Ever wonder how someone is able to purchase that skyscraper office building downtown, or the 300+ unit apartment complex down the street for multi millions of dollars? Well, I can tell you, it’s not typically someONE that purchases these properties it is usually a group. It’s an age old concept, if something costs $200,000 but you only have $100,000; then find another person with $100,000 and partner. When it comes to large properties that require say, $1,000,000 to purchase, and you partner with several others in a group investment it is called syndication.
Syndication can add some complexities but also offers some huge advantages that can far surpass the minor hassles of some additional paperwork. After all there is a reason why 95% of large properties are owned in some kind of a group structure, in fact some of the largest real estate tycoons you may know of (like Trump) made most of their wealth by being involved with and leading investment syndications.
The Advantages:
Bigger Property, Bigger Profits
The larger a property, the more efficient the property can be managed, income maximized, and expenses minimized. A 300 unit apartment complex is only going to need 2-3 managers that can be located on site and be paid a wage, a few maintenance personnel on staff, one roof to worry about ( well maybe several, but much fewer than 300), one insurance policy, one property tax bill, and one marketing budget. Contrast that against the prospect of managing 300 individual homes spread throughout a county or state, and the economies of scale become apparent.
Add to that, the fact that most large multi-family and commercial properties are purchased by professional investors looking to make a profit, and you will notice that cash flow and returns are typically higher. With individual homes the competition from inexperienced investors, speculators and homeowners themselves can drive investment returns as low as 0% or negative in a hot market as these part-time investors are happy just “breaking even” while they chase unpredictable and uncontrollable market appreciation.
With a group investment you may be “splitting the pie” with your partners, but the partnership itself allows everyone to split a much larger pie, creating a win-win for all.
Multiple Exit Strategies
With individual properties, your strategy is limited to some combination of buy low, sell high. And in the middle there are either renovations done to the home to appeal to an end user (in the case of a short-term flip) or a period where the property is rented until such time as the market has increased the value of the property.
With syndication into larger multi-family and commercial properties you have several additional options and more control over your returns.
There is the traditional strategy of single families; Buy, renovate, and Sell, though slightly modified. Buy, reposition/renovate (like updating a property and marketing to a different demographic of people), increase your rents (which has a direct relation to the value of the property…see article on “Advantages of Multi-Family Investing”), then re-sell to another investor. An added bonus with multi-family is that since your property can be big enough to essentially “be the neighborhood” in some sense, you may be able to move a property from being a class “C” to a “B” or “B+”. Take a distressed property with some repairs needed, higher vacancy, or a complicated deal; and turn it around into a stabilized property that now may fit into an institutional investor’s guidelines and you can re-sell the property to them. Institutional investors can and will purchase properties at lower CAP rates than most other investors, which directly correlates to a higher selling price. (See “Adv of Multi-Family” for an example)
The next strategy involves the long-term holding of a property. Buy, increase rents either through repositioning or a gradual market rise, and then simply re-finance the property at its now higher value, pulling out all or most of your original investment. Then continue to collect the income the property produces indefinitely. You can do this over and over again, and because proceeds from a loan are not taxable, you are in effect receiving this money tax free (or at least deferred until the eventual sale). This strategy works best with Multi-Family and Commercial properties because the financing you would use with this strategy would be non-recourse financing, meaning you have no liability to personally pay back the loan on the property should anything go wrong (see limited liability below). What this essentially adds up to is that you can have your original investment only tied up for a short period of time before you get it back. And on top of that you would still be receiving an income from the property without your money still being tied up.
One more possible strategy (and there are many more not mentioned here), is “Buy, Split, Sell”. Certain properties are more suited to this strategy than others, but you may be able to purchase a Multi-Family property with many units as one, split up each unit into individual properties (condos), and re-sell the condo’s to end users. Essentially buying in bulk, then selling off each piece in smaller increments at a much higher total price. These properties are called condo-conversions, during the last real estate bust this term took on some negative connotation (rightly so) as properties were hastily and poorly converted leaving the end buyers with a bad property, but with the right property or the right market, this strategy can prove to be very successful.
Smaller Investment Lower Risk
There is a reason even those people with $1,000,000 don’t invest it all in one property all at once. Diversification is a powerful risk mitigation strategy that is one of the most powerful reasons why large property purchases are typically structured as a group investment, as no one person will typically have the risk tolerance to put $1,5,10, or 100 million into one investment all at once. Even banks won’t do this on larger loans, they bring in several other banks to “participate” so they don’t have to put too much of their assets at risk in one loan.
Group Investment, Limited Liability
When investing in an individual property alone, there are of course ways to limit your liability, from as simple as purchasing it in a corporate name or land trust (no financing possible this way though), to insurance policies and overall asset protection strategies. However, as long as you are the sole owner of that property and are the operator, if something bad enough happens you may have some liability. Plus if you ever want to finance or re-finance an individual property, the only attractive financing available is going to require you to personally sign on the loan, putting liability on your personal wealth to ensure that loan is paid.
With a group investment however, when set up properly, as an investor your liability is limited to the amount of money you have invested. Similar to if you own shares of IBM; if someone sues IBM you wouldn’t be personally responsible to pay that person. Plus on commercial and multi-family properties, there is attractive financing available without anyone having to sign personally on the mortgage, and if personally liable financing is needed, typically only the sponsor signs for the mortgage, and not the other partners in the group (meaning they are not personally liable for the debt, only the sponsor).
Limited Time Investment
When investing with a group, typically the groups’ sponsor is the one that finds the property and performs due diligence on the property for presentation to the members of the potential group. An investor’s time can be limited to the amount of time it takes to review the property proposal. There is no interviewing realtors, searching for properties, endlessly making offers until something is accepted, negotiating with sellers, arranging financing, inspections, insurance, property repairs or finding and overseeing a property manager. All of these tasks (each of which can make or break an investment) is taken care of and usually paid for upfront by the sponsor of the group.
Again similar to purchasing stock in a company, you can think of the sponsor as the CEO of the syndication. They take care of running the property and making sure the original strategy stays on track and stays relevant in a changing market.
Professional Involvement/Ownership
You may have noticed by now I’ve mentioned that there is a “sponsor” and that they are at the center of a group investment. A sponsor basically takes on the leadership role of the group as well as takes on the main liability of the investment and the property. A sponsor by definition should be a professional with the experience and the resources to pull together a successful deal and operate the business profitably (make no mistake, owning an income property is a BUSINESS!)
In the corporate world CEO’s of course make quite a bit of money running a profitable company. They are motivated internally to excel (hopefully) and more importantly they have their interests aligned with those that own the company (shareholders) because their compensation is tied to the performance of the company, and in many cases the CEO is also a partial owner of the company. The same is true for the sponsor, but even more so. In most group investment structures the sponsor isn’t compensated at all unless the property performs at or above expectations and the best sponsors will invest their own money into the property alongside their investors. This ensures the alignment of the interests of the group with that of the sponsor. If the group loses money, the sponsor loses money…and in some cases, more money than the investors.
For more on the structure of a Syndicated Group Investment check out “Structuring a Group Investment” and "Participating in a Group Investment"
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