What is a Real Estate Syndication?
received a question recently when I was speaking at a conference in Las Vegas. A doctor came up to me and asked, “Hey, David, I'm getting ready to get involved in a real estate syndication, but could you explain what a syndication is?”
Well, I’m glad that he at least asked before he jumped into a real estate syndication.
A real estate syndication is a group of investors pooling their money into an LLC entity, each having member shares managed by a manager or a sponsor (also called a syndicator) who is then on the forefront of acquiring a certain asset. A few examples are a multi-family apartment house, self storage, or a mobile home park community.
How it works, in a nutshell, is that the aggregation of all the capital plus the debt that the syndicator will take on from a banking institution will create the acquisition price. They’ll have some kind of value-add to the investment and they’ll give a prognostication to the investors of what their returns are expected to be.
In a syndication you’re investing in a single asset, but you're not doing the work and you’re not going to own it. You’ll have a member share while someone else is going to do the work. Now, you better know who that somebody is and make sure they know what they're doing. That's my key piece of advice today.
Real Estate Syndications have been around for a long time
and, like anything, when we get late in the market of any cycle, all kinds of people will be out there syndicating.
But why exactly would someone want to be a syndicator? Because when there's a lot of money chasing yield, it's easy to raise capital and find investors, particularly when the stock market is not doing so well. People say, “Well, I need to run to real estate because real estate's been really good for the last 5-10 years.”
And it has, but real estate is also susceptible to the market cycles, just like the stock market. It's just that people don't understand the correlation. Certainly, we can be a lot more prudent about how we invest in real estate (even during a market correction) but the key is who is doing that for you?
If you're investing in a real estate syndication, you are depending upon that syndicator's track record, their knowledge base and whether they have the discernment or scrutiny to understand where we are in the market cycle.
These factors are important to consider so that they’re not just putting your money (your hard-earned money) into something that maybe worked two or three years ago when the market was different as opposed to where we are today, rolling into a recession with higher interest rates.
It's going to be a different ballgame.
There are a lot of people in different market niches (dentistry is one of them) who have created a community or online tribe, and then they connect with people in the real estate space and tell that real estate sponsor, “Hey, I've got a tribe of people over here. They’re doctors or dentists who really want to get into real estate. I can help you raise the capital because these people know me and I do a lot of marketing. If you, as the syndicator/sponsor, cut me into the deal then I will market what you’ve got into this group.”
Well, there's nothing illegal about that, but what's in it for you? Who has real skin in the game? Who cares about your money?
See, that's the problem most of these real estate syndications have.
No one cares about your money. Oh, they'll tell you they do. They'll tell you they do the best they can. That they've had a great track record for the last four or five years. I get all that. But what about going forward?
Syndicators have to keep the deals rolling because that's how they make their money. They make money off of front end fees, commissions, and management fees. Certainly, if the deal goes well to fruition, they make some additional money. But if the deal doesn't go well to fruition, they still made their money on the front end and they could, unfortunately, care less about you.
Be careful when signing up for a syndication with a syndicator who tells you they've done X, Y, Z over the last several years. Have they underwritten properly for the market we're in right now?
I look at a lot of them all the time, and most of them are missing the mark and making some big mistakes in their pro formas, i.e. their prognostications. You, the passive investor, have no knowledge and no control over this.
You're in it for the long run and if it's not a good deal, or it’s a very poor performing deal, you've got no recourse. It's just the way it is unless they commit actual fraud.
I'm not saying these people commit fraud, but I think they're close to being negligent in terms of not doing the proper due diligence and underwriting of their deals. Why don’t they? Again, the money's coming at them and they have to put it somewhere to continue to make their money.
For most of us in our group, in Freedom Founders, we're taking a big pause right now. We're watching this market turn. Why do we need to keep our money in something when the gamble is high? The odds are high that the equity markets are going to continue to take a tumble.
There will be a right time to buy back in. But is that now? Maybe yes, maybe no. In most cases, probably not, but how would you know? You won’t, unless you have a network of people who have been doing this for decades, who have been through downturns, and who know what to look for.
To your freedom!
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