit is split between the Investors and the Sponsor.
***In a nutshell, syndications are a “hands-off,’ passive way for Real Estate Investors to quickly and easily buy high quality properties for less money and excellent returns.
What are the benefits for Investors?
1) Investors can purchase a large property that hedges any downturn or volatility in the Real Estate Market, that they could not afford to buy outright on their own.
2) There is no Investor day-to-day management required.
3) They have easy access to excellent Multifamily projects.
4) Investor liability is only limited to their original investment amount.
What is the Structure of a Syndication?
1) All deals have a minimum investment required.
2) Some deals, but not all are for Accredited Investor participation. In other words, some have a combination of accredited and unaccredited investors.
3) As an Accredited Investor, there are some income and net worth requirements (more on this later).
4) Syndications offer “Preferred Returns” which are accrued during the holding period and are paid before all other types of profit sharing.
5) Dividends are paid towards these returns from rents accrued from tenants of the property.
6) These dividends are tax deferred, paid on a K-1, which has the advantage of *depreciation, off setting income. Most investors pay little if any taxes on their dividend income!
7) Profit sharing occurs at the end of the syndication when the property sells and after sale expenses and preferred returns are satisfied.
8) All remaining profits are split between the Sponsor and Investors, in a predetermined split.
9) These profits are taxed as favorable long-term Capital Gains.
10) From a business standpoint, a Syndication is generally structured using an LLC. This is done because of the ease and low cost of the formation. Additionally, LLC’s can have multiple owners and as a “pass-through” entity the LLC is not a separate tax entity like a corporation.
*Tax depreciation is the depreciation that can be listed as an expense on a tax return for a given reporting period under the applicable tax laws. It is used to reduce the amount of taxable income. Depreciation is the gradual charging to expense of a fixed asset's cost over its useful life. You take a depreciation deduction by filing Form 4562 with your tax return.
***It is important to understand all aspects of a syndication in order to make an informed decision towards reaching your diversified investment goals.
The Law
1) Crowd Funding – NEW – Regulation CF - An investor is limited in the amount he or she may invest in crowdfunding securities in any 12-month period:
A) If either the annual income or the net worth of the investor is less than $100,000, the investor is limited to the greater of $2,000 or 5% of the lesser of his or her annual income or net worth.
B) If the annual income and net worth of the investor are both greater than $100,000, the investor is limited to 10% of the lesser of his or her annual income or net worth, to a maximum of $100,000.
2) Regulation D 506 B (Safe Harbor) - The company cannot use general solicitation or advertising to market the securities.
The company may sell its securities to an unlimited number of “Accredited Investors” and up to 35 other purchasers. All Non-accredited Investors, either alone or with a purchaser representative, must be sophisticated—that is, they must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment.
3) Regulation D 506 C - Under Rule 506(c), a company can broadly solicit and advertise the offering and still be deemed to be in-compliance with the exemption’s requirements if:
A) The investors in the offering are all accredited investors; and
B) The company takes reasonable steps to verify that the investors are accredited investors, which could include reviewing documentation, such as W-2s, tax returns, bank and brokerage statements, credit reports and the like.
4) Mini IPO – Regulation A Plus, A company can raise up to $20,000,000 under Tier 1; $50,000,000 under Tier 2. However, approval from the SEC is required but General Solicitation is allowed, and any type of investor is allowed. An audit or State approval is also required.
Types of Investors
1) Non-Accredited Investors (also referred to as unaccredited) - These Investors are not sophisticated (they must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment).
2) Sophisticated Investors must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment.
3) Accredited Investors – These Investors earn yearly salaries of $200,000 (single) or $300,000 (married) or have a net worth of $1,000,000 (not counting their primary residence). Only 3%-10% of the population.
Examples
Example 1
Investors Preferred Return (At Years End) = 8%
Acquisition of Building $1,000,000 (no mortgage – Investors fund total amount)
Net Income = $120,000 each year
Split at year end = 50%/50%
Investors Preferred Return – 8% x $1,000,000 = $80,000 (per year)
Net Income = $120,000 – Minus $80,000 = $40,000
50% of $40,000 = $20,000
$80,000 Plus $20,000 = $100,000
Total Income for the Year = $100,000 or 10% Cash-on-Cash Return
PLUS, Investors would still have an equity percentage (agreed upon at the start) in the appreciation of the property, so there is still an opportunity to make more money on the back end, once the property is refinanced or sold.
The K-1 Tax Depreciation advantage can also increase the return.
Example 2
Investors Preferred Return (At Years End) = 8%
Initial Investment = $100,000
Net Income = $14,000 each year
Split at year end = 50%/50%
Investors Preferred Return - 8% x $100,000 = $8,000 (per year)
Net Income = $14,000 - Minus $8,000 = $6,000
50% of $6,000 = $3000
$6,000 plus $3000 = $9,000
Total Income for the Year = $9000 or 9% Cash-On-Cash return
PLUS, Investors would still have an equity percentage (agreed upon at the start) in the appreciation of the property, so there is still an opportunity to make more money on the back end, once the property is refinanced or sold.
The K-1 Tax Depreciation advantage can also increase the return.