Guide to Real Estate Syndication Structures & What They Mean For Passive Investors
In preparation to become a real estate investor, the single most important thing you should do is establish your investment goals.
A great way to help you determine your goals is to simply ask yourself: “What do you want real estate investing to do for you in your life? How do you want investing in a multifamily syndication to help your family and loved ones? What do you want your life to look like as a result of this investment strategy? What kind of investment opportunities will help you achieve these goals, and when do you want to achieve these financial goals?
Answering these questions will help guide you as to what you want your real estate portfolio to look like and the commercial real estate investments you wish to pursue based on the projected passive income that these investments can provide for you.
As real estate investors who invest in a property syndication, for example, you will want to know your risk tolerance because you take a passive role in the real estate project. This means you give up control of the investment and hand the reins over to the deal sponsor (the real estate syndicators) and the property management team.
Benefits to Passive Investors
As a passive investor in a commercial real estate syndication you pool your capital with a group of individual investors to acquire an otherwise unaffordable investment property such as a 400-unit apartment building.
The benefit for you – the passive investor seeking passive income – is that you receive cash flow distributions on a quarterly basis while someone else does all of the work. You rely on the syndication agreement and how the real estate deal is structured to receive your projected returns.
So, when pursuing syndication deals, what do you look for with these types of real estate deals? Where do you start? How do you know which deal structure is best?
In this article, we will discuss what the components of syndications are, the deal structure of the real estate syndication, and how the returns will be distributed between all of the passive investors and the general partners.
Why Real Estate Syndications Are Structured Differently
Real estate syndications differ from one commercial property to another. Some deals will allow for greater returns, but oftentimes that will also mean higher risk – such as in an extensive value-add project or the project may be in an area that has not quite gentrified. On the other hand, some deals may have much less risk but will have more conservative returns.
Syndications are structured differently based on the real estate market, the asset class and asset type, the location and condition of these assets, and so much more.
There are two common structures utilized with real estate syndications: The Straight Split & The Waterfall
Real Estate Syndication Structure #1 – The Straight Split
As the name implies, the “straight split” structure means that all returns (cash flow distributions and profits from the sale of the asset) are based on the same percentage. So, for example, if a deal uses an 80/20 split, this means that 80% of the returns (cash flow distributions and profits from the sale of the asset) go to the limited partnership or the group of passive investors. The remaining 20% is distributed to the general partnership (real estate sponsor team).
No matter the amount of the returns on the property, how this particular structure works is that 80% of the total returns are distributed to passive investors and 20% of the total returns are distributed to the syndicators.
Real Estate Syndication Structure #2 – Waterfall
One of the most common real estate syndication structures is a preferred return (“pref”) waterfall structure.
If, for example, the deal is offering investors an 8% pref, then those passive investors get the first 8% in monthly cash flow distributions, and the general partnership ONLY receives returns if the passive investors receive their 8% preferred return first. In the waterfall model, each few additional percentage points in returns (or additional profits generated) activates a new split among all of the parties.
As an example, if you invest $100,000 into a syndication investment opportunity with an 8% preferred return, the payout structure may outline that returns between 8%-14% are a 70/30 split (70% to limited partners and 30% to general partners) and any returns that reach 14% and beyond will be a 50/50 split.
Waterfall structure syndication deals are a win-win – the general partners are incentivized to reach very lofty revenue goals or otherwise, they won’t be compensated as well, and you as the passive investor in these types of investments are getting preferential treatment for the first 8% (not guaranteed of course), but about as close as you can get when it comes to investing.
How to Choose the Best Real Estate Syndication Structure
There is no particular investment syndication structure that is necessarily better than the other. It just depends on the deal itself and what your goals are and the timeline you want to achieve them.
Most investors we work with would rather receive a preferred return so that they can anticipate a specific return even though it’s never guaranteed. However, these types of structures (the waterfall) can offer investors more conservative returns. It all depends on the performance of the asset and the team behind the execution of the business plan.
When The Waterfall Structure is Better
Let’s say that you invested $100,000 in a syndication with annual returns of about 10%. With a “pref”/ preferred return waterfall structure, the majority of the distributions would go to you – the passive investors (limited partnership).
An 80/20 straight split structure on your $100,000 investment returning 10% per year would yield you $8,000 per year.
A waterfall structure, however, with that same 10% would yield you 100% of $8,000 + 80% of $2,000 ($1,600), which equals $9,600.
When a property has high cash flow percentages for the distributions, then a waterfall structure/pref structure provides higher distribution amounts to the limited partnership. In that scenario, on the other hand, the straight split provides more value to the general partners.
When the Straight Split is Better
Let’s pretend the same property in which you’ve invested $100,000 makes a high profit of 50% at the sale. A straight split on the sale will yield you 80% of $50,000, equaling $40,000.
Using the example above, in a waterfall structure, your returns and share of the profits would look like this: you would get 100% of $8,000 (the pref) + 80% of $6,000 + 50% of $36,000, which would be a total of $30,800.
So in short, when the sale of the property produces a high profit, then the straight split structure will distribute more returns to the limited partnership and a waterfall structure will distribute more returns to the general partnership.
Using Your Investing Goals to Determine Which Real Estate Syndication Structure is Best for You
So, again the type of structure that will best suit you is dependent upon your own financial goals. If you are looking to receive steady passive income, then a real estate syndicate with a preferred return (the waterfall structure) might be the type of deal that will be best for you because it is more likely that throughout the lifecycle of the project you will receive greater cash flow distributions.
However, just know that you may receive lower returns when the property is sold and profits are distributed. Passive investors who are investing cash (as opposed to retirement funds) may find this option more attractive because of the ongoing cash flow distributions.
Otherwise, if your financial goals are long-term and you are interested in high returns through anticipated appreciation and profits when the asset sells, then a straight split structure may meet your goals better because you are more likely to receive a larger return as a percentage of profits upon the exit strategy.
Limited partner investors utilizing a self-directed IRA investment vehicle might find this a better structure because any cash flow distributions cannot be accessed until retirement anyway.
Remember this is all about establishing your financial goals ahead of investing in real estate syndications. No choice is wrong. These are just two different ways that these real estate structures can potentially give you great returns. You just decide which structure is best for you.
Note: we are not financial advisors and are not offering financial advice of any kind. Please consult with your advisors before making any investment or financial decisions.
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!
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