How to Generate Passive Income through Syndication
Did you know that regular people like you can own apartment complexes, shopping plazas, or even office buildings? Yes, you read it right. You can own large properties through real estate syndications. Most people think that only rich billionaires own them. Well, some of them are but not all. In this article, you will learn how to generate passive income through syndication.
What is Real Estate Syndication?
Syndication is a way where multiple real estate investors pool their capital together to purchase and pursue real estate opportunities. It helps the investors buy a property that they may not be able to buy on their own.
What are the Roles in Syndication?
Syndication is a transaction between a Sponsor and a group of Investors. The Sponsor is responsible for managing and operating the deal. On the other hand, the Investors are the main providers of financial equity.
The other tasks of Sponsor may include:
- Find investment properties
- Determine the viability of the investment
- Onsite visits
- Perform Due Diligence
- Organize the group if investors
- Acquisition of the property
- Disbursement of profits to investors
Real Estate Syndication Legal Structure
There are two common types of real estate syndication: limited liability company (LLC), and limited partnership (LP).
A limited partnership is a business structure formed by two or more business partners. It involves a general partner (GP) who acts as the sponsor and limited partners who provide capital. One or more partners may enjoy limited liability. This means they are responsible for a certain amount of cash investment. Typically, the sponsor is liable between 5-20% of the total required equity capital. While the limited partners put in between 80-95%. In LPs, the partners do not enjoy dividends. Rather, they receive profit from the rental income.
In Limited Liability Company, a managing member or active organizers will be the Sponsor and the passive investors will be classified as regular members of the LLC. The LLC owns the property and the passive investors are part owners of the LLC. In this type of partnership, there are flexibilities in control and division of returns. Even how they deal with the taxes. In addition, the owners do not have personal responsibility for the debt of the property.
How to Generate Passive Income through Syndication?
The two main ways on how the Sponsor and Investors make money from syndication is through rental income and property appreciation.
The distribution of rental income from a syndicated property may vary depending on the agreed terms. The Sponsor may distribute it on a monthly or quarterly basis. Besides, the payment of the profit also depends upon the time the investment needs to mature. Some take within 6-12 months while others may take 5 years or longer. Oftentimes, the Sponsor takes an upfront profit at the beginning of the deal. It is also known as the acquisition fee. The acquisition fee is for sourcing and acquiring the property. On average, the Sponsor charges a 1% acquisition fee. But it can also be between .5 and 2% depending on the transaction.
Before a Sponsor shares in the profits for his work, all investors will receive a “preferred return”. It is a benchmark payment divided between investors. Usually, it is about 5-10% of the initial investment capital. An 8% preferred return is ideal for most investors
Example of a Real Estate Syndication
Let us say you are a passive investor who invested $25,000 in a deal. The deal has a 10% preferred return, profit split structure of 70/30, and a 2% acquisition fee. With this setup, you could take home $2,500 yearly preferred returns when the property earns enough profit. Once every investor receives their preferred return, the remaining money will be distributed between the Sponsor and the investors. The distribution depends on the syndication’s profit split structure.
In this example, the investors can net 70% of the profit while the sponsor nets 30%. For instance, everyone has received their preferred return and there is $800,000 remaining. In a 70/30 deal, the investors will receive $560,000 while the Sponsor will get the remaining $240,000. Aside from that, the sponsor will get 2% upfront of the gross revenue for the acquisition fee.
So, what will happen if you continue investing for 10 years?
If you continue to invest $25,000 in a syndication every year; you would keep adding passive income of $2,500 pear year. That means if you continue this for 10 years, you will have $25,000 per year of passive income while your investment is growing.
Properties to Invest in Real Estate Syndication
There are many ways to invest in real estate. And in almost every type of real estate property, syndication can apply. Here are the common real estate types:
- Multifamily or apartment buildings
- Mobile Home Parks
- Self Storage facilities
- Private money lending/note fund
- Retail properties used as strip malls, large tenant stores, or grocery store
- Office spaces
- Industrial properties for warehouses and production facilities
- Hospitality properties like hotels and motels
How to Join A Real Estate Syndication?
Are you thinking of joining a real estate syndication? You will need either a real estate network of check out syndication websites and real estate crowdfunding. Here are the things you need to assess before joining one:
- Your qualifications – There is a list of attributes and requirements an investor must possess to join syndication. Some require an income requirement. Make sure you are financially and mentally ready.
- Find a Great Sponsor – Once the deal is placed, the Sponsor manages the property. Hence, if you want to make sure the property will make a profit, find a good sponsor. Review the sponsor’s track record and his reputation. Remember, you are putting your money in his hands.
- Carefully Evaluate and Study the Terms and Conditions of the Deal – Before vetting in the deal, make sure you comprehensively understand the terms and conditions of the deal. You would want to make sure that the deal meets your goals and investment strategy. Do not jump on the deal just because the numbers look attractive.
DISCLAIMER:
Neither Alpesh Parmar nor Wealth Matters associated claim to be an expert in tax, legal, or insurance strategies. WE STRONGLY URGE PROSPECTIVE INVESTORS TO CONSULT WITH THEIR OWN ADVISORS PRIOR TO DECIDING WHETHER TO INVEST. Please consult an expert or advisor.