As a landlord, chances are you don’t want to deal with plumbing issues at 2:00 AM, so syndication may be the perfect real estate investment strategy for you. This article explains how you can pool resources with other real estate investors for bigger investment projects and maximize your returns.
Real estate syndication involves two or more investors, either individuals or companies, who partner to raise capital to purchase a property or multiple properties. By pooling resources, investors can go for larger or more lucrative properties that would otherwise be out of reach for most single investors. Think about it like crowdfunding for major real estate investments!
Traditionally, real estate investors would advertise and ask for private funding. However, the Securities Act of 1933 changed things. The Securities and Exchange Commission (SEC) wanted to ensure that issuers selling securities to the public disclose material information and that securities transactions are not based on fraudulent information or practices. So, syndication was born as a way to work within the SEC’s limits on who can purchase and sell securities for the purpose of acquiring real estate assets. The returns on investment are high and can act as passive income, but ensuring your syndication is set up within the limits of the law is critical.
There are a few different ways you can set up your real estate syndication and start making returns on your investment. The main legal setups include Limited Liability Companies (LLCs) or Limited Partnerships (LPs).
LLCs involve members holding limited personal liability but are at risk of losing up to their financial investment in the LLC. Members are generally not personally liable for the debts and obligations incurred by the LLC. The manager of the LLC plays an active role in business management and is subject to more liability as the decision-maker for the LLC but generally is not personally liable for the acts of the LLC.
Similarly, limited partners are not subject to personal liability with an LP, but are also at risk of losing up to their financial investment in the LP. There is a caveat, which is that limited partners don’t manage the company. A general partner manages an LP and is personally liable for partnership debts.
Registration
Registering an LLC or an LP is just about the same process-wise. Each setup must be registered in the state where it will be operating, and in most cases, hiring a registered agent is the simplest and most efficient way to go.
Taxes
LLCs and LPs also generally have similar taxation setups. Both structures use what is known as pass-through taxation. That means that each member or partner pays individually through their personal tax returns.
Profit and loss distributions also tend to be more or less the same.
Now that we understand how you can set up your syndication from a legal entity perspective let’s go a little deeper.
Who needs to be involved?
Syndication Sponsors
Once an LLC or LP is established, someone needs to be identified as the responsible party. Remember, an agent can set up the business entity, but a sponsor is required to manage the day-to-day workings of the real estate investment.
That starts with looking for investors. The sponsor, sometimes called the general partner, principal, or syndicator is responsible for operations, while investors put in the money. Sponsors are generally responsible for finding the property or properties in which the syndication or fund will invest. They underwrite any property purchases, and after raising the necessary capital, they manage the property’s operations. Think of the sponsor as the “manager” of the entity. Ultimately, they do the legwork to help all investors make a return. That’s why the fund's structure or syndication is important to get right from the start.
Investors are usually involved in syndication because they want passive income without worrying about the day-to-day property management (remember, we don’t want to call plumbers at 2:00 am). But the right sponsor is key to ensuring the maximum return on investment. It’s best if the syndication sponsor is also an investor, so the other investors know they have some skin in the game.
Part of investing in passive income growth through syndication is the fees investors pay. Those fees are essentially paying for peace of mind. Not only do they not have to worry about managing the property, but they also don’t want to think about legal concerns. That’s where transparency comes into play. Ongoing communication between syndication principals and investors is an important aspect of this investment. Enter private placement memorandums or PPMs.
The private placement memorandum (PPM) can help with transparency between the syndicator and investors. It contains an in-depth description of the investment offering. It's commonly referred to as an offering memorandum similar to a stock prospectus.
The private placement memorandum is a key document in real estate syndication because it holds disclosures and disclaimers to investors, explains the Operating Agreement, and tells investors why this investment opportunity is worth their time.
PPM Development
There are three primary phases to syndication:
A PPM is necessary to engage in those phases within the SEC’s requirements. It has all the information about the securities available to investors, such as risk factors and the investment objectives (step 2 - the business plan). The PPM serves as protection for investors
PPM Timeline
From the time of asset acquisition or identification, drawing up the PPM is crucial for a syndicator to seek out investors. This means it needs to be ready and legally sound as soon as possible. Real estate investment is a fast-paced game, and syndicators need to show their investors that the investment is, in fact, going to be profitable. Therefore when we think of the timeline, we think as soon as possible. One week maximum to get the PPM to investors so they can sign and the property can be bought.
Writing the PPM
Some syndicators working in property investment for a long time have developed their own PPM strategy. However, legal counsel is the best way to go if you are new to investing or new to syndication. The PPM is a highly technical document that serves to protect investors. Still, it also needs to be readable, understandable, and compelling to the investors themselves, who may not understand complex legal vocabulary. Every real estate offering is different, meaning no legal template captures all of the necessary information. Over time, most syndicators gain their bearings and tend to rely less on legal counsel for these deals. But better safe than sorry!
Real estate investment and syndication are excellent ways to drive passive income for all parties involved. However, the intricacies of the laws surrounding tax requirements are genuine you’re an investor or the principal syndicator, you’ll want to be aware of exactly what you’re getting yourself into as you develop and review your PPM.
This blog post is intended to provide general information and should not be construed as, and does not constitute legal advice on any specific matter, nor does this message create an attorney-client relationship with Premier Law Group.