for Every Homebuyer
The Plan:
Syndication is a form of passive real estate investment that employs the pooled funds of multiple investors to finance the acquisition of an income-producing asset that is otherwise outside of the financial capability (or risk tolerance) of any individual investor.
Within this system, there are two parties. The first usually consists of a sole individual known as the syndicator (also known as the "sponsor"), whose responsibilities encompass facilitating the actual acquisition. This spans everything from identifying suitable investment opportunities, engaging in negotiations, determining costs and returns on investments, conducting any necessary improvements to the property, managing the property, and more. Essentially, they are the boots on the ground, and (as to be expected) are skilled professionals in real estate investment that hold much responsibility for the success of the joint venture.
The other party is comprised of the investors, or "limited partners", who provide the financing to make the deal happen. While the syndicator can offer their expertise and time rather than investment capital, investors only hold the responsibility of contributing funding (though any wise investor would ensure that the deal makes sense before dedicating their funds). Other than financing the deal, investors play a very passive role, leaving the day to day operations to the syndicator to manage. In return for their contributions, investors are entitled to a percentage of profits proportional to their contribution sizes, and also retain ownership of a percentage of the property.
Syndications are often structured as LLCs (Limited Liability Companies), with investors being members of the LLC. The operating agreement would then cover the communication, profit-sharing, and voting practices of the syndication in writing. As a form of passive income, real estate syndication is a relatively safe way to generate profit from property acquisitions at a lower up front cost. However, in reality, the chances of success are no different than the acquisition of an investment property by a single individual; your risk exposure is simply lower than it would be financing a property acquisition on your own.
Process Breakdown
Step 1: Investors form a Business Entity and Outline Operating Agreement
Investors and a chosen and trusted syndicator band together to form a business entity under which their operations will be carried out. This is most commonly an LLC, which efficiently facilitates the division of company ownership among members. Operating agreements will be set in writing at this point, which prevents disputes or confusion further along in the process.
Step 2: Syndicator Identifies Investment Opportunities
The syndicator will identify properties of interest and share them with the investors. Once suitable properties are found, investors will carefully consider the various aspects of the property and cast a vote on acquisition. The rules of the voting process will be outlined in the operating agreement. Should a property be selected through the voting process for acquisition, the syndicator will move forward with the purchase offer.
Step 3: Property is Acquired under Business Entity
The property will be acquired through a transaction not dissimilar to any other real estate transaction, particularly if acquiring a residential 1-4 unit property (note that bedrooms are not the same as units). The property will reside within the business entity and under joint ownership of the syndication participants.
Step 4: Property is Managed (or sold), Profits are Divided
The property can either be retained for rental income or flipped and sold soon after acquisition. In either case, all proceeds will be distributed to the participants of the syndication proportionate to their contributions. Assuming that the venture is profitable, investors will have recouped all their funds plus profit, allowing them to immediately rinse and repeat this process. However, as many syndications are meant for the acquisition of rental properties, investors may have their capital tied up in the investment property for a lengthy period of time before an exit is made. Investors who wish to exit earlier may have opportunities to cash out their investment as outlined in the operating agreement.
Summary
Pros:
The most impactful benefit of syndication is that it lowers the barrier of entry for individual investors to begin investing in real estate. With the cost (potentially) split among many investors, a venture into real estate can become much more affordable.
With investment capital divided among many investors, your risk exposure may be lowered significantly depending on how much or how little you choose to contribute.
Unless acting in the role of the syndicator, syndication is very passive and does not demand much attention.
Cons:
The largest weakness of syndications is that the potential to generate substantial profits is severely reduced due to your involvement in the venture being partial.
If the syndication venture is to acquire a rental income-producing property, your investment capital will likely be tied to the investment for several years, in which time the value of the acquired asset may decrease.
Due to the majority-rules structuring of the voting process, it is possible that your investment in a syndication may not be desirable to you, in which case you are investing in an asset you do not have faith in.
This one is more symbolic, but an important consideration nonetheless. Whereas with all other strategies, you have the pride of whole ownership, you will lack such distinction with syndication.
Conclusion:
Overall, syndication is a very safe play in the real estate investing field. If your contributions are low relative to what you would have faced investing solo, you will have substantially lowered your risk exposure. It is also a strategy that can easily meld into a variety of lifestyles and be accessed by individuals with lower amounts of liquidity. However, your profitability is severely hampered by the safety and partial nature of this strategy. While syndication can be a great way to park funds and hope for steady returns, it will not be a desirable mode of investment for more active investors.