Why Passive Investors Love Syndications
There’s no question that real estate is one of the best investments available. The problem is, these investments are expensive and can be difficult to manage. Syndication investing is the solution to this problem. Syndication allows people to invest in real estate deals they couldn’t afford or have time to figure out how to manage it.
What is Syndication?
A syndication investment involves multiple investors pooling their money and resources into one property. In most cases, they buy properties that would be difficult to buy as single investors.
Real Estate Syndication Structure
Syndication deals are usually set up as a limited partnership or a limited liability company (LLC). Both types of entities include someone that manages the investment and investors that simply contribute capital.
The syndication structure also involves other key individuals:
- Management company
- Real estate broker
The management company handles daily operations. This includes finding tenants, collecting rent, and handling maintenance requests. Their primary goal is to help find opportunities to increase income and reduce expenses while improving the quality of living for the residents.
The commercial real estate broker analyzes the market and sources various deals. They also assist in the entire transaction to ensure it closes successfully.
The attorneys specialized in real estate and securities close the circle. They are responsible for drafting and reviewing the deal’s contracts. They will make sure that the following contracts secure their preferred return:
- The buy and sale agreement is the contract that lays out the terms of the sale. The seller’s attorneys are in charge of creating the contract. Still, the buyer’s team of attorneys should also make sure that it protects his or her interests.
- The syndication operating agreement states all the terms of the syndication. The general partners (GP) form a new entity for each deal and sells membership interest to each limited partner (LP).
- The private placement memorandum outlines the investment details, required disclaimers, and risks.
- The subscription agreement includes the number of shares available, the price, and the preferred return.
When doing syndication partnerships, there are two types of investors:
- Accredited investor – A person with a net worth of $1M+ excluding primary residence or anticipated income of $200k+ for the current year and for the past two years. In the case of joint income, the threshold is $300k.
- Non-accredited investor – A person that doesn’t meet the requirements to be an accredited investor.
The Securities Act of 1933 created the first regulations affecting real estate syndication. The Act put several rules in place to protect investors. Syndicates now had to conduct an Initial Public Offering (IPO) to sell securities.
Rule 506 of the Act made an exception for developers selling securities to people they already had a relationship with. Thus, developers could skip the registration process when syndicating a deal.
Rule 506 allows investors to sell securities to up to 35 non-accredited investors and any number of accredited investors. The rule requires non-accredited investors to have enough knowledge to make informed investment decisions.
The 1936 regulation lets developers ask the public for investments without an IPO. But, the developer has to submit their offering to the SEC first. The developer can start selling securities once the SEC approves the offering.
Regulation A does have limitations. It states who is eligible to offer securities and the amounts they can raise.
The JOBS Act
The Jumpstart Our Business Startups (JOBS) Act was issued and implemented in 2012. It allows investors to sell securities without an existing relationship with the investors. This new rule is Rule 506(c). This rule allows investors to only secure investments from accredited investors.
This rule commits investors on the long-term. They cannot trade their equity shares. The issuer can buy the shares back but is not required to. The JOBS Act stimulates business startups and offers investors alternative investment options.
The JOBS Act was amended in 2015 with Regulation A+. According to this new rule, the amount of raised capital can be higher. The obligation for state and SEC registration was also lifted. However, the rule about SEC submission is still in place.
Regulation A+ includes two tiers:
- Tier I has a $20 million threshold for how much an issuer can raise from investors. They still have to submit the offering to the SEC and the state for review.
- Tier II no longer asks for state review. It goes through a more severe SEC evaluation. The threshold for Tier II is $50 million.
Investors can invest a maximum 5% of their yearly income or net worth if it is below $100k. The percentage goes up to 10% for investors with a net worth or income higher than $100k in one year. The maximum investment for each is $100k.
Investors can sell their shares through the exchange used by the issuing company. They can also choose either after-market exchanges or registered broker-dealers. Regulation A+ is suitable for real estate investors that are well established or raising a large amount of money.
What Is an Accredited Investor
An accredited investor is a person who meets one of the following criteria:
- Has had an annual income of at least $200k (or $300k together with her/his spouse) for the past two years, and is likely to reach the same limit, or higher, in the current year, OR
- Has a net worth over $1 million. The net worth is calculated either for the person alone or together with the spouse. The primary residence is excluded from this calculation.
An accredited investor can also be included in one of the following categories:
- A trust that owns assets evaluated at more than $5 million. If the trust decides to purchase securities, the process must be directed by someone with adequate knowledge and experience in business and finance.
- A group of accredited owners organized in the form of an entity.
Federal securities laws allow accredited investors to invest in more deals than non-accredited investors. Because of the income and net-worth requirements, it’s assumed that accredited investors can handle losses.
The Main Benefits of Syndication Investments
Real estate investments can be very expensive. When it comes to an apartment or mobile home park syndication returns, this option holds more advantages. An investor who chooses this model has the following benefits:
- Passive investors are liable only for the losses associated with the amount they invested.
- Having multiple tenants keeps cash flow consistent, even during months with higher vacancy.
- This syndication offers stable value over time. The property’s value is determined by its net operating income (NOI). You can increase the NOI by addressing any management issues and making capital improvements.
- Experienced investors are able to secure financing at lower interest rates, which provides higher cash-on-cash returns.
Investing in the Right Syndication
As an investor in a syndicated investment, your investment is only as good as the person or company managing the investment. It’s essential to look at the knowledge, experience, and success of the syndicate partner(s) you’re considering investing with. You also want to invest in properties that match your investment goals. If you want a long-term investment, avoid deals aimed at flipping the property within a couple of years.
Schedule a call or request more information on partnering with Vecno Capital on their next syndication deal.