Real Estate Syndication Structure Types & How They Work
Real estate syndication is one of the best ways to enjoy truly passive income as a real estate investor. Once you invest your money into a reputable syndicate, there is nothing for you to worry about other than cashing your regular dividend checks. Many investors opt for syndications because the person overseeing the syndicate (known as the syndicator or the sponsor) generally has a proven track record in real estate investing. When you invest in a syndication, you’re really investing in the person who is leading it. Their success is your success. However, it’s just as important that you fully understand different syndication structures so you can make the best decision for your own financial future.
506(B) syndications are often referred to as “friends and family” syndications. Under this syndication structure, sponsors are allowed to raise money from an unlimited number of accredited investors while also allowing up to 35 non-accredited investors to put money into the syndication. The only catch is that the sponsor has to be able to prove that he or she had an existing relationship with each of the investors. In order to ensure that this rule is followed, there are advertising laws that govern 506(B) syndications. In fact, there is no advertising of any kind allowed. Instead, the sponsors can only contact people with who they already have an established relationship with to seek funding.
506 C syndications are only open to accredited investors. Accredited investors are those who have met personal or joint net-worth or annual income requirements with a spouse or if they are a general partner with the company that is issuing an unregistered security. 506C syndicates are much easier to find because there are fewer advertising regulations in place that limit the number of people who may find out about the syndicate. However, if you do not meet the SEC’s criteria for recognition as an accredited investor, you will not be able to invest in this type of real estate syndication.
Straight splits are probably the most simplistic real estate syndications to understand. As the name suggests, straight split syndications use the same split for all returns across the board. For instance, if you invest in a straight split syndication that is structured as an 80/20 split, 80% of the profits go to the investors who have put money into the syndication while 20% of the of the returns go to the syndicator or syndicators who have headed up the investment. This structure is generally preferred by investors since they can forecast the amount that they can expect in their returns.
Investors in real estate syndications also like waterfall structure syndications since it gives them priority over the sponsors when collecting returns. Waterfall structure syndications rely on the principle of preferred return when giving investors their returns. For instance, if you invest in a syndication that uses a waterfall structure that offers a 9% preferred return, you and the other investors get access to the first 9% of the returns generated by the investment. To put it in layman’s terms, the investors get 100% of the first 9% of the returns. The sponsor (or sponsors) gets a piece of the return only if the returns are over 9%.
You may also want to find out if the real estate syndication that you’re investing in operates under the concept of blind pools. In a blind pool, you do not have any information about the properties that the syndication is considering. Instead, you are simply investing in the syndicators who are heading up the investment. During the 1980s and 1990s, blind pools developed a shaky reputation, as some people used them as a way to defraud people out of their funds. If you decide to invest in a blind pool syndicate, you should do as much due diligence as possible on the people heading up the syndication.
Investing in real estate syndications is a great way to increase your personal net-worth passively. Choosing a syndication that is led by proven, trustworthy industry professionals is an excellent opportunity to diversify your portfolio while ensuring that the financial needs of your heirs are met.