What is an Apartment Syndication?

When a group of investors pools their assets to buy a large piece of real estate, this is known as a syndication. Apartments, mobile home parks, land, self-storage units, and other real estate assets are acquired through real estate syndications.  Apartment or multifamily syndication is often used to buy large complexes or communities that would be too difficult for the individuals to buy and run independently, allowing them to pool resources and share risks and benefits.

In every real estate syndication venture, the two most significant players are the sponsors and passive investors.   The sponsor or general partner (GP) raises money (typically referred to as capital) from qualified investors.  Those investors are typically limited partners (LP) on the deal because they take a passive role in the project.

Investing passively in apartment syndications is perfect for someone that has capital to invest but lacks the time or desire to acquire and manage the property.  When passive investors partner with a sponsor in a multifamily syndication both groups can benefit from owning an investment property, sharing in the cash flow, appreciation, and tax deductions.

Apartment Syndications Types

There are two primary structures to a syndication.  Because syndications are taking private placements from investors, these projects must follow regulations set forth by the Securities & Exchange Commission (SEC) referred to as Rule 506(b) and Rule 506(c). One significant distinction is the type of person who can invest in each offering type. 506(c) is solely for accredited investors, 506(b) offerings can take up to 35 unaccredited (also referred to as sophisticated) investors.

This article defines the differences between accredited and non-accredited investors in more detail. 

Suppose the general partners are making a 506(c) offering. In that case, they must have a third party validate each investor's accreditation status, which entails reviewing tax returns or bank accounts, verifying net worth, or getting written certification from a broker, attorney, or accountant. Additionally, the general partner is permitted to publicize the offering and accept only verifiable accredited investors under Section 506(c).

The general partners are not required to verify the accredited investor's status with a third party if they undertake a 506(b) offering; the passive investor can self-check whether they are accredited or sophisticated. In addition, to show that the general partners did not solicit the 506(b) offering, which is not allowed by the SEC, they must have documentation of a pre-existing, substantive relationship with the passive investor before opening up the investment opportunity.

Significant Parties Involved In Apartment Syndications

General Partner

The general partners (GP) come first in an apartment syndication and have complete responsibility of the project from purchase to sale.  This team is ultimately responsible for the outcome of the entire project because they manage the day-to-day operations of the company. The GP is also known as the sponsor or syndicator in an apartment syndication.

The general partner is in charge of selecting a target investment market, hiring team members, obtaining funds from passive investors, and overseeing the entire apartment project from start to finish.

While the general partnership could be just one person, it is more likely that the general partner will be several people. One member of the general partnership may be in charge of investor relations and capital raising; another member may be in charge of acquisitions and asset management; one member with a high net worth (known as a Key Principal (KP)) may sign on the loan. In some cases, the property management firm or attorney could be a member of the general partnership as well. In other words, there are many ways a general partnership can be structured to effectively manage the project.

General Partner Compensation

The general partners receive compensation for their work putting together and managing the deal.  This compensation structure varies based on the deal, it’s projected returns to investors, the experience of the GP team among other factors.  Below are the most common forms of compensation.

Profit split: The GP will organize the split of profits from the apartment syndication which can range anywhere from a 50/50 split to 90/10 (LP/GP) split, although the most typical is 50/50 for experienced GPs and 70/30 for less experienced, newer GPs.

Acquisition fee: The acquisition fee is a one-time payment made to the GP at the time of the loan closing. Depending on the size, scope, experience of the GP, and profit potential of the sale, the fee ranges from 1% to 5% of the acquisition price. The acquisition fee is comparable to a consultancy fee paid to the general partner for the effort done behind the scenes to put the deal together.

Disposition fee: The disposition fee is a one-time payment made at the sale of the asset that typically equals 1-2% of the property sale price and is calculated before the profit split between the LPs & GPs.

Asset management fee: The asset management charge is a recurring fee given to the GP in exchange for supervising the property's operations and putting the business plan into action after the deal is closed. The price is calculated as a percentage of the collected income (1% to 3%) or on a per unit basis each year. The magnitude of the percentage collected is determined by the amount of work required to implement the business strategy and the GP's level of experience.

Limited Partners

Limited partners (LP) are another critical player in apartment syndications. The LP, also known as a passive investor, is only liable for their ownership stake.

They have no influence over the business plan in any way. It is an entirely hands-off investment, except monitoring investor reports and filing taxes at the end of the year.

Most commonly the limited partners are a group of investors that fund the equity (down payment on the loan, construction & renovation costs, etc) for the project.  In some cases the limited partnership could be comprised of one or only a few high net worth investors that receive a large stake in the deal as compensation for taking an increased risk position on the deal.

Apartment syndications typically compensate their limited partners in three ways.

Cash on cash return: Returns paid to the investor as a percentage of the amount of capital invested in the project.  In addition, many sponsors offer a preferred return (also called a pref) which means the LP gets paid before the GP gets paid. A typical cash on cash/pref ranges between 8% - 10%. A preferred return motivates the GP to achieve or exceed the business plan because their pay is at risk in order to ensure the limited partners get their return.

Refinance or additional loan proceeds: The LP will generally receive a payout equal to a percentage (or in some cases the entirety) of their initial equity investment if the GP refinances into a new loan and gets a supplemental loan.

The proceeds from a refinance or supplemental loan are often considered a return of capital, as opposed to a return on capital.

Profit split at sale: When it’s time to sell the property, the remaining profits after all expenses and fees are paid is shared between the LP and the GP. As previously stated, profit distributions typically range between 50/50 and 70/30 (LP/GP) split.

Property Management Company

The property management company is one of the most critical team members on the project. The primary responsibilities of the property management firm are to oversee the day-to-day operations of the apartment community and carry out the GP's business plan. A great property manager, on the other hand, will provide additional services such as assisting the GP during the due diligence process, inspecting the property and its operations to generate reports along with helping the GP finalize capital expenditures and ongoing budgets.

In apartment syndications, the property management company is often compensated in three ways:

Management fees: Ongoing management fees are the primary source of compensation for property management companies and can range from 5% to 10% of the monthly revenue collected through rents, service charges and fees. In addition, the property manager may charge lease-up costs, renewal fees, eviction fees, application fees, marketing fees, referral fees or other fees incurred on behalf of the GP that is not covered by the ongoing percentage-based fee.

Construction management fee: The property management company may oversee the renovations for an additional cost if the business plan includes interior and exterior modifications. Typically, the fee is a proportion of the total capital expenditures budget, with the cost being lower for larger projects.

Equity ownership: As previously stated, the syndicator may provide the property management company an equity part in the GP in exchange for a lower ongoing management fee and as motivation to meet or exceed the business plan. Furthermore, suppose the property management company brings in its own investors or directly invests in the deal. In that case, they will almost certainly obtain an ownership part in the GP and LP based on the equity they secured and contributed.

Commercial Real Estate Broker

The commercial real estate broker is another crucial player in apartment syndications. A commercial real estate broker actively seeks out apartment deals in a particular market. When a transaction is found they create a marketing package (i.e., an offering memorandum) and put it on the market for sale or offer it off-market to GPs with which they've previously worked. A commercial real estate broker oversees the offer process, which typically includes one or more calls to offer and a best-and-final round of offers. The commercial real estate broker ensures that the deal reaches the closing table once awarded to an investor.

In apartment syndications, the commercial real estate broker is compensated with a commission earned at the closing of the sale of the property.

Commission: The majority of fees received by commercial real estate brokers come from closing an apartment community in which they represent the buyer and seller. The charge varies by broker and market, but a decent rule of thumb is between 3% and 6% of the purchase price for apartment communities under $8 million and a flat fee of $150,000 for apartment communities exceeding $8 million.

Real Estate and Securities Attorney

Attorneys are the fifth important player in apartment syndications. Real estate and securities attorneys are the two primary specialty attorneys involved in a multifamily syndication.

The attorneys are in charge of drafting and approving all contracts. The four critical contracts required for apartment syndications are the purchase and sale agreement, the operating agreement, the private placement memorandum and the subscription agreement.

Apartment syndication attorneys earn money by preparing the four central contracts and agreements listed above. These contracts can cost from a few hundred dollars to tens of thousands of dollars, depending on the size and breadth of the business and the GP/LP partnership structure.

 

Conclusion

Investors should ultimately know, like and trust the syndication partner and understand their level of experience before investing.  Here are 20 questions to ask an apartment syndication team when evaluating whether to work with them.

It's critical to form relationships and invest with people you can trust on an apartment syndication project.  Do not choose an investment opportunity only on the basis of it promising large returns, a deal is only as good as the team that is managing it.

Investing in real estate syndications can be a wonderful way to diversify your portfolio and generate passive income when investing with the right sponsorship team. We can talk you through the process for investing in apartment syndications, simply schedule a call or join our investor list.