(The Ultimate Beginner’s Guide to Making Passive Income the “Easy-Button” Way)
The Ultimate Investment Rule has to be investing in something you understand. While Multifamily Syndication is a profitable venture for large scale earners to make returns passively, at medium risks, you must understand the Real Estate Syndication World before venturing. Not to worry though, in these series, we have compiled all the basic information you should know.
In Series II we looked at the Financial Terms involved in Syndication, in this concluding series, we shall look at 10 things you must know about the Structure of Real Estate Syndication, particularly the structure of crowdfunding and the structure of profits.
- The Structure of a Syndication and how the funds are generated has a lot to do with the Crowdfunding structure, most commonly the Reg A and Reg D of the JOBS Act, and the method of Sharing the Profits.
- Reg A requires a Securities Exchange and Commission (SEC) approval known as ‘qualification’. Reg A allows crowdfunding from non-accredited investors (general public), but the registration, regulation, SEC approval, audits, and other processes involved make Reg D a more preferred option to Reg A. Although Syndicators can raise more funds with Reg A, it would usually cost tens of thousands of dollars. Reg D, in contrast, does not include rigorous registrations and requirements as all passive investors must be Accredited Investors (net worth of $1 million or annual income of $200,000).
- Again, track record matters here. Relatively new or early-stage Sponsors make use of the Reg D route since the costs and requirements are much lower, while more established Sponsors make use of the Reg A route since they already have a good track record and can spend relatively more on fundraising.
- Once the Crowdfunding structure is determined, Sponsors can then proceed to make an Offering. The Sponsor must have chosen a market, identified an appropriate deal, and mapped out an effective business plan (more of these are articulated in Series II).
- There are numerous ways that profits are structured in Syndications. The profits can be split using a Straight Split structure where all profits (cash flows and back end profits) are split at an agreed percentage, or by a Waterfall structure where profits are shared first from the initial profits, from the additional income and/or from the possible equity appreciation of the deal, more on that below.
- For a Sponsor, there are three major sources of income – acquisition fees, asset management fees, and equity participation. The acquisition fees are a minimal fee (1-5% of the property) or a fixed fee as compensation for the Sponsor’s acquisition of the property. The asset management Fee is also minimal (0.5-2% of gross revenue), paid to the Sponsor for managing the Property and the Syndication Partnership. The equity participation is the main profit for the Sponsor, which is the money left after the investors have been paid the agreed returns, the fee is then split in a pre-determined percentage between Sponsors and passive investors. Sponsors could also earn deposition fees, financing fees, administrative fees depending on the deal.
- For an Investor, there are two major sources of income – Preferred/Annual Return (‘pref’) and additional income. The ‘pref’ is usually around 7-15% of the Capital. Additional income would usually be around 50-90% of the remaining profits.
- For instance, the Sponsor of a Syndication wants to acquire a property in a deal worth $5 million, a year later a profit of $940,000 was made. Assuming that after the settlement of all fees and expenses, we are left with a Net Operating Income (NOI) $700,000. Now, if the ‘pref’ for the deal was predetermined as 8%, i.e. 8% of $5M which is $400,000 (from the $700,000), the 8% is solely for the Investors. The remainder fee is $300,000, is also split at a predetermined rate. For instance, if a rate of 70%-30% was agreed, then the investors take 70% which is $210,000 for their equity participation in the deal’s cash flow, and the Sponsor gets 30% which is $90,000.
- Both the Sponsor and investors can make further profits from the deal should the property appreciate (in market value) when the property is refinanced or sold. It’s usually a win-win situation for both parties.
- Knowing that the Sponsor has ‘skin in the game’ cannot be over-emphasized, the Sponsor is responsible for the management of the deal, legal details and consequently, is largely responsible for the success of the deal.
We hope you’ve learned from these Series, and you’re well equipped with information as a potential passive investor.
Disclaimer: The views and opinions expressed in this blog are provided for informational purposes only, and should not be interpreted as an offer to buy or sell any investment or course of action.