Real estate investing can be a lucrative way to build wealth, but it requires time, expertise, and capital to be successful. Fortunately, there’s a way to invest in real estate without all the hard work: passive investing in real estate syndications.
Investing in real estate can be a daunting task, particularly for those who lack the necessary knowledge and experience. While purchasing a smaller property might seem like a good starting point, the syndication model provides a better alternative. With the syndication strategy, investors can pool their resources and invest in larger assets managed by experienced teams who handle the day-to-day operations. This approach offers several advantages, including portfolio diversification, cash flow, appreciation, and tax deductions, without the need to search for, purchase, and manage the property on their own. By leveraging the expertise of experienced sponsors, individuals can access higher quality properties, avoid costly mistakes, and achieve better returns.
The Apartment Complex Team
Successful investment in an apartment complex is not a one-person show. It involves a team of professionals with different skills and expertise to ensure the investment is profitable. The team is divided into two main groups—the general partners (GP) and the limited partner (LP) passive investors.
The GP team is responsible for sourcing the deal, securing financing, implementing the business plan, and managing the daily operations. They bring the necessary knowledge and experience in acquisitions, financial modeling, asset and construction management, and investor relations to ensure the apartment complex is profitable.
On the other hand, the LP team invests their capital into the deal, but they are not responsible for making operational decisions. Their role is to provide the necessary capital to fund the deal, and in turn, they receive a portion of the profits.
In addition to these groups, other professionals may be involved in the deal, including property management companies, accountants, real estate attorneys, and lenders. They may or may not have ownership in the deal, but their expertise is essential to ensure the success of the investment.
Investing in an apartment complex is not a solo venture, but with the right team in place, it can be a profitable investment.
The Investment Structure
Once the general partner team identifies a promising apartment complex for investment and conducts a thorough assessment of its financial and physical health, they extend the opportunity to passive investors. To acquire and manage the property, a Limited Liability Corporation (LLC) jointly owned by the general and limited partners is formed.
The profits from the property will be shared between the general partners and the limited partners, according to the terms set out in the private placement memorandum (PPM). The PPM will provide a detailed breakdown of the agreement, including information about the typical profit sharing ratios, which can range from 70/30 to 80/20 in favor of the limited partners. This means that LP investors will receive 70-80% of the cash flow during the holding period and profits upon sale. The PPM may also outline performance hurdles that the general partners must meet before they can receive a share of the profits.
The Business (Project) Plan
The GP team has a responsibility to transparently communicate the business plan for each offering to potential investors. It’s essential to fully comprehend the investment before committing your hard-earned money.
Value-add is an integral component of the business plan. The rationale for this approach is to raise the net operating income (NOI) of the asset, resulting in an increase in its value through forced appreciation. The GP team should explicitly outline these plans during the funding period, whether it’s a high-risk construction project or a low-risk improvement plan with steady cash flow. Each investor should carefully consider how the project’s plan fits with their individual financial goals and objectives, to determine whether it is a suitable investment opportunity for them.
After purchasing the property, the GP team will execute the business plan, which typically involves making renovations and implementing operational efficiencies to add value to the property. Once the property stabilizes, investors should expect to receive regular quarterly distributions.
The Disposition Strategy
The exit plan in real estate investment is essentially the strategy for when the property will be sold by the sponsorship team. As an investor, you would naturally wonder when you can expect a return on your investment. Syndications typically have a 4–6-year hold period, but depending on the specific business plan, investors may receive some capital back before the property is sold. When the property is sold and the investment is exited, the limited partners (LPs) will receive their initial investment capital along with any gains or losses incurred during the investment period. The exit strategy is a crucial aspect of a real estate investment because it determines the potential return on investment and the overall success of the investment.
There are several exit strategies that real estate investors use to exit an investment, including:
- Sale: This is the most common exit strategy for real estate investments. The property is sold to a buyer who is willing to pay a price that generates the desired return for the investors.
- Refinance: In some cases, investors may choose to refinance the property, taking out a new loan with better terms and rates to return the initial capital to investors while retaining ownership of the property.
- 1031 Exchange: This is a tax-deferred exchange under Section 1031 of the Internal Revenue Code, allowing investors to sell their investment property and purchase a new one while deferring capital gains taxes.
- Buyout: In some cases, another investor may buy out the initial investors, providing them with a liquidity event and allowing the new investor to take over ownership of the property.
The exit strategy is typically determined by the investment sponsor, who evaluates the market conditions, the investment property’s performance, and the investors’ needs. For example, if the real estate market is strong and property values are high, the sponsor may choose to sell the property to realize a higher return for investors.
On the other hand, if the market is weak, and the property is underperforming, the sponsor may choose to refinance the property, allowing them to hold onto the property while returning some capital to investors.
In conclusion, the exit strategy is a vital aspect of any real estate investment. It determines the potential return on investment and the success of the investment. As an investor, it is important to understand the different exit strategies and the factors that influence them to make an informed decision.
