I recently was able to sit down with a great Dallas area syndicator. He owns over 2,000 units between Ohio, Texas, and Oklahoma. He wants to maintain his anonymity but he was willing to share his great knowledge with us!
Real Estate Syndication
At some point, you’ve wondered how people could possibly afford giant apartment buildings, office buildings, or even shopping plazas.
The answer: with real estate syndication.
Real Estate Syndication Defined
Syndication is a way which multiple real estate investors pool their funds together in order to purchase a property that is more expensive than any of them could have afforded on their own.
It is also an effective way to spread risk by allowing investors to buy into multiple real estate deals, rather than locking all of their money into a single deal.
Structure Of A Syndication
First of all, let’s talk about how a syndication is set up and what it’s structure is.
A syndication is a group of investors who pool their money together. There are countless ways to set up a syndication and share the income, but I’ll just talk about how I like to do it.
The person who puts the deal together is called the principal. The principal takes 10-20% of the deal just for putting it all together. The amount really depends on the deal and the investors experience.
Most of the investors are just equity partners and take a more passive role in the deal. They will split the remaining 80-90%. The principal is usually expected to put some of his own money into the deal as well, which would be added on top of his principal portion.
So just to explain this a bit – let’s say the investors need to put in $1 million to make the deal work. Let’s say the principal is a newbie, so his principal stake is 10%.
The total cash invested is $1 mil and that is worth 90% of the deal. So everyone who invests into the syndication get’s to split up the 90%.
If the principal also invests some cash, he get’s to dip into that 90%. If he put’s in $100,000 into the deal, he gets 1/10 of that 90%. This means his portion of the deal is actually 19%.
There are a lot of different ways to split the profits, but I like to keep it simple. We split the revenue according to the ratios. When we sell, I make sure the investors are “made whole” first before I take anything.
The structure doesn’t require it, but, if I have to eat a loss just to maintain my reputation, that’s what I’ll do.
This all seems pretty complicated, do you have an attorney draft the paperwork?
In order to be compliant with the SEC, you need to have some specific documentation in place.
The biggest piece to it all is called the private placement memorandum (ppm). This document will protect you legally by making sure all the proper disclosures are made.
Also, most of the investors are required to be accredited investors. Non-accredited investors can be part of the deal, but they need to be covered under the “friends and family” exclusion. You really need to consult with a securities attorney to make sure you are following all the rules.
How do you find deals to syndicate?
Let’s change gears. How do you find deals? Do you use Loopnet or some other online listing site to find deals? How do you find them?
Loopnet is where deals go to die. The only way to find deals is to build a relationship with the big commercial real estate players in the market.
How do you find those agents and how do you make them take you seriously?
A market generally only has a few major names. The top 2 or 3 people have access to virtually all the deals, so you just need to identify them.
It’s not hard to get yourself onto their email list, but it can be more difficult to get people to take your offers seriously. It’s important to have some experience in the field. If you don’t make up for the experience with price on your offer.
I’ve always heard that people tend to take a deal that is more likely to close. You are saying that this doesn’t really matter?
Think about it. If you are guaranteed to close on a deal for $5.1 million, but a newbie offers you $5.2 million, are you going to leave $100,000 on the table just to close a few weeks faster?
The worst case scenario for the seller is they get to keep the earnest money deposit, then go sell it to the second best offer.
What does it cost to syndicate a real estate deal
You mentioned the EMD. In smaller real estate, the EMD is refundable if funding falls through. That isn’t the same for apartment buildings?
The earnest money deposit is usually 1% of the purchase price and it’s non-refundable after the due diligence period.
You better make sure you really want the deal before you make an offer.
Alright, so we are getting a bit into costs. How much money do you actually need to make a syndication deal happen?
Great question, it’ll be easier if we just break down some of the up front costs you’ll encounter.
One of the most costly things you’ll encounter is the PPM. It generally costs me around $12,500 to get one done and meet all the legal requirements.
You’ll also have an expensive loan application. Expect to pay another $10,000 to $12,000 for that.
Then you’ll need the 1% EMD to put down. On a $4 million deal, that’s another $40,000. This goes toward the purchase price, but you still need to pay up front for it.
You will need to pay for due diligence. I generally can get it done for free by the property management company I plan to hire, but you should account for another $40-50/door in due diligence costs.
So in all, you will need $65-75,000 in cash in order to syndicate a deal.
Sometimes I also like to offer a 0.5% – 1% bonus to the agent. It ensures that I get all the best deals in my inbox and they really push my offers over others. This helps me stay really competitive in a hot market.
These are all costs that the syndication will cover, so you will get reimbursed once the deal closes. Or, you can apply that money toward your portion of project and increase your ownership.
So you need quite a bit of cash up front just to make the deal happen. If you think about it though, $75,000 cash is not really a ton of money to lock into a $4-5 million deal.
Being able to do a huge deal with so little money seems pretty good.
I generally also have an asset manager. This person checks on the property once a month and makes sure the property management company is doing a good job.
The asset manager generally gets 1-1.5% of gross revenue.
If you are the principal and the asset manager, you can collect this fee for yourself to help provide a salary.
How big does a syndication deal need to be?
We are talking some pretty big numbers here overall. Realistically though, how big or small does the deal need to be in order for it to make sense?
Well, it really depends on the deal. The fixed costs don’t change much which are about $30,000. So, on a $1 million deal, it’s about 3% of the price while on a $4 million deal it’s only 0.75%.
If you find a killer small deal, then go for it. Generally though, I think about $1.5 million is the lowest I’d go just to keep the syndicating costs a small percentage of the project.
How do you find investors?
Ok, most people reading this are probably wondering how you find people to invest so much money. Most people can save up $50-100k, but you are talking about raising hundreds of thousands, or even millions of dollars for a deal. How?
It doesn’t happen overnight. You have to build up your investors list and communicate with them on a regular basis.
Also, most people can’t just jump right in and start on $5 or $10 million deals. A $1.5 mil deal needs less than $400,000 cash. You only need a few investors to reach that goal, especially if you are putting in close to $100k.
Once you get that first deal done, you can use that as experience to gain access to investors.
It’s also a good idea to go to local investor meetings to gain more contacts and find potential investors.
Example Syndication Deal
That’s the end of the interview, and you may be left wondering exactly how much the principal earns in one of these deals. So, I put together this example based upon the knowledge I gained.
Let’s assume we found a 6.5 cap property somewhere in Texas. It’s about 70 units and is selling for $60,000 per unit. That’s $4.2 million total.
A 6.5 cap rate means the property nets about $273,000 per year before finance costs.
With about $875,000 as a down payment, that’s about $190,000/year in finance costs (I’m rounding).
So the cash flow is about $83,000/year.
Of course some of that goes toward principal, and eventually the deal will be sold and that will get distributed back to the investors. For now though, let’s just focus on cash flow and not the entire return.
What The Principal and Equity Partners Earn in a Syndication
Now we have to take the 1% asset management fee out of the gross rents. We don’t have a number on gross rent (only NOI). Let’s say it’s $8,000. If you were the asset manager, great you get to pocket that. If not, someone else does.
The rental income is now $75,000.
Of that cash flow, the new syndicator will earn 10% of the deal up front. If the principal also put in about $100,000 into the deal, they would have a total equity of 21.4% or about $16,050. That’s about an 16% cash on cash return for the principal (excluding the asset management fee) and about 7.6% cash on cash return for the passive investors.
To be realistic though, you probably won’t be able to find many investors for a deal that cash flows only 7.6%. You’re going to want to find deals where you can add value and bump that cash flow into the double digits.
Either way though, this example illustrates how lucrative it can be to put together deals as the principal in a syndication.