Real Estate Syndication: A Passive Investment OptionApr 28, 2023
Syndication of real estate is a great way to invest in property without having to purchase it outright. As a syndicator or sponsor, I bring together investors and real estate opportunities and put the deal together. Today, we'll be discussing how sponsors make money through real estate syndications. With this information, you can better structure your real estate deals and maximize your profits.
Understanding the Terminology
Before delving into the specifics, it's essential to understand the terminology used in real estate syndications. As mentioned earlier, sponsors are the people who put together the real estate deal. On the other hand, investors are those who invest capital in the deal.
The Promoter's Fees
Since putting a real estate deal together takes a lot of time, effort, and work, there are generally fees associated with it. The fees include acquisition, asset management, and property management fees.
The acquisition fee is a fee paid upfront to the sponsor for bringing the deal to the investors. The asset management fee is an ongoing fee for managing the asset after the deal is done, while the property management fee is for managing the on-the-ground work that needs to be done with the property.
In addition to the fees mentioned above, sponsors also receive a percentage of ownership in the deal, also known as equity or a "promote." The purpose of this is to align incentives, and sponsors are paid as the asset makes money.
How Fees and Income Work for Sponsors and Investors
To illustrate how fees and income work for both sponsors and investors, let's use a hypothetical example. Suppose we have a self-storage deal worth $2 million, and we're putting down $300,000. The revenue generated is $170,000 gross, and the net income is $100,000.
Assuming a 2% acquisition fee, 1% asset management fee, and a 5% property management fee, the sponsor would make $50,200 in the first year, broken down as follows:
- Acquisition fee: $40,000
- Asset management fee: $1,700
- Property management fee: $8,500
The ongoing disbursement of profit to both the investors and the sponsor is determined by the equity or promote percentage.
Understanding Net Income Distribution
When investing in real estate, the net income is distributed to the investor and the sponsor in the form of a return. The return follows a structure of 70% to the investor and 30% to the sponsor. However, this only falls to the sponsor after the investor gets 8% of the income first. This 8% is called a preferred return.
For instance, if an investor puts $300,000 into the deal, they will receive an $8,000 preferred return first, and then the remaining income will be split at 70%, which is $64,400, and 30% which is $27,600. Therefore, the investor will receive a total of $72,400 in net income, which is a 24% return on their $300,000 investment. The image below provides a visual representation.
How Equity Distribution Works
Now we’ll talk about Equity Distribution. Equity distribution is a crucial aspect of self-storage income. The structure of the 70-30 plus the 8% preferred return to investors is determined between the sponsor and the investor. Generally speaking, the investor gets more of the deal, the less experienced the sponsor is, or the better the opportunity, and the more experienced the sponsor, the more they get of the deal.
This is a negotiation that is determined between the parties involved, and all parties go into it knowing how much equity they receive, when that equity will be paid out, and how much of the net income they will receive and when.
Fees Involved in Real Estate Syndications
It's essential to understand that some of the fees involved in real estate syndications are paid in the first year, and this will affect how the income is distributed. The sponsor for bringing that deal together is paid a two percent acquisition fee plus asset management and property management fees, which add up to $77,800.
Assuming the sponsor is doing everything for this real estate deal; they're running the property, managing investors, and putting it all together. The investors are paid $72,400, and the sponsor is paid $5,400 in year one.
In year two, the fees change, and the sponsor is getting two of the fees, asset management and property management, because these are ongoing fees, plus participation in equity after the 8% return is given to the investors, and the 70% is given to the investors. Therefore, the sponsor gets 30%, which totals $37,800, and the investor gets the 8% preferred return plus the 70% of the profit, which equals $72,406, or a 24% return on their $300,000 investment.
As a sponsor, you can establish a real estate business that enables other investors to invest with you passively. They can benefit from your expertise and hard work while directly receiving returns from the real estate investment. This is the essence of Real Estate Syndication and when used efficiently, it can be utilized to grow your wealth with passive income.
To summarize, real estate syndication provides an excellent opportunity for investors to invest in real estate without having to purchase it outright. By understanding the terminology and fees involved, investors can maximize their profits. Sponsors or syndicators make money through various fees such as acquisition, asset management, and property management fees, as well as through equity or a "promote." The ongoing distribution of profits to both the investors and the sponsor is determined by the equity or promote percentage.
Additionally, it is important to understand how net income distribution and equity distribution work, as these can significantly impact profits. With the right knowledge and expertise, sponsors can establish a successful real estate business that benefits both themselves and their investors.