Real Estate Investing: Understanding Syndication Structures
What is a real estate syndication?
Commercial real estate investments have become increasingly popular as investors look to attain a passive role in their investments while developing an investment portfolio that will provide diversification and extensive tax benefits. Commercial real estate syndications can provide just that for real estate investors.
A real estate syndicate essentially is the pooling of resources by a group of people who contribute their capital, expertise, knowledge, or skills to acquire a piece of real estate such as an apartment building. Other commercial syndication acquisitions could be, for example, a mobile home park, an industrial complex, a self-storage facility, an office building, or a variety of other types of commercial properties that would otherwise be difficult, if not impossible, to purchase as an individual investor.
Passive Investors & Deal Structures
As passive investors review and evaluate commercial real estate syndication deals, they will want to explore some basic information about common real estate syndication structures to fully understand how these common structures can affect their cash flow distributions in different ways.
In this post, we’ll discuss the essential components of the real estate syndication fee structures and how these structures determine the distributable cash allocation between the real estate sponsor team (or deal sponsor team) and the equity partners or the passive investors.
As a side note: There are different roles in a real estate syndication. The real estate syndicators or deal sponsor team is also referred to as the general partnership (GP) and the passive investors or equity investors are also known as the limited partnership (LP). The limited partnership has limited liability in these real estate syndication investments. Their liability is limited to their capital contribution only.
Understanding the most common structures such as straight splits, the preferred return structure, and the waterfall structure, are a best practice if you are going to invest in a property syndication.
Real Estate Syndication Structures
There are different deal structures in every commercial real estate syndication, so you will want to do your due diligence and choose the deal sponsor team wisely when you’re looking to invest because this can significantly affect your share of the profits and returns.
At PCRP Group, we prefer to be more simplistic in our structures, so we’ll be highlighting the most commonly used syndication structures that we see and that we participate in with our group of investors.
These are the three main real estate syndication structures that we see most often when presenting investment opportunities to our potential investors:
- — Straight split structure
- — Preferred return
- — Waterfall structure
The Straight Split Structure in Real Estate Syndications
A straight split structure in a real estate syndication deal just means that the distributable capital is split using a simple percentage. This is the simplest of structures to understand. A typical split that we utilize in our real estate deals is a 70/30 split which means that the passive investors (LP’s) receive 70% of the distributable capital and the deal sponsor team (GP’s) receive 30% of the distributable capital.
When the property is sold, the profits from the sale of the asset are distributed in the same manner with 70% of the profits going to the LP’s and 30% of the profits will go to the GP’s.
This type of structure in a real estate syndication deal takes into consideration the cash flow distributions allocated every month or quarter and the profits from the sale of the asset when the deal closes. The cash flow that is distributed monthly or quarterly is primarily revenue derived from the rental income that the tenants pay each month as well as other numerous ways the real estate property generates cash flow.
This straight split structure of 70/30 is a common split that we offer to our equity partners in most of our multifamily syndication deals, but remember every deal has different structures so you may not always be offered a 70/30 split. It could be higher or it could be lower.
The Preferred Return Structure
So, a common question that is asked is: “Who receives their distribution of capital first, the general partners or the limited partners?
The preferred return structure will determine, as outlined in the private placement memorandum (PPM), that those investors who have a preferred return will be the first group of people who will receive the cash flow distributions and equity from the sale of the property proportionate to what is outlined in the PPM. The investors who have a preferred return will get their portion before the general partnership can profit. Essentially, the preferred returns determine who gets paid first in the deal.
Having the option of being paid first in the deal structure can often incentivize investors to participate in the deal.
After investors receive their passive income from their preferred returns any excess in revenues beyond that percent return, for example, a 7% preferred return, would be distributed to the general partners as dictated by the terms of the PPM. This incentivizes the general partners to work hard on getting their business plan solidified so that they can begin receiving distributions also.
Preferred returns for real estate syndication opportunities usually range between 5-10% depending on the deal, the asset type, the real estate market, etc.
At PCRP Group we like to be able to offer our potential investors a preferred return on the majority of our real estate investment opportunities.
The Waterfall Structure
A waterfall structure simply means when certain return percentage hurdles are met that there will be a predetermined allocation of revenue between the general partners and limited partners.
So let’s take an example of a typical real estate syndication structure: say the preferred return is 7%. The first 0% to 7% of returns go directly to the limited partners, and the general partners receive zero. The waterfall structure may dictate that if a project hits a hurdle of between 7%-16%, then the split for investors would be 70/30 with 70% going to passive investors and 30% going to the sponsor team. Then if a project hits a hurdle of over 16%, then the split could be 50/50 with an even split among all types of investors in the project.
Virtually every real estate syndication opportunity available to an accredited investor and a sophisticated investor will have a waterfall structure.
Again, one of the purposes of the waterfall is to also incentivize the deal sponsor management team to work as hard as they can to make these return hurdles so that they can get compensated in the real estate project.
You will want to review the investment summary and particularly the PPM to fully understand all of the revenue hurdles that will outline how much money you are projected to receive based on these return thresholds.
Understanding the Cash Flow In a Real Estate Syndication
The most important thing to remember is that these types of real estate transactions have various levels of returns. If you want the highest returns possible you will want to understand the different structures that are made available to investors with commercial real estate syndications. Additionally, you will want to determine if these projected returns align with your financial goals.
When you are educated on the fundamental concepts around syndication structures such as the straight splits, preferred returns, and waterfalls, you can become a much more savvy investor. You will become considerably more confident in selecting an investment property that will help you build your wealth, grow your real estate portfolio and create the future you’re envisioning for yourself and your family.
Until next time, Earn Passively & Live Abundantly!
Note: We are not financial advisors or tax advisors. Before making any financial decision you should consult with your financial and/or tax specialists.
Ready to Learn More?
The best way for you to learn more about commercial real estate syndications is to join the PCRP Passive Investor Club.
Through the PCRP Passive Investor Club, you’ll get a priority review of all the deals we offer. We’ll work with you to determine your investing goals and then present you with the best deals to meet those goals. We’ll then guide you every step of the way as you invest in those deals.
So if you’re ready to start investing passively in institutional-grade, commercial real estate in fast-growing, climate-resilient markets in the U.S., join the PCRP Passive Investor Club – IT’S FREE! – and get started on your path to EARN PASSIVELY and LIVE ABUNDANTLY!
If you would like to know more about what we do and how it may be of value to you, please reach out to us anytime. We’re always happy to help!
