What is a Syndication?
Updated: Aug 20, 2019
This is Madison Investing's Wealth Windup series. We take the most frequently asked questions that we receive from investors and we break them down for you.
At Madison Investing, we help busy people like you build passive income streams and real wealth to live life on your terms. Today's Wealth Windup is "What is a real estate Syndication?" To nail this topic, let's break it into three concepts starting with the basics.
Concept #1: Investors can actually pool their capital and invest as a group
Concept #2: Real Estate Investing - Now it's a broad term and it encompasses many strategies but we use the concept as a point of comparison to segue into the primary topic, and the primary topic...
Concept #3: Passive Investing in a commercial real estate syndication.
Now before we jump into this first concept a few quick words the amazing benefits of real estate investing remain out of the average investors reach largely because of a lack of familiarity. Let's change that today and get familiar with some of the basics. There's so many smart and hardworking people that stay within their comfort zones of mutual funds, 401ks and stock investing. And why did they do this? Well typically it's because the Wall Street marketing machine guides them there. And it works really hard to keep them there, and their capital spinning within that machine. Now each of those investment types have their place and we believe in building a balanced portfolio that includes a healthy allocation of real estate.
Concept #1: Pooling capital to invest as a group.
Let's start with a simple setup. Person A has one dollar. Person B has an amazing thing that person a once the price is right and the buyer has enough capital. The result is a successful transaction with two happy people. They go on their merry way.
New setup person is still only has one dollar. Person B still has that Snickers bar but now it's actually worth two dollars. Person A already knows that the deal won't work because they don't have enough cash to buy the thing, but Person A... well they have a strong network, they have connections. So Person A calls it their friend who has an extra one dollar to invest they are willing to join them in the deal and buy the Snickers bar. Let's call them a team because they are so "Team A" has two dollars. Person B still has that thing worth two dollars. Team A has enough to buy the Snickers bar now, but now they know also that this team strategy comes at a cost. But team A is smart. They know that getting 50% of something that they want is better than 0%.
They know that half of something valuable is better than nothing at all.
So they pull the trigger and they move forward with the deal. Team A celebrates with their new acquisition in Person B is satisfied with their two dollars in income. And just like that, you now have a fundamental understanding of how a syndication works that a really basic level. And all it took was three minutes of your day. Now you're watching this clip to learn about real estate, not candy bars. So let's apply the syndication concept to something more material.
Concept #2: Real Estate Investing
At Madison Investing, we help investors build wealth and passive income streams by investing in commercial real estate syndications. That's why this Wealth Windup is actually focused on that. So, why are you looking at this picture of a single family home? Well, we've included this section to acknowledge that the most common association people make when they hear the phrase real estate investing is a single family rental. Let's use that example to associate the simplicity of a down payment when you buy a single family home, with the equity raise on a commercial deal. That term will make more sense in a moment.
So here's the new setup: bigger numbers than our Snickers example. This investor has capital to invest. Something between $25k to $100k.
They're not sure how they want to deploy the capital, but are open minded and they've heard good things about real estate. The most common type of real estate investing that the investor has heard of are single family rentals. In this investors local market housing prices are pretty expensive but they can wrap their mind around the concept of buying single family rentals more easily than jumping into a syndication and they decide to move forward with that strategy instead. Now the average purchase price for a single family home in their market is around one million dollars. A down payment for that type of property exceeds the investor's budget. Bummer the investor is priced out. Now, what if there were actually two investors both working successful professionals. They can pool their capital to purchase the rental property. So in this case that's what they do. And just like that they are proud new owners of a rental property and all that the new property comes along with - the trials and tribulations of rental ownership. Rental property ownership, in all of its glory. Now, by now you understand the concept of syndication and you've seen even one simple application of it toward buying a single family rental. So now onto the main event and what you came for: passively investing in a commercial real estate syndication.
So at this point you already know this investor. They have capital to invest - something around $25k to $100k. This investor has heard a little bit about real estate and syndications from a friend. They heard about what they're all about and that they can produce a lot of returns and great benefits but they have no understanding of how they actually produce it. They'd heard that this thing called the Real Estate Syndication can produce a monthly income for the investor or a quarterly income, and then after about five years of receiving these these payouts they receive a big payout at the end. So along the way they've paid no taxes on the income they received and the only work that they actually did was wire the capital and e-sign the agreement upfront. They heard that you can invest in big deal - properties with hundreds of units. Things like apartment communities, self-storage facilities and mobile home parks. They learned that these big deals are actually less risky than buying a single family rental, since one vacancy in a single family rental means they receive zero rent but one vacancy out of 400 apartment units means that the property is still receiving rent from 399 other tenants.
And they also heard that they can invest passively in these deals meaning that they wouldn't deal with maintenance issues, angry tenants and neighborhood headaches. Those things would be entirely someone else's problem to deal with. And since they can invest passively they can invest in deals far outside their own market where the returns are stronger and still reap all the benefits of investing in these bigger deals. We'll cover that long list of benefits in another video. So in this case, the investor is eyeballing a 400 unit apartment community in Texas. The price tag on this property is $40M. Now in commercial real estate the down payment is referred to as "equity." The amount needed to close on this particular project is $17M. The investor has done a great job saving up capital but there's a sizable gap between their one $100k dollars and the equity needed to acquire this property. The good news is that there are hundreds and thousands of like minded investors facing the same dilemma. So what happens when the investor joins forces with hundreds of others each ready to invest somewhere between $25K and $100k in capital. Now, each understands the remarkable and superior benefits of investing in commercial real estate projects instead of residential rentals.
Their strength in numbers opens up a ton of new possibilities, so they pool their capital totaling $17M in equity.
But although they have capital to purchase the property there's still a problem: they lack the expertise and they lack the right relationships to acquire and manage this property. That's where the General Partnership comes in. This "operator" sometimes known as the "Deal Sponsor" has executed this type of purchase dozens of times and worked with hundreds, maybe even thousands of passive investors also known as "Limited Partners" or LPs. In a project like this, Limited Partners (or LPs) and General partners (GPs) form a unique business identity just for this one special occasion of purchasing and improving this property. The operator does all the work. The passive investors provide the capital. That's the deal. Buying, improving and managing a 400 unit apartment community takes a lot of work and a lot of expertise. The operator knows this, and they call in their teams. The construction team has done improvement projects like this dozens of times across thousands of units. The property manager actively manages dozens of similar properties ensuring an amazing living experience and a sense of community for thousands of happy tenants. This is the team that actively manages the entire project from before close all through the life of the project whether it's a five year, seven year, 10 year or other... up until the time that it's sold.
It's also helpful to mention that at the time of this recording for 100% of the projects that we had Madison investing have partnered on the Operators have actually invested at least $100k of their own funds. They have put "skin in the game" in every project. At Madison investing, that's actually one of the criteria for us partnering on a deal. So just like that, you've gone from "syndication newbie" to "knowledgeable investor" and you've taken off the Wall Street blinders and understand how it works when you invest passively in a commercial real estate syndication. If you want to learn more about how it works behind the scenes and found this Wealth Windup helpful, just stay tuned for another segment where we break down things like: how it works before closing on the property and through the life of the project. For now the best way to keep learning is by joining our investor mailing list. Get started by completing the form on our website. Add your NAME, EMAIL and check boxes and you'll be on your way to financial freedom in no time.
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Disclaimer: This article is intended for educational purposes only and does not constitute investment advice. You should always contact a registered financial professional before acting on this, or any advice. I am not a tax advisor or financial planner. This article represents my opinions.