Real estate syndication is among the lucrative businesses in the modern era. The introduction of the JOBS Act in 2012 has opened the doors of this business to inexperienced, non-accredited investors. However, it is crucial to understand the structure and investor earning distribution in real estate syndication.
For instance, investors pool their investment along with a syndicator to acquire a 50-unit apartment building in a prime location. The syndicator promises investors certain returns on a long-term basis. Where does this money come from?
In this article, let's figure out the investment distribution in real estate syndication.
The Parties Involved in a Real Estate Syndication
Real estate syndication comprises two significant stakeholders
- Sponsor or syndicator acting as General Partner and
- Passive Investors, who are Limited Partners.
The sponsor's capital share may vary from 5% to 20%. To raise the remaining capital, passive investors pool their financial resources under the leadership of the syndicator. They own the property collectively.
Usually, passive investors get 70% of the profit. In comparison, the syndicator gets 30%, along with sponsor fees. The syndicator is responsible for finances, decisions for investment management, and routine administration.
Understanding the Two Primary Real Estate Syndication Structures
In real estate syndication, there are two primary structures used to organize and manage investments: the legal entity structure (organizational structure) and the real estate syndication structure (deal structure).
Let’s under both:
1. The Entity Structure, a.k.a, Organisational Structure
The entity structure of a real estate syndication refers to the legal and organizational framework of the syndication between the two parties. It defines how the syndication is formed, managed, and how profits and losses are distributed among the participants.
- Limited Partnership (LP):
- The syndication becomes a limited partnership. This is the most commonly used real estate syndication structure. In this, there are primarily two parties involved, i.e., the General Partner (GP) and Limited Partners (LP), as explained above.
- The GP is the sponsor who takes on the maximum responsibility for the syndication, whereas the LPs are the passive investors who contribute capital and share profits and losses. They typically have limited liability and involvement in management.
- Limited Liability Company (LLC):
- Sometimes a real estate syndication can take the form of LLC. Compared to a Limited Partnership (LP), an LLC offers more flexibility in terms of management. There can be multiple managers, or the management role can be assigned to specific members.
- A key benefit of using an LLC is the limited liability. This means the personal assets of the investors are shielded from liability if the syndication encounters lawsuits or debts. Only the assets owned by the LLC itself are at risk.
2. The Real Estate Syndication Structure, a.k.a the Deal Structure
The real estate syndication structure, also known as the deal structure, is all about how the profits and any gains generated by the real estate investment itself are divided between the LPs and GPs.
- Straight Split
This is the simpler and more straightforward structure. It emphasizes on a predetermined proportional sharing of all capital gains and cash flow between the GP and LP. This is based on the ownership percentages defined in the syndication agreement.The split can range anywhere between 50/50, 60/40, 70/30, 80/20 and 90/10. For example, if the agreement states that there will be a 80/20 straight split, 80% of the cash flow and capital gains will go towards LP and 20% will go towards GP.
For example, let’s say that in a syndication, there is a $200,000 cash flow which is to be distributed amongst GP and LPs at a 80/20 straight split. This means 80% of the cash flow will be distributed amongst the LPs and the remaining 20% will go to the GP (sponsor).
So, 80% of 200,000 = $160,000. That means $160,000 will be distributed amongst LPs. The remaining 20%, i.e., $40,000 will go to the sponsor.
- Waterfall
This is a more complex structure that prioritizes returns for LPs before the GP receives a significant share of the profits. It uses a tiered approach to distribute cash flow and eventual sale proceeds.These profits are distributed sequentially in accordance with predetermined tiers outlined in the waterfall structure. Each tier represents a different level of priority for distribution.The first tier is Return of Capital (ROC). In this tier, all cash flow from the investment initially goes towards returning the LPs' initial capital contribution. This includes the money they invested in the property itself.
Then, the next tier utilizes the ‘preferred return’ method where LPs receive a fixed annual percentage return (e.g., 8%) on their investment before any profits are distributed to the GP. This means that the LPs receive 100% of the first 8% of the returns and any amount that remains after the LPs are paid, it goes to the GP.After that, GP Catch-up can be incorporated. It is a provision for the GP to receive a larger share of profits after a certain point. This "catch-up" can occur after LPs have recouped their initial investment and received their preferred return for a set period. This incentivizes the GP to focus on long-term value creation for the property as their interests become more aligned with LPs in the later stages.
Standard Real Estate Investment Distribution
Now, usually, the cycle for distribution is predefined in the agreement. Meanwhile, investors receive regular communication from the syndicators regarding the upgrade and repairs of the property and the periodic financial statements.
The distribution may be carried out usually quarterly or, in some cases, monthly. The syndicators calculate the profit and divide it for every investor. The investors' profit shares depend upon their agreed-upon percentage and the contribution in the capital investment.
Calculating the Returns for Investors
Calculation of the investor earning distribution is a crucial part of the financial accounting of any real estate syndication. Let's analyze the process in a simplified manner:
- Gross Rental Income
Let's continue with the previous example- The 50-unit apartment building.
Considering the rental rate of $500 per month, and considering that all units are filled,
Gross Rental Income Per Month will be 50 Units * $500, totaling $25000.
So, the Annual Gross Rental Income will be $300,000.
Here, we haven't considered the vacant units and the expenses. So, naturally, any investor will not receive the total sum of gross rental income as the real estate investment distribution.
Expenses: The Other Side of the Coin
Mortgage Installments
While acquiring the property, syndicators usually get a mortgage. Repayment of the mortgage is their liability. The installments are paid from the rental income the syndication makes.Usually, syndicators close a deal when they have sufficient funds to make the down payment for the mortgage and pay the processing charges. Later, they raise funds by convincing more potential investors.
Renovation and Maintenance
Property with better amenities attracts more high-paying tenants. The syndicators may renovate the parking lot, the gardens and plantations, and other social amenities within the apartment building to attract the tenants. The cost for upgrades is an essential aspect of expenses.
Taxes
Any real estate syndication needs to comply with the norms of the SEC and the regional authorities. Some taxes are applicable, like property tax, which will be paid out of the rental income.
Net Rental Income
The net rental income of the real estate syndication is the difference between the gross rental income and the total expenses.
The real estate investment distribution is usually lucrative if the syndicators strike a proper balance.
- The capital investment to acquire the property and
- The rental income or cash flow it generates, in the long run
Investor Earning Distribution
Now, let's turn to the eternal question- What will an investor get as a return on investment?
Syndicators calculate the net rental income and distribute the predefined share to the investor community.
Here, investor earning distributions depend upon the initial capital investment of every investor. So, the investment distribution will be directly proportionate to the initial funds deposited by every investor.
Investors' Share During Exit
It is important to note that the recurring rental profit share is a part of the ROI every investor receives. The crucial game is to work with experienced syndicators. Choose syndicators who know real estate investment management and possess a successful track record.
Usually, the holding period of a multifamily apartment will be 5 to 10 years. Investors can discuss this with the syndicators initially or during any stage. The recurring quarterly passive income will keep flowing to the investors up to this period.
What happens next?
Syndicators discuss their exit strategy and alternate plans initially. After a considerable holding period, syndicators start looking for a buyer for the property. If they find a profitable deal, they will sell the property at a better price.
At this stage, the investors will get their initial capital back. Is that all they receive? Wait! The good news is here- Investors also receive a profit share in the appreciation.
Importantly, all this chaos can be managed efficiently by adopting the best real estate syndication software. The tool for syndicators and investors helps you accelerate the business. It keeps various operations on the auto-pilot mode so that real estate syndicators can spend more time closing more deals!
To help you understand the concept of real estate investment distribution better, we have created an infographic. The infographic covers various aspects discussed in the article briefly. We hope that the infographic will help you remember the process quickly. Here is the infographic:
The Final Thoughts
This article explains the process of real estate investor earning distribution from a real estate syndication's perspective. We are sure that the various aspects of calculating the profits and sharing it among investors will be helpful.
Never rely on conventional methods for real estate investment distribution. Switch to the most appreciated real estate syndication software to attain more transparency, better efficiency and to enjoy its time-saving features. Take your growth in real estate syndication to the next level by adopting the best investor management portal today!
