What is Real Estate Syndication Structure?
Who Owns What, and What is the Duration of a Syndication Investment for a Real Estate Physician Investor?
“I would give a thousand furlongs of sea for an acre of barren ground.”– Shakespeare
In Part 1, you have learned about the Real Estate Syndication definition for physician investors, the players involved in a Real Estate Syndication investments, and what it means for a physician investor. In the current part, we will focus on the Real Estate Syndication structure for physician investors. This will give us a better understanding of the legal structure of this process.
How Does the Real Estate Syndication Structure Look Like?
Real Estate Syndication Structure for a Physician Investor
- What is the Real Estate Syndication structure? When a group of people invest together, you need to have a legal structure. Most syndication investments are set up as an LLC (Limited Liability Company), this LLC owns the property. The investors and real estate sponsor own shares in this LLC.
- Real Estate Syndications can be structured in multiple ways. The real estate syndication structure is created by the real estate sponsor. Real estate sponsor will explain the Real Estate Syndication structure to the investors during the discovery process. Real Estate Syndication investments are usually structured for investors to receive 80% of the distributions, and real estate sponsor to receive 20% distributions. These numbers can however vary widely based on the specifics of a property. They can range from 50-50 to 90-10.
- Investors will often hear a term called “Preferred Returns.” When the property makes money (cash flow), this is usually distributed between the investors and the real estate sponsor. Example: When a real estate sponsor says that the physician investors get 12% preferred returns, the physician investors will be paid all the cash flow from the property until they reach 12%, and only after that, the real estate sponsor gets their share of distributions from cash flow. So basically, with preferred returns, the real estate sponsor gets paid only after the physician investors receive their distributions.
- All the syndication investments offer some sort of equity to investors. This allows for the investors to receive profits when the property is eventually sold. A few syndication investments give profits when they refinance the property.
An Overview of a Real Estate Syndication Structure – My first Real Estate Syndication investment was in a bed & breakfast hotel.
- It was a 2 million dollar project to buy and renovate an existing hotel. The real estate sponsor needed $600,000 cash, and a bank would lend us the other $1.4 million.
- For the money I invested (example for the ease of understanding: $100,000), I received 8% ownership of the property. I was given a preferred return of 10%, paid out every quarter.
- The distributions were split 80/20 (investors/sponsor) after the 10% preferred return, and anything after reaching 15% was split 50/50.
- The strategy was to refinance the property at 3 years. It was a value add property projected to refinance at a much higher price.
- The capital amount I invested was returned to me in full, when the property was refinanced. I still was able to keep my 8% ownership of the property.
- However, after the refinancing and return of my initial capital, the distributions of cash flow did change from 80/20 to 40/60, and there were no preferred returns from this cashflow. The property will be sold in 10 years, and at that time I will receive 8% of the sales proceeds.
- In my opinion, I found this to be a very complicated Real Estate Syndication structure. Not all syndication investments are this complicated.
- All that being said, the numbers presented to you by the real estate sponsor will make or break any deal. You have to understand the numbers thoroughly, make sure the projection being made by the real estate sponsor are practical and achievable. The project must fall within your risk tolerance levels, and you have to make sure the real estate sponsor has skin in the game. Make sure the syndication investment is structured in such a way that the real estate sponsor makes money only after you make some money, and make sure that the real estate sponsor has a lot to lose if the deal does not work out. This is to create a healthy environment with a win-win situation, where everyone benefits from a successfully run property.
- In the above-mentioned syndication investment I made, the bank lent the $1.4 million amount to the real estate sponsor, but the real estate sponsor had to provide collateral/security. So if the deal were to fail to perform, the real estate sponsor has a lot to lose. The real estate sponsor also contributed capital to the initial investment, so we know that he/she is personally motivated for more than a few reasons, to make this project a success.
- Investors interest’s and the real estate sponsor’s interest should align together in the same direction.
Duration of Real Estate Syndication Investments – Real Estate Syndication Structure
- Most syndication investments are 3 to 10 years term. They fluctuate widely based on the property, market cycle, and syndication team’s investment philosophy.
- In the above-mentioned example, although the term of my investment was 10 years, the deal was structured in such a way that the investors were returned their initial capital in 3 years, and still got to keep the equity until the property is eventually sold.
- It is important to understand the time frame of the project, and plan accordingly. Investments into syndication are locked in, and you cannot liquidate at your will. Once you invest, you will have to wait until the end of the term to see your money. In order to be prepared for a case of an emergency, you can have a clause added to your agreement that allows you to sell your share to another investor and get liquidated.
Now that you have learned about the Real Estate Syndication definition, Real Estate Syndication structure for physician investors and time frame of a syndication investment, in the next part, you will learn how about the pros and cons of Real Estate Syndication.
You will find the rest of the topics regarding Real Estate Syndication for a physician investor here.
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