Real Estate Syndication

Real estate syndications were the first crowdfunding. In modern real estate crowdfunding platforms, people pool together their money and open a company. But it is the owners of the company who are going to manage it and execute the business plan, not the people who funded it.

Real estate syndications are the same thing, except the "company" is usually a large real estate investment. People pool their money into a real estate investment fund that invests in properties such as mobile home parks, self-storage units, automated teller machines (ATMs), land, apartment buildings, and so on.

Instead of purchasing ownership shares in a technology company, real estate syndication deals involve buying "shares" in property that might otherwise be out of the reach of individual investors.

As a veteran tech employee myself, with two IPOs under my belt, I eventually looked to real estate investing to make my money work for me.

Deciding to get into real estate investing was something I didn't do lightly or on a whim. I got into real estate investments when I saw that the life of a tech employee was a little like being in a "golden jail" of working extremely long hours for a nest egg that wasn't half as valuable as the time and grind required to produce it.

As a tech employee, you work hard and you earn well. But how can you earn more without breaking your back so much? A real estate syndicate is one option, so long as you educate yourself on the subject properly before jumping in the deep end.

In this article, I aim to give you a deep dive into real estate investments, commercial real estate, and the world of real estate investors so that you, as a tech employee, can make your hard-earned money work for you.

Just a quick heads up—this is not financial advice, and you should always verify any real estate investing information with an experienced real estate attorney.

Everything you need to know about Real Estate Syndication

How does a real estate syndication work?

A real estate syndication is when a group of real estate investors pools its capital into a Limited Liability Company or Limited Partnership that is then used to purchase real estate that is usually inaccessible to a single private investor. The real estate syndication can invest in apartment buildings, commercial properties, mobile home parks, self-storage units, and other large properties.

Structure of a Typical Syndication

A real estate syndication is a method for investors to pool their funds together to increase the total investment amount available for a large real estate investment. Real estate syndicates are made up of a team with specific roles.

There is a sponsor for the project who sources the investment and looks to bring in other investors. The sponsor is referred to as a general partner, managing partner, or operating partner. These are the names that generally apply to real estate syndicators.

The legal structure of a real estate syndication is usually a Limited Partnership or an LLC (Limited Liability Company).

Investors take on the role of limited partners. But they are also commonly referred to as passive investors because they are not involved in the day-to-day management of the property and are therefore removed from the liabilities associated with operations.

The real estate syndication investors provide the capital required for the sponsor to invest in high-yield real estate assets. A Private Placement Memorandum or PPM is the contract that limited partners execute to invest in a real estate syndication.

At Wealthward Capital, we have built a real estate portfolio that is ideally suited to tech employees who wish to turn their hard labor into steady cash flow and passive profits. Tech employees work hard for the compensation they receive. But if they don't turn that compensation into steady passive income, they're going to burn out.

Have real estate syndications been around for a long time?

Yes, real estate and property syndication has been a tool in private equity investing for many years. However, it was after the 2008 Financial Crisis that real estate syndications started to gain more awareness.

The passing of the Jumpstart Our Business Startups Act (also known as the Jobs Act) in 2012 was a direct response to the financial crisis. From that act—specifically, Title III—came crowdfunding.

This piece of legislation empowered people to raise capital by selling a modified version of a security to "the crowd." These private securities are different from stocks and are managed through Regulation D of the Securities Act.

Regulation D allows certain exemptions from registering a security with the Securities Exchange Commission (SEC).

Since 2012, real estate syndications have been more popular and seen explosive growth as investors began looking for ways to diversify outside the market, and gain healthier streams of income.

Is a real estate syndication a good investment?

As with all high-reward investments, a real estate syndicate can be high-risk if you are not educated as an investor. It is crucial to learn all you can regarding the risks of any investment and to perform all necessary due diligence before investing.

The main attraction of a real estate syndication structure is that it lets you invest in commercial real estate without a lot of capital. A standard minimum investment is $25,000.

There are enormous benefits to investing in commercial real estate, including predictable income, tax benefits and high-yield equity multiple.

Commercial real estate is an asset class that is mostly out of the reach of even accredited investors because financing such an investment usually takes resources only available to institutions. Real estate syndications were created to overcome this hurdle.

In today's market, commercial real estate syndications are essential to generate meaningful passive income in your portfolio, and provide diversification from stock market volatility.

How much does a real estate syndication make?

By pooling capital with other investors, real estate syndication platforms are able to use that pooled capital to invest in high-yield properties. Through sweat equity and the natural appreciation of the land, that real estate project can gain in value and each investor in the real estate deal can earn respectable cash flow.

Real estate syndications protect investor capital by investing in assets that are outside the stock market. They tend to operate on a “preferred return” basis, meaning that the limited partners receive their payments before anyone else, because they invested the bulk of the capital.

Many real estate syndicates also use a system called “Forced Appreciation” which is a way to rapidly appreciate the value of a real estate investment. This is done by increasing the property’s ability to generate income, also known as its Net Operating Income (NOI). This could be done by increasing rents, or finding other ways to monetize the property, such as using sections of it for paid storage.

How much a real estate syndication makes is determined by the business plan and exit strategy. Generally, the greatest amount of gain is generated through a predetermined exit strategy. The final sale price is usually the key indicator of whether the investment met its target or not.

Wealthward Capital's approach for tech employees is to focus on cash flow. Our philosophy is that a tech employee should start earning passive income as soon as possible after investing in syndicated real estate.

How is a real estate syndication taxed?

Provided the real estate syndication property has been held for more than 12 months, passive investors will generally pay capital gains tax at a rate of 15% after the property is sold.

But the tax treatment of real estate syndications is a detailed subject, with tax benefits to be had during the entire lifespan of the investment.

One of the primary tax benefits is that of accelerated depreciation which is an advantageous method of counting paper losses for a commercial property in its early years.

Accelerated depreciation can result in an accounting loss on paper when there is nonetheless cash flowing out of the investment to passive investors. Some of these losses must be recouped on selling the property, but the acid test of competent syndication management is how much the sponsor can reduce those taxes.

Investors in real estate syndications can also receive a portion of the rental income based on the goal and structure of the syndication. This income is labeled as passive income or passive activity by the IRS. It is taxed at the rates of a person's ordinary income. But because the activity is classified as passive, then passive expenses such as depreciation can offset these gains. 

Tax strategy

Passive activity is defined as an investment or business that the investor did not materially participate in during the tax year.

An important thing to know is that real estate is an asset class that the IRS tends to look favorably upon because of its ability to boost an economy. Real estate brings jobs, homes, and economic activity to an area. That's why the IRS has provided numerous tax breaks to real estate investments.

Unlike a REIT (Real Estate Investment Trust), investors in a real estate syndication own actual real estate. Investing in a REIT gives you shares in that company, but no legal right to the underlying property. That's why real estate syndications can offer more real estate-related tax benefits.

For a full understanding of a real estate syndication's tax benefits, contact Wealthward for a no-obligation consultation.

What are the three phases of a real estate syndication?

A real estate syndication has three primary phases: (1) Origination, (2) Operation, and (3), Liquidation. This full cycle covers everything from acquiring the real estate property to raising capital, executing the business plan, and eventually reselling it.

In the Origination phase, the real estate syndicate sponsor must take all due diligence to plan and research the project, properly register and disclose it, and then market it to potential investors.

In the Operation phase, the sponsor must manage both the underlying investment as well as the real estate syndication itself. For this, the sponsor usually charges sponsor fees.

It is not uncommon that the property is refurbished at this stage to secure a higher selling price for it and so maximize returns for passive investors involved in the project.

In the Liquidation phase, a liquidation event is held. Invested capital is returned to investors and any necessary capital gains taxes are paid.

Sometimes, instead of liquidating the asset, a sponsor might find that refinancing it is a more viable option. In this case, the Operation phase will continue until the final liquidation event at a later stage.

How do real estate syndications make money?

The pooled capital in a real estate syndication generally opens the door to high-yield investment opportunities that would not be available to individual accredited investors. The sponsor is responsible for making sure that the underlying investment results in passive income to other investors during the entire life cycle of the syndicate.

A sponsor or general partner will usually charge an acquisition fee for his or her service in identifying, assembling and marketing the opportunity.

For managing the underlying investments, a syndicator will charge an asset management fee. This fee supports the business in achieving profitability so that passive investors or limited partners can regularly receive the distributions due to him or her.

A passive investor can deduct any passive losses against any other passive income that they are earning.

Other ways that a real estate syndication can make money are:

  • Refinancing a property in the Liquidation phase.
  • If a sponsor also happens to be a real estate broker, he or she can sometimes earn commissions on property sales.

Investor returns typically come through in the form of distributions. These occur in the operations and refinancing phases of the real estate syndication.

Equity investors tend to receive between 6% and 10% of their initial investment amount in distributions. Debt investors will often receive preferred interest.

A debt investor might also earn loan guarantor fees if they sign a loan on behalf of the syndication.

It is during the exit that the majority of money is made in most syndication deals. Most business plans are focused on increasing the value of the property and selling it for more than it was purchased for. This final profit or gain from the original price will be paid out to the investors and managing partners to meet the goals of the investment.

Can you 1031 into a syndication?

Yes! By 1031ing into a syndication, you defer any potential taxes owed from the liquidation of the first asset. To 1031 into a syndication, you need to enter into a "tenants in common" (TIC) structure, which is essentially a type of joint venture.

It is only possible to 1031 into a syndication if you own an investment property or business property. It cannot be done with your primary home.

By using the TIC structure, you take in a share of ownership in the syndication, and thereby also direct title to it. This is required for the 1031 exchange to be valid.

Deferring taxes owed in this way means you can invest in larger properties due to the capital you have on hand and only pay taxes on them later when it might be more favorable. If you hand down the properties to heirs upon your death, the deferred taxes will fall away

What are the risks of syndicated real estate?

Real estate syndications are only open to accredited and sophisticated investors because they are, by nature, high-risk.

Lack of returns is the first risk. The solution to this is to diversify your investment portfolio. You can even invest with different syndicators only if you wish to stay solely within the real estate field.

It's extremely important to take only a passive role when investing in a real estate syndication. By doing this, you are protected from liability should the syndication be the subject of a lawsuit. If you get involved in the day-to-day management in any way, you might lose that protection.

What is a multi-family syndication?

A multi-family syndication is a real estate syndication that invests in an apartment building. This type of real estate syndication has the benefit of giving the passive investor rental income in addition to any other distributions, according to the syndication agreement.

The passive investor's role in a multi-family syndication is purely to bring in equity. It is up to the syndicator (sponsor) to push the multi-family syndication through all its phases: Origination, Operation, and Liquidation.

The lack of involvement of investors means that they are engaged in passive investing as per the IRS's definition. Any revenue received from a passive investment can be offset by passive losses, such as depreciation.

This is a detailed subject that should be ideally discussed with an experienced real estate attorney or a tax attorney, but it is one of the primary reasons for the existence of real estate syndications.

How do I invest in syndicates?

You must be an accredited investor or sophisticated investor to invest in a real estate syndication.

An accredited investor is:

  • Someone with a net worth of $1 million or more (excluding your private home), or
  • Someone who earns a net annual income of $200,000, or
  • Someone who earns a combined net annual income of $300,000 with his or her spouse or spousal equivalent.

A sophisticated investor is an experienced investor with in-depth knowledge of investments. These investors are considered able to properly adjudicate the risk involved across a wide variety of asset classes and investment opportunities. Sophisticated investors can be non accredited investors.