A supplemental loan (or “second loan”) is used utilized to reward our passive investors with a portion of their original investment without refinancing into a new loan or selling the property. For example, once renovations are complete and higher rents are secured, our value add strategy comes to fruition. With a variable rate loan, we may go to the bank for a higher property value to be assessed and refinance. However, if we have a fixed rate loan, we may obtain a supplemental loan so we can then pull equity out of the property and increase cash on returns for our passive investors.

You only need to submit your financials if the syndication is a 506c offering; if it’s a 506b offering, then you don’t need to submit your financials.

Because the syndicate itself invests via an LLC, it is unnecessary to form an LLC on your end. Most passive investors invest in their own name, and while you certainly can create an LLC and invest through that limited liability company, it wouldn’t offer any extra protection beyond the syndicate LLC. However as I am not a tax professional, this is a good question for your CPA.

To determine the debt structure, ask your sponsor if they’ve already secured debt financing. Alternatively, they may still be working on assumptions. If they are working on assumptions, be aware that the projected returns may change when the debt is secured. Another important factor to consider is the interest rate. Ask whether the interest rate is locked or floating, and if floating inquire if they purchased a cap. Remember that an increase in interest rates will reduce the return projections. Also be sure to ask whether the loan is short-term or long-term. Short-term loans have specific refinance assumptions, such as the interest rate and loan amount. Follow up with your sponsor on why these assumptions were made, and whether they can purchase an extension on a short-term loan.

With a 1031 exchange, an investor can sell a property and as long as they follow a specific process, they can purchase another property while deferring tax from the gains of sale. A 1031 is applicable for any tax paying entity that can own real estate. One of the primary requirements of the 1031 exchange is that the taxpayer of the old property (the sold property) is the same taxpayer of the newly purchased property. However the caveat here is that the investors in a syndication purchase membership interests in the LLC and they themselves are not owners of real estate, but owners of shares of the LLC. The syndication itself is not considered real estate for purposes of 1031. What the passive investor can do, however, is the LLC can sell an asset and perform its own 1031 exchange to purchase another asset, with the investors deferring taxes as long as they remain members of the partnership when it purchases the next asset.

Because the syndicate itself invests via an LLC, it is unnecessary to form an LLC on your end. Most passive investors invest in their own name, and while you certainly can create an LLC and invest through that limited liability company, it wouldn’t offer any extra protection beyond the syndicate LLC. However as I am not a tax professional, this is a good question for your CPA.

For large projects, syndicated loans allow lenders to spread risk and participate in financial opportunities that may be more than their capital base can sustain. For these loans, interest rates on can be fixed or floating. Longer-term lenders, such as Fannie and Freddie, tie their loans to treasures and thus offer fixed-rate debt. Because these fixed-rate loans are in place for a presumably long-term period, the prepayment penalty can be high. This may deter the sponsor from selling or refinancing the loan early. Shorter-term lenders offer floating rates tied to the 1-month London Interbank Offered Rate (LIBOR). These short-term loans offer greater flexibility for the sponsor to sell or refinance without a large prepayment. Whether fixed-rate of floating-rate is the best option comes down to the property. Your sponsor will choose either loan type depending on the goals of the business plan. Generally, value-add properties are better suited for fixed-rate loans. If the sponsor chooses to refinance the fixed-rate debt early in the holding period, they can secure supplemental loans.

We always opt for a conservative approach. In figuring our cap rate, we presume that the market at sale will be worse off than it is at purchase. We first calculate the in-place or “going-in” cap rate – this is based on the purchase price and the in-place net operating income. Next, we calculate the exit cap rate by adding 20 to 50 points (in other words, .2% to .5%) to the in-place cap rate. In so doing, we’re protecting our return projections during a downturn while giving a healthy boost to the true returns we see if the market stays the same or gets better.

As of this writing, the IRS tax code permits investors to use SD-IRA (self-directed IRA) and 401K for alternative investments, such as real estate syndications. However, in terms of tax there is a distinction between the SD-IRA and the 401K, with the SD-IR­­A having a UBIT tax while the 401K has no UBIT tax. Most Sponsors will accept investments through a SD-IRA, however, be sure that you’re working with a custodian with experience investing SD-IRAs in syndications to ensure you are following the IRS tax code.

When a syndicate secures an interest-only loan, the interest-only payments yield additional cash flow versus simply paying down the principal. Let’s take an example. Say we have a $10,000,000 loan at 4% - the interest only annual payments would be $400,000. However, if the loan was amortizing, the annual payments would be $572,898. Interest only payments yields an additional $172,898 in cash flow distributions. It’s nice for limited partners to see this cash flow throughout the hold period. In this way, this additional distribution is greater than receiving a larger distribution at sale. In addition, if there is a market downturn so great that the property loses value, it would have been better to receive that additional cash flow prior to the sale of the property.

Cap rates are important to know because you can compare it to the cap rate in the market. A “going-in” cap rate that is higher than the market cap rate is good; it means that the property is purchased below market. However, if the sponsor’s business plan is distressed or value-add, then the cap rate doesn’t matter all that much because net operating income would be lower than at purchase. In which case, you would want to know the “stabilized cap rate” vs. market cap rate. In this scenario, you would want the stabilized cap rate to be higher than the market cap rate.

The term “limited partner” may be used interchangeably with “passive investor” in a syndication deal. In other words, the passive investor has limited liability wherein their exposure to risk is limited to the amount of their original investment. They are not on the bank loan nor are they responsible in case of a lawsuit. Any other assets that the limited partner owns are completely protected.