What Is A Syndication?
"Helping Our Investors Reach Their Financial Goals Through Passive Real Estate Investing"
-Maple Capital Partners Mission Statement
At Maple Capital Partners, we take our mission statement very seriously. We aim to help investors understand how they can use passive real estate investing as a crucial part of their overall portfolio. We hope to do this by providing them with free, high-quality educational content on the subject. Whether they decide to one day invest with us or a different sponsor is of lesser concern to us than making certain that they understand the unique risks and opportunities presented by this investment strategy. As such, we'll dedicate this post to laying out the basics of our preferred method of investing passively: through syndication. We hope you find this content useful.
What Is A Syndication?
When we mention the word "syndication" to new investors we usually get a couple of pretty funny responses:
- "Wait, like Al Capone's organized crime syndicate? Actually, I'm good on that."
- "You mean like a syndicated series? Are we talking Seinfeld or How I Met Your Mother?"
Although entertaining, neither of these responses are related to real estate syndications. The real estate syndications we know and love are defined as follows:
Real Estate Syndication: A pooling of financial and intellectual resources between active and passive investors in order to invest in real estate projects together. This investment vehicle allows investors to acquire assets much larger than they could possibly afford or manage on their own.
Let's now dig a little bit deeper into how they work practically-speaking.
The syndication business model came into existence in order to solve two complementary needs in the marketplace.
1.) Passive investors, also known as limited partners ("LPs"), are looking for a return on their capital through real estate but don’t have the time, experience, or desire to invest actively themselves. Just like stocks, bonds, or other asset classes, it takes a lot of time, sacrifice, energy, and effort to develop a winning strategy in real estate and many investors intelligently would rather outsource this aspect of their portfolio to qualified professionals than do it themselves. Whatever the reason, these passive investors have the capital but not the experience/time/desire to invest in real estate on their own.
2.) On the other side of the coin are active investors. Sometimes called general partners ("GPs"), syndicators, sponsors, or operators, they are professional real estate investors looking to leverage their experience, time, energy, and industry contacts in order to invest in larger deals than they might be able to with only their own capital. Just like professionals in other industries, the best GPs have spent years and sometimes decades developing the requisite experience and knowledge to invest proficiently in real estate. Besides experience, they also have the contacts needed to be successful in this highly relationship-driven asset class. These investors subscribe to the OPM strategy popularized by Robert Kiyosaki, author of “Rich Dad Poor Dad.” In short, they need the capital to be able to scale their own real estate portfolio faster than they might if they were using only their own money.
These two investor groups’ needs are solved by each other via a real estate syndication. The passive investors partner with active investors so that together they can use their collective capital, knowledge, and industry contacts to successfully invest in large real estate projects.
Role of GPs & LPs
By now you should have a good idea of what each group of investors (LPs & GPs) brings to the table. However, we’ll expand on these roles a bit further. General Partners are responsible for the heavy lifting in this relationship. Just like in horse racing, real estate syndication is a business where you bet primarily on the jockey (the GP) and only secondarily on the horse (the deal). In other words, when you invest in syndications, you’re investing in the jockey’s ability to lead and execute on the business plan for a particular deal. Some of the GP’s high-level responsibilities include:
Developing a team (brokers, property managers, lenders, contractors, etc.) with expertise in the local market.
Building an acquisition pipeline to find deals.
Underwrite deals to see if they meet stringent return criteria.
Make offers and perform due diligence on deals to ensure risks are understood/ mitigated prior to acquisition.
Line up financing for the deal.
Legally structure the operating entities with the help of a qualified SEC attorney.
Close on and take over the asset.
Re-position/add value to the asset. This part is called “asset management” and, although it’s less glamorous than some of the other responsibilities, this is the real bread and butter of a skilled GP. See Maple Announcements section below for more on this.
Provide updates, tax documents, and ongoing financial reporting to LP investors.
Refinance, sell, or hold depending on business plan.
Limited Partners on the other hand simply provide the initial capital, collect their regular distribution checks, and their responsibilities pretty much end there. Ahh, the good life!
How Is A Syndication Organized Legally?
Great question, voice in my head. Syndication is technically a financial security, similar to a stock in some ways. From a regulatory perspective, this means that they're overseen by the SEC and for good reason. Real estate transactions generally involve hundreds of thousands or even millions of dollars in capital. So this SEC oversight should give investors some comfort that they have certain protections.
In this next part, we’ll discuss how the legal entities are set up but we should introduce the usual caveats/qualifiers when speaking on legal issues. Neither Gonzalo nor Marc are real estate attorneys nor do they pretend to be on TV. As such, this content isn’t intended to take the place of the advice of a qualified legal representative. Any and all of the following should be taken for informational purposes and is based on the experiences of Maple Capital Partners only. Now that that’s out of the way, the following is a diagram of generally how we’ve structured our own and seen others’ syndications structured in the past.
Hopefully, the above makes perfect sense. While the property LLC owns the property, that entity has both GP and LP members as its owners. In other words, these members own a piece of the company that holds title to the property. In this case, the ownership split is 80/20 LP/GP.
Fees & Profit Split
So we’ve covered what the LPs and GPs each bring to the table. But how does this partnership look in terms of splitting profits? The profit split, or "promote" as it's known in some circles, can take any form that both parties agree to in their operating agreement. However, the most common arrangement in the industry is for GPs to get a slightly lesser share of the profits for their role. Usually this means somewhere in the 20-40% of net profits range depending on the deal. In addition to this share of cash-flow and eventual profits from sale, the GP usually charges fees at various points throughout the investment lifecycle—acquisition, annual asset management, and disposition fees are common. “Why would GP’s make both a profit split AND fees?” you might ask. Simply put, most of the return for a GP comes at the backend of the deal upon sale of the asset. That’s when the lion’s share of the profits will be realized. Until then though, the GP is making relatively little to perform all of the duties laid out in the above "Role of GPs" section. These duties aren’t cheap, and the GP needs to be compensated for things like developing an acquisition pipeline (finding deals), traveling to the asset, document preparation, book-keeping, etc. These are simply the costs of keeping the lights on in a real estate syndication.
Syndication vs. Sole Ownership
So by now you should have a better understanding of what real estate syndications look like in the real world. Let’s now analyze some of the trade-offs for an LP in this structure vs. owning real estate outright as a true landlord.
Con's of Syndications vs. Sole Ownership
Equity give up: As an LP in a syndication deal, you’re giving up a share of your equity in return for having a professional run the deal. While this may be a worthwhile trade-off for your particular situation, some LPs may actually have the time/experience/desire to invest directly themselves and not want to part ways with their precious equity.
Lack of control: A passive investor will not have the same degree of control over their real estate as a GP or landlord would. Depending on how the syndication is structured, the LPs will likely not have much input to the day-to-day decisions of the investment. A landlord on the other hand has total control over their asset.
Tax implications: A lack of direct say in the day-to-day management of the asset could result in circumstances where the LP's individual tax situation isn't optimized. For example, the decision of when to sell may have taxable consequences on an investor and thus the landlord might be in a better position to decide that timing based on their own situation. Whereas, the GP will likely have decision-making discretion on when to sell in a syndication.
Pro's of Syndications vs. Sole Ownership
Get back your time: The one commodity that is more or less fixed for every investor (and indeed every human being) is TIME. As an LP in a syndication, you get the benefit of earning returns in real estate without having to give up your most valuable resource. Besides time, there is a ton of energy and stress that goes along with being a successful real estate investor. This is time, energy, and bandwidth that LP’s could otherwise spend on things they enjoy doing. Rather than dealing with tenant delinquency and late night maintenance requests, wouldn't you rather focus on the things that light you up?
Tenant diversification: This is one of the benefits of owning larger assets via syndication. If you own a fourplex and one tenant doesn't pay rent, that's 25% of your rent gone. If you have a stake in a 100 unit building, a single tenant's non-payment likely won't affect your profitability much.
Geographic diversification: It would be very difficult for you to acquire single- and small multi-family properties in multiple different markets. You'd lose the economies of scale that it takes to make these investments really profitable. However, when you're investing in others' deals, you don't have to specialize in a particular market. That's what the sponsor is there for. If you wanted, you could invest in a different market on every deal--owning a stake in properties throughout the US and thus lowering your exposure to any single region or market.
A good operator will make you more $: Even taking fees and the promote into consideration, you will make more money with a seasoned, skilled operator than you might ever be able to on your own. That's because this is their sandbox. While you might be spending time on certain weeknights or even weekends trying to find your next deal or managing your current properties as a sole proprietor, it's unlikely you'll ever amass the knowledge they've acquired over years as a full-time investor.
Economies of scale: We touched on this above but it's much more cost effective to run on a large multifamily property on a per unit basis than it is to run a smaller asset. This is because your fixed costs are spread out over a larger number of units. For example, if you own a single family and your roof needs to be replaced, that's a higher per unit capital expense than if your roof needed to be replaced on a 30-unit asset.
Less headaches: On a large syndicated deal, a GP can afford hire a team of qualified professionals to manage the various aspects of the business. This team could be composed of a property manager, book-keeper, contractors, on-site maintenance, leasing agents, and many more whose focused expertise means less headaches for you as an investor. It's highly unlikely that you'd be able to outsource all of these roles on a smaller asset (and still be profitable).
Congratulations! Just by reading the above, you should have a basic understanding of what a syndication is, how it works, and why an individual might choose to invest in real estate via this vehicle. As always, if you have any questions or would like further clarification on anything in the above, don't hesitate to reach out to Gonzalo or Marc.