If you’ve never heard the term “real estate syndication,” you’re not alone. Most people haven’t, and fewer know what a real estate syndication is or how they work.
Historically, only the wealthy could access private equity investments like these. That has changed in recent years, and increasingly the middle classes can access real estate syndications.
But what is a real estate syndication? How are real estate syndications structured? How well do they pay, and what are the risks? And do you really need at least $50,000 to invest in them?
Strap in, because real estate syndications have changed the way I think about real estate investing and supercharged my returns while minimizing my labor.
What Is a Real Estate Syndication?
A real estate syndication is a private equity deal where the lead investor (called the sponsor, syndicator, or general partner) raises money privately to help fund buying a large commercial property. Types of properties could include multifamily apartment complexes, self-storage facilities, mobile home parks, office buildings, even industrial parks or oil and gas fields.
For example, you find an apartment building for sale at a deep discount, and you want to buy it. But even with an investment property loan covering 75% of the purchase price, you still can’t afford the 25% down payment. So, you raise some of the remaining money from friends, family members, neighbors, and your aunt’s second cousin once removed.
For a portion of the ownership, of course. Each of these “limited partners” becomes a fractional owner in the property, too.
Of course, most people don’t have enough rich family members to cover huge commercial real estate deals. So as they scale, they start raising money from people they don’t know.
People like you and me.
Real Estate Syndication Structure
In a real estate syndication, the general partner (GP) finds the deal and oversees purchase, management, and selling. They take out an investment property loan to cover some of it, put some of their own cash in the deal, and raise the rest from limited partners.
The GP usually builds in some extra fees and returns for themselves to compensate them for their trouble. For example, they might collect an acquisition fee of 1-3% of the purchase price or a disposition fee when they sell the property.
They also structure the returns so that the more the property earns, the greater their cut.
For example, the limited partners (the passive investors like you and me) might get an 8% preferred return on all revenue. That means that we get paid the first 8% in returns, before the GP gets a dime. Above that 8% threshold, there could be a 70/30 split on returns up to 20%, with 70% of returns coming to us LPs and 30% going to the GP. Over 20% annual returns, the split might drop to 50/50.
In this example, a property earning a 25% annualized return would break down profits like so:
- Limited Partners: 18.9% returns (8% preferred return + 70% of the next 12% + 50% of the next 5%)
- General Partner: 6.1% (none of the first 8%, 30% of the next 12%, 50% of the next 5%)
This kind of arrangement is called a waterfall, as the share of profits change once they hit certain thresholds.
In practice, the GP usually gets their big paycheck once the property sells. That year, the property might generate an 80% return, and most of that gets split 50/50.
As for the legal structure, the sponsor creates a legal entity such as an LLC and all partners get listed as partial owners.
Returns on Real Estate Syndications
I’ve seen real estate syndications pay annual returns over 100%.
Of course, that’s not typical. More often you’re looking at 12-30% annual returns, including both cash-on-cash returns (yield) and capital gains when the property sells.
Which raises another point: sponsors use several measurements for returns on real estate syndications.
The simplest is equity multiple: what the property sells for, as a multiple for what they bought it for. For example, if you invest in a syndication that buys a property for $1 million, and you sell it five years later for $2 million, that’s an equity multiple of 2.0. If it sold for 80% higher than what you bought it for — $1.8 million — that would be an equity multiple of 1.8.
Another simple way to measure real estate syndication returns is the average annual return. It’s literally just the total return on the project after it sells divided by the number of years you owned the property. In the example above, if you sold the property for $2 million after five years, that would mean a 20% average annual return: a 100% return on the initial investment, divided by five years of holding it.
The reality looks a little more complicated, as most syndications pay cash flow distributions along the way. For example, say that same project paid out 7% per year in distributions while you owned it, before selling for twice the initial investment five years later. In that case, the average annual return would be 27%.
The most complicated — and most accurate — measure of real estate syndication returns is internal rate of return (IRR). It sounds complicated, and the calculation is complicated, but the concept is simple enough. It calculates the annualized return you earned, taking compound interest into account. Because investments compound over time, but most real estate syndications pay out most of their returns at the very end, you don’t get to reinvest most of those returns along the way. The IRR metric calculates what your annual return would be if you had received the return each year and reinvested it at the same rate.
If you like the idea of 12-30% returns on passive real estate investments, but want to invest with $5,000 instead of $50,000, check out our Co-Investing Club and FIRE from Real Estate program. Our “tribe” proposes a real estate syndication deal every month, and we all pool funds together so we can each invest with less.
Real Estate Syndication Risks
When people first learn about real estate syndications, their eyes often see dollar signs at the enormous returns most syndication projects generate.
But high returns never come without risk. Large commercial real estate deals can and do go wrong, leaving investors with low returns or even losses.
The renovations could cost double the estimated amount, or take twice as long. Occupancy rates could come in lower than expected. The local housing inspectors could refuse to issue permits until getting paid hefty bribes (you laugh, but I’ve seen that happen).
For that matter, the sponsor could take your money and run off to Guatemala.
More mundanely, the local market could just see a housing market correction or a recession could strike. While rental properties are more recession-proof than most investments, they aren’t immune to economic downturns. Rents don’t typically drop, but vacancy rates and eviction filings do rise in recessions.
So how do you mitigate these risks as you evaluate investment opportunities?
First, vet the sponsor carefully. How long have they been investing in this real estate niche? How many real estate property deals have they done in the past? What’s their track record and past returns on those real estate projects? Have they ever lost investors’ money?
Next, do your due diligence on the real estate deal itself. Is the local real estate market seeing population growth? Economic and job market growth? What’s the local unemployment rate? What class of property is it (A, B, C, etc.)? How conservative is the underwriting of the deal? At what occupancy rate would the deal break even? How much property leverage is the sponsor borrowing?
Keep asking questions until you either have a hard yes or a hard no on the deal. If you’re still on the fence after asking all your questions, opt out of the deal.
Real Estate Syndication vs. REIT
What’s the difference between a real estate syndication and a REIT (real estate investment trust)?
Real estate syndications are private equity investments, not traded on public stock exchanges and not necessarily available to the general public. Many are only open to accredited investors, with a net worth over $1 million or high incomes.
There’s no secondary market for selling your shares in real estate syndications. That means no liquidity: once you buy in, your money remains locked in the deal until the GP either sells the property or refinances it to return capital to you and the other investors.
In other words, think of real estate syndications as long-term investments. Once on the ride, you stay on until it comes to a full stop.
Real estate syndications also come with much higher minimum investments than public REITs. Most syndications require a minimum investment between $25,000 and $100,000 — hardly chump change. In contrast, you can buy shares in publicly-traded REITs for the price of a single share, often $10–$100.
If those all sound like downsides (and they are), real estate syndications come with an enormous upside: dramatically higher return potential. Public REITs, being available to the public, earn returns based on whatever Joe Six Pack is willing to accept. If you’re only willing to invest at a yield of 10%, but he’s willing to invest for a 7% yield, he’ll outbid you on the stock.
But real estate syndications are private investments, not open to every Jimmy and Joe. That exclusivity is precisely what drives up the returns.
Real Estate Syndications vs. Crowdfunding
While real estate crowdfunding investments have more in common with real estate syndications than public REITs, they’re still available to the public. Some only allow accredited investors to participate, others allow anyone to invest, but they’re all publicly advertised.
Most real estate crowdfunding platforms allow investors to sell early, even if they charge a penalty for it. You have the option to pull your money out early, if you’re willing to take a hit. That option doesn’t exist at all for most real estate syndications.
Like real estate crowdfunding investments, some syndications allow equity investments, others offer debt investments. Some offer both. Debt investments pay more consistent and high cash flow, while equity investments offer more upside potential when the property sells.
If you’re new to passive real estate investing, start with real estate crowdfunding. You can more easily find public reviews of crowdfunding platforms than private real estate syndicators, making them easier to vet. Plus, you can usually invest at any time, rather than waiting for individual property deals to come along.
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Tax Benefits of Real Estate Syndications
Syndications come with significant tax advantages, even for passive investors.
The syndication legal entity doesn’t pay any taxes itself — all profits and losses pass through to individual investors. That prevents double taxation.
It also means that all investors, including limited partners, get to take advantage of all property tax deductions. From loan interest to closing costs, repairs to property management fees and beyond, these deductions reduce the taxable income from syndications.
Most notably of all, those deductions include paper losses from depreciation. Even as investors collect distributions and cash flow, they typically show paper losses on their tax returns in the first few years due to accelerated depreciation. You can use those paper losses to offset passive income from other sources, but unlike how rental income is taxed, you can’t use losses from syndications to offset up to $25,000 in active income.
If you don’t have other streams of passive income to offset this year, you can carry the paper losses forward. They’ll come in handy when the property sells, and you get a fat paycheck (and tax bill).
You can also use 1031 exchanges with real estate syndications, but it’s tricky. If you want to 1031 exchange funds from another real estate sale into a syndication, you have to convince the sponsor to structure your investment as “Tenants in Common” rather than a typical LP investment. Most sponsors are only willing to do that for high rollers investing $500,000 or $1 million in their deal.
Alternatively, entire real estate syndications can 1031 exchange when they sell a property. But it requires all (or at least most) LPs to be on board, so it’s usually designed this way from the start.
Real estate investors can make money in countless ways, from long-term rentals to short-term, flipping houses to wholesaling real estate, mobile home parks to self-storage to office buildings. And that says nothing of passive real estate investing options like REITs, private notes, and real estate crowdfunding.
But few real estate assets blend the high return on investment, positive cash flow, tax breaks, and hands-off nature of real estate syndication deals.
As you consider expanding your investment portfolio to include real estate syndications, keep your long-term investment goals and financial needs in mind. You may not get your money back for five years or longer — a deal breaker for many investors, regardless of the returns.♦
How do you see syndications fitting into your real estate portfolio? What questions do you have about them?
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About the Author
G. Brian Davis is a landlord, real estate investor, and co-founder of SparkRental. His mission: to help 5,000 people reach financial independence by replacing their 9-5 jobs with rental income. If you want to be one of them, join Brian, Deni, and guest Scott Hoefler for a free masterclass on how Scott ditched his day job in under five years.