Real estate syndications are an excellent way for investors to collectively invest in large real estate projects that a single investor could not afford or run on their own.  It is also a great way to invest passively in real estate without doing the legwork of managing your property.

Passive investors can generate cash flow from their investment. For example, they can receive monthly or quarterly distributions with potentially higher returns after the team sells or refinances the property. It is possible to generate passive income because the sponsor (active investor/ general partner) of the investment is doing the work of evaluating the property, securing financing, and managing the property’s daily operations.  This allows the passive investor to leverage the knowledge, expertise, and capital of the sponsor team.

When considering investing in a real estate syndication, it is important to perform due diligence about the deal, the sponsor, the business plan, and the profit split structure. This will help find opportunities that fit your financial goals.  These tips to look for are good ways to compare different deals.

1. The Sponsor

Since this is a passive investment, the sponsor team of a syndication plays a crucial role in the partnership.  Look at the track record of the sponsor team in acquiring and managing a similar investment.  Such a track record will help you feel comfortable that the sponsor exhibits sufficient knowledge about the market and asset class they are investing in.

A good sponsor is transparent, communicates well with their investors, and has their investor’s interests in mind.  You may want to ask how often they share updates and how they have aligned themselves for their investors’ interest in the past.

2. Business Plan and Exit Strategy

Before investing in a real estate syndication, it is important to understand the sponsor’s business plan and strategy since they will be the ones who make critical decisions about the investment.  This is helpful in evaluating if the investment is a good fit for you.  Is there expected cash flow early on or later?  Does this match your goals?

Understanding the investment duration will allow you to determine if the investment is a good fit and matches your investment goals.  One thing to always keep in mind for a syndication investment is that the expected hold period may not always match up with the hold period that ends up happening.  Market conditions can change and the sponsor team should react accordingly.

For value-add deals that require renovations, you want to know the execution plan, projected costs, and schedule.  If the upgrades are intensive or the property is in bad shape, there may be more risk involved.  There could also be a delay in cash flow if there are large renovations underway at day 1.  The renovation schedule can delay the initial cash flow.  This should all be transparent upfront.

By the nature of syndications, it is harder to liquidate your principal as compared to the stock market for example.  It is important to understand the different exit strategies before investing.  The investment packet normally outlines the most expected exit strategy, but a strong sponsor team already has contingency plans if that exit strategy is no longer the best option.

3. Asset Management

The sponsor is responsible for managing the asset in a real estate syndication.  Understanding how they plan to operate and improve the property’s operations and plan to implement them over time can be useful in making an investment decision.  Does the plan make sense?  Do the projected rents make sense and have they shown reasonable comparable rents?

4. Profit Split

In syndications, the profit split will vary depending on the type of investment, risk, and the hold period.  The profit split will be an indicator of how a sponsor values their investors.  We have another blog post that digs more into the types of profit splits, but the TLDR is that there should be an alignment of interests.

Both the sponsor and the passive investor should make money on the success of the asset.  A red flag is that the sponsor makes money even when the asset is not performing.  Conversely, another red flag is that the sponsor does not make money when the property is successful.  The best deals have alignment of interests between the sponsor and the passive investors.  Make sure you review the partnership agreement thoroughly to understand the profit split structure.

5. Investor Communications

Before investing in a deal, ask how often the sponsor team communicates with investors.  Do they give updates monthly, quarterly, or only when an investor asks?

Personally, I like to receive updates without having to ask for them on a monthly or quarterly basis.  This was particularly top of mind when Covid started.  What safety precautions is the team making to ensure the residents are safe?  What adjustments to the plan are they making now that renovations are halted?

Understanding the communication expectations upfront will help you decide if you want to partner with this sponsor team.  Updates often come in the form of an email.  It can include any issues or successes they have encountered and how they have addressed them.  Having an open line of communication is crucial.

Investing in a real estate syndication can be an excellent option for many real estate investors. Still, passive investors need to perform up-front due diligence before making a decision. You should evaluate the deal’s pros and cons to determine if it aligns with your investment goals and risk tolerance.

If you enjoyed this post and picked up a few helpful tips but want to learn more about getting started investing in real estate syndications, click here to schedule a call with us.