Syndications are like the mutual funds of the real estate world—multiple investors passively invest into a fund, while a manager is responsible for picking the real estate to invest those funds into, and managing the portfolio. Because of this structure, the syndication investors are considered “Limited Partners” and the Fund, or it’s Managing Entity, is considered the “General Partner.” One of the biggest benefits of investing in a Syndication Fund, is that the most a syndication investor can lose is the amount they put into the deal. The Fund Managers and Principals of the General Partner, that are managing the deal, are responsible for the full repayment of all of the debts and loans that are entered into in order to buy and renovate the property, or do any construction. They have considerably more financial exposure and risk than the Limited Partners.
The General Partners are also responsible for the day-to-day operations and management of the property. In many cases, the payment of profit dividends are done in what’s referred to as a waterfall, or preferred equity and promote capacity (which is just Legalese for the following). It means that the Limited Partners (those investors such as yourself) get paid first, before the General Partners, but only up to a certain threshold. A syndication I recently worked on was structured to disburse the first 7% of profits to the Limited Partners. Then anything between 7% to 10% of returns were disbursed 70/30 in favor of the Limited Partner Investors.
10% to 12% returns were to be divided 50/50 among the Limited and General Partners and any returns exceeding 12% would be disbursed 70/30 in favor of the General Partners. It’s these levels of returns and the incentive for the General Partners to reach them, which make investing in syndications so attractive. It’s also the reason why the deals these syndication funds invest in are typically large and complex and beyond the scope of most investors to accomplish on their own. In most cases, the Principal members of the General Partner Fund, also invest individually as Limited Partners, which means they are investing their own personal money side-by-side with your money, which is reassuring and inspires confidence.
Now let’s say you want to structure your own syndication in order to attract investors to invest in your deals. To be blunt, it is VERY expensive and requires strict SEC compliance to structure a fund that can solicit investments from the public. Trust me, as a real estate attorney, I represent a number of these funds in their purchases, sales and structured financings of different large real estate deals. I have seen what their securities counsel legal fees look like for setting up these funds and preparing the fund documents specific to each deal for SEC compliance. The legal fees are in the 6-figures, but at the same time, the deals are in the 8-figure to 9-figure ranges. That said, if you are investing with friends and family, you can probably mimic the corporate structure of a Syndication fund, which would allow your friends and family to invest with you, without being personally responsible for guaranteeing any mortgage loans or other financial obligations that come with owning real estate. It would involve setting up several corporate entities to own and operate the property, but the specifics of those structures will vary slightly based on your state laws and the tax structure that is most beneficial for you, so make sure you consult with your accountants, financial advisors and an attorney who has setup similar structures in the past.
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