Real Estate Syndication for the Passive Investor
Real estate syndication is an increasingly popular method of passive investing. Here are the basics any potential real estate syndication investor needs to know.
Real estate syndication has become a popular method of passive investing for various reasons. They provide a low-stress way to invest in real estate for those who are short on time; they also work for investors who have limited budgets for investing and they also have significant tax advantages. The upfront investment and due diligence in the beginning can pay off in the form of cash flow along the way and at the end when the property is sold.
Here is an overview of real estate syndication for the P.A.S.S.I.V.E. investor.
P – Private Placement
Real estate syndication is a pooling of capital between a sponsor and multiple investors to invest in real estate and is considered a type of private placement which allows a company to raise money without going public. Private placements do not have to be registered with the Securities and Exchange Commission (SEC) and may also be referred to as an unregistered offering. They are however still somewhat regulated by SEC, but under different rules, collectively known as Regulation D (Reg D) which allows companies to issue securities based on the investors buying them.
A – Accredited Investor
An accredited investor as defined by the SEC is a person or entity that can invest in securities that are not registered with the SEC such as private placements.
As of August 2020, the SEC adopted amendments that expand the definition of accredited investor. The adopted changes now allow individuals to qualify based on their credentials which include professional knowledge, certifications, or the individual’s relationship with the issuer (regardless of income or assets). To get LLC accredited every member of LLC must be accredited.
S – Structure
Syndications can be structured in many ways. Two common structures are a limited partnership or a limited liability company. If our client is the investor, we may recommend they have a WY LLC that is a limited partner in the syndication and a corporation that is the manager of the WY LLC. Having one entity for the syndication investment and one managing entity will cover all the available business deductions and is a solid strategy for tax mitigation as well as asset protection.
S – Sponsor
The Sponsor is actively engaged in buying, operating, and ultimately selling the property; they solicit funds from investors as well as handle all the business of the syndication such as accounting and making distributions to the investors. Depending on the legal structure of the organization created for the investment, the Sponsor is technically known as the General Partner (GP) or Manager. Sponsors should seek SEC counsel to structure and ensure compliance. An SEC attorney will create the subscription agreement, operating agreement, and a Private Placement Memorandum (PPM) and they charge $30,000-$40,000 on average for their services. Having a solid, compliant syndication is imperative to avoid costly mistakes and any violation of SEC guidelines that could result in a complete “disgorgement” or forfeiture of all profits.
I – Investors
Investors are known as Limited Partners or Members depending on the legal structure and will typically use this type of investment as one way to meet their passive income goals. Minimum investment amounts can vary greatly depending on the type of syndication (Multifamily, hospitality, retail, industrial, etc.). Any number of accredited investors can take part in private placements and but participation by non-accredited investors is limited to no more than 35. Also, it is important for investors to know the sponsors and vice versa. Because of the no-solicitation rule, the deals are put together based on personal relationships where deal sponsors and passive investors know one another.
V – Verification
Potential investors may be asked to respond to a questionnaire and submit various financial documents to verify their qualification as an accredited investor such as account information, financial statements, tax returns, W-2 forms, credit reports, and letters from reviews by CPAs, tax attorneys, investment brokers, or advisors. Anderson Business Advisors Tax professionals will do an accredited letter of verification for clients based on income but not on the net worth calculation. Issuers or investors can also complete verification through verifyinvestor.com
E – Evaluate
It is imperative for investors to properly evaluate both the sponsor and the deal. There are unfortunately too many people ready and willing to take your investment dollars and are unqualified or simply incapable of handling the job. Investors should focus on who is running the syndication and their experience and be comfortable with them and their ability to get things done. In other words, focus on the jockey and not the horse. Do not just choose an investment opportunity because it promises the highest returns, the lowest fees, and the highest profit. Just like an iceberg, you can see the tip but you may be unaware of the enormous mass under the surface and that’s where the danger lies. In these types of investments, it is important to build relationships and invest with people that you trust.
If done properly, investing in real estate syndications can be a great way to invest, diversify your portfolio and generate passive income.
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