Real estate syndication (also called “property syndication”) is broad term, however simply stated it is when multiple investors pool their capital to increase their buying power to buy or build property that they would otherwise be unable to afford on their own. In a syndication deal, the investors are passive partners. The active partner in a syndication deal is the Sponsor (also called a “General Partner”). The role of the Sponsor is to scout and secure the property, initiate the business plan, and manage the investment.

The tax impact for value-add apartment syndication is significant – and often favorable – to the passive investor. Because the passive investor in a syndication usually receives a profit from annual cash flow as well as the profit at sale, being a profit this money is taxable. However, the numerous tax benefits such as deduction in property taxes, loan interest, and depreciation offer significant tax advantages. In addition, accelerated depreciation via cost segregation and depreciation recapture confers even more tax benefits. Look out for your K-1 statement in March from your sponsor for the previous tax year. For a $100K investment, we often see an 8% preferred return combined with a paper loss on your annual K-1. Added to this we may have refinances or supplemental loans (which are a return of equity). When the property is sold, you may even be able to do a 1031 exchange into another property with the same sponsor and continue to defer your long-term gains tax.

Yes. We aim to keep expectations conservative so we can overdeliver and have satisfied passive investors that may want to go on and invest with us on future syndications. Before entering a syndication, be sure to review the financial forecasts made by the sponsor and be careful if the numbers seem exaggerated. You’re paying close attention to rents. Are the rents projected by the sponsor inline with area comps before and after renovations? Other areas to hone in on are projected rent growth and occupancy rates. I also advise prospective passive investors to review the T12 – this is a document you can obtain from the previous owner that trails the previous 12 months of income and expenses.

Negative reviews signals to us that there is room for improvement. We aim to sell our properties at a substantial value add, so the poor reputation of the property allows us to turn it around at a considerable gain. We often rebrand the property, with a new name, website, and property management team. In terms of negative reviews, we’ve learned operational improvements are key. We seek out ways we can boost retention and minimize turnover.

A sensitivity analysis (also called a “what-if” analysis) is a way to forecast outcomes based on various variables. It helps predict all the possible returns under varied economic conditions, including downturns. As there’s always a possibility that we may not achieve our rental forecasts due to either higher vacancy rates or lower rents than projected, it’s important to analyze possible "bad endings" so our investors are 100% clear on worse-case scenarios, as unlikely as they may be.

In our experience, most owners sell because they’ve achieved the goals they set out to achieve per their business plan. However, there are cases where the owner sells because they need the money or perhaps because they had trouble managing the property or did not achieve the cash flow they had forecasted. The latter is often is due to not making significant value-add renovations to the property.

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.

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.

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.

There are numerous benefits conferred to a passive investor / limited partner who may want to branch out to form his own syndicate on his own, but I’ll list just three. 1). As a limited partner, one learns and may observe how underwriting large apartment deals is done. 2). As a limited partner, one has an opportunity to ask as many questions as he pleases and pick his sponsor’s brain. 3). As a limited partner, one earns a reputation for being a valuable partner in deals. All three combined enable the limited partner to build the skillset needed to speak with lenders. In addition, this experience allows one who is interested in taking an active investor approach in syndications to gather prospective passive investors on his own deals.

The Securities and Exchange Commission (SEC) regulates who can invest in a syndication. These regulations are in place to protect investors, particularly unaccredited investors who may not have the income or wealth to sustain them if an alternative investment went south. In contrast, accredited investors are those individuals who earn $200K or more per year, or a couple earning $300K or more per year in the current year as well as the trailing two years. Or, an accredited investor is deemed such if their net worth is $1M or more (excluding their primary residence). It’s forbidden per SEC regulations to actively market syndication deals to unaccredited investors; we can only market syndications to accredited (high-earners/high net-worth deemed by the SEC) individuals and/or couples.

Whether a sponsor invests his own money in the deal depends from deal to deal. In an ideal scenario, both the sponsor as well as the limited partners pool their dollars together so that their interests are more deeply aligned. It’s best to participate in syndications where the sponsor has a financial vested interest in the deal as this will create more of an imperative on the part of the sponsor for the syndication to succeed. When the sponsor invests with dollars (versus sweat equity alone), the split may change to reflect both the investment of time as well as the financial stake the sponsor has in the deal. For example, if the split is 70/30, and the sponsor adds their own money to the deal, he increases his stake so the split may change to 60/40, with 60% to the limited partners and 40% to the sponsor.

As the holding period is contractual, you will be clear on when your original investment will be returned before signing a contract with the Sponsor or General Partner. In general, most syndications run their course in five years, which means you will receive your original investment in year five. Before signing anything, be sure you are comfortable with the hold time as well as the exit strategy.

The Securities and Exchange Commission (SEC) requires what’s called the “Private Placement Memorandum,” or “PPM.” This memorandum outlines the syndication offering and risks of the syndication deal. As well, the PPM describes the partnership agreement, investment summary, and subscription agreement (which includes basics, such as number of units). Better find a comfy chair before you sit down to read the PPM as it’s seldom under 100 pages long. While many new investors are boggled by the risk section (it includes every risk under the sun), it’s there for a good reason: a reminder that like all investments there are risks.

Real estate syndication Sponsors require a minimum investment, also called the “original investment.” This minimum investment may vary depending on the size of the project. For example, the larger the project the more money required to invest. Our syndications are set at $50K minimum and increase in increments of $5K. In terms of maximum investment, Sponsors rarely allow a single investor to invest more than 19% of the total equity. Reason being, if a passive investor invests more than 19%, they would then have to be underwritten by the lender.

For shortfalls and unexpected challenges, all syndicates should have a contingency or operating fund. If renovations are planned, we like to use a 10% - 20% of the renovation budget to be our benchmark for the operating fund. When fielding sponsors, ask them how much upfront money they’ve budgeted to cover potential shortfalls. The unexpected happens when you’re not expecting it – such as maintenance issues, low occupancy, insurance payments, etc. We abide by 1% to 3% of the purchase price. You may also ask them how much money they budget each year to a reserves account. We reserve $250 to $300 per unit per year. For example, a 100-unit apartment community should save $25,000 to $30,000 as reserves. Beware if the operating fund doesn’t account for shortfalls, as the sponsor may reach out to his limited partners for additional capital if an issue does arise.

The condition of the major systems – such as the plumbing, roofs, siding, windows, and HVAC – are absolutely crucial to assess as they figure into the capital expenditures budget. If the major systems need work, then you better make sure that the contingency fund is robust enough to fix those systems if need be. We recommend that you ensure your sponsor assesses the major systems rather than taking the owner or real estate broker’s word for it as to their condition.

Also called a CapEx budget, the capital expenditures budget should detail how much money is budgeted for each project. Understand how the CapEx budget is calculated. Are the costs estimated by the sponsor or are based on actual bids from contractors who inspected the property? Accuracy is king in CapEx budgets, so we opt for contractor bids, that way we have a clear idea of what we and our passive investors are getting into. Another important key here is knowing what portion of the CapEx budget is earmarked for the contingency fund. We aim for 10-20% of the total CapEx costs.