Real Estate Syndication: the What, Why, and When
Real Estate Syndication: a Brief History
Real estate investing is not new. In a sense, “real estate crowdfunding” – often touted as a contemporary tech-enabled disruption of real estate investing and finance – is not new either. The concept of including individual investors in large-scale ventures as part of a limited partnership structure dates to ancient civilizations – as early as 1800 BC in the Mesopotamian city of Ur, entrepreneurs supplemented debt capital with investments from citizens (often small contributions such as a bracelet or two) to help fund ventures like maritime expeditions and palatial construction. Tablets excavated from the time period indicate that profits were shared pro rata among investors, and that GP/LP relationships were established, with the risk-taking entrepreneur entitled to a higher proportion of profits while the LP investors were protected from liability and benefitted from the expertise and motivation of the GP.
Indeed, the archeology of Mesopotamia evinces ancient examples of “real estate syndication” – the concept of a lead investor sourcing capital from a group of investors who, on their own, would not be able to afford or execute the investment.
The Securities Act of 1933 curtailed the legal feasibility of real estate syndication, making illegal the “public solicitation” of securities (including LP interest in commercial real estate ventures). As such, real estate syndication in the ensuing decades tended to be secretive, and typically involved a small group of LP investors each contributing large sums of capital. In effect, this has relegated passive commercial real estate investing largely to the realm of institutional investors like pensions, endowments and hedge funds. Following the JOBS Act of 2012 and the advent of modern real estate investing platforms like EquityMultiple, however, real estate syndications have become much more accessible and efficient for both the GP (the party raising capital) and the individual investor (a member of the LP partnership investing in the real estate project).
How Individual Investors Benefit from Real Estate Syndication
In short, real estate syndication allows individual investors to tap into professionally-managed commercial real estate and lowers the barrier to entry.
- A Lower Minimum: Instead of acquiring and managing a property on one’s own, individual investors can participate in the same class of properties at a small fraction of the capital outlay. Platforms like EquityMultiple have lowered the minimum entry point even further, with a minimum check size as low as $5,000
- Diversification: Related to the first point. With a lower per-investment minimum, investors are able to spread their real estate portfolio among a greater number of projects, and across markets, risk/return profiles and property types.
- More Passive: As opposed to direct real estate ownership – wherein an investor must manage the acquisition, operations and sale of a property – investing as part of the LP allows the individual investor to benefit from the expertise and motivation of the GP (sponsor) without having to expend time and energy managing property.
- Less Liability: Because individual investors participate through a limited liability entity, they are shielded from the majority of risk that the GP (sponsor) assumes in undertaking the project.
In short, real estate syndication makes commercial real estate more accessible to individual investors. This is more true than ever as technology continues to revolutionize real estate finance, with online platforms like EquityMultiple affording an even greater level of access to individual investors while providing more transparency and efficiency. Real estate syndication has matured quit a bit since Ancient Mesopotamia and its cuneiform ledgers.
How Sponsors and Lenders Benefit from Real Estate Syndication
As we discuss the benefits of real estate syndication for the party that originated the investment, let’s make a distinction between two kinds of real estate syndication:
Equity real estate syndications
A real estate firm pursuing a real estate project almost always leverages debt to some extent, and often up to the 80% LTV that most banks will require when issuing the real estate firm a loan. The remainder of the capital stack must be filled with some combination of bridge financing (mezzanine debt, a bridge loan, and/or preferred equity), the firm’s own equity, and outside equity.
Real estate syndication enables a real estate firm (the sponsor) to tap into a greater diversity of more passive capital, and often to get more mileage out of their own capital; the sponsor can execute on more projects by utilizing real estate syndication and filling gaps in the capital stack with LP investor capital. Again, platforms like EquityMultiple make this process more efficient and can lower transaction costs for real estate investment firms.
Real estate debt syndication
Real estate debt syndication refers to the fractional offering of an existing private loan to a group or network of investors. In EquityMultiple’s case the syndicated loans are all on commercial property, and generally secured by a first lien.
In short, individual investors are able to invest in a short-term commercial loan, underwritten by a professional private lender, and are entitled to a high-single-digit or low-teens annual rate of return. Meanwhile, the lender syndicating the loan is able to recoup capital. For more on this topic, please review our article on syndicated debt.
The Basic Anatomy of Real Estate Syndications
Return of Capital – Limited partners (the LP investors participating in the syndication) typically their principal returned prior to the GP, a measure of protection for the passive investors.
The preferred return – This is a component of many – though not all – real estate syndications: the LP investors earn up to a certain percentage return before the GP (sponsor) receives any profits.
The “Sponsor Promote” – Following repayment of principal, profits are typically split based on a contractually-established ratio (such as 80/20 or 70/30). For more about the structuring of equity commercial real estate investments, please review this article from our Learning Series.
Real estate syndication is a concept nearly as old as recorded history. If structured and executed properly, real estate syndications can benefit all parties, allowing individual investors to participate passively at lower minimums and tap into the expertise and drive of the sponsor, while the sponsor can finance more projects more efficiently, adding more value to the build environment.
With the advent of modern investing and finance platforms like EquityMultiple, real estate syndication has become more accessible, more transparent, and more efficient.
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