Are you ready to start a real estate syndication? What’s the best structure and how will you ensure you and your investors earn a profit? There are plenty of ways to structure a syndication and regulations to follow along the way. In this episode, Aaron breaks down the benefits of different syndication structures and how a sponsor can structure a win-win for their investors. Be sure to listen to this episode before deciding if running a real estate syndicate is right for you.
00:00 Real Estate Syndication Structure
00:53 Legal considerations
06:17 Will there be Security
07:44 Compensation structures
10:24 Ownership and compensation
12:00 Preferred returns
15:05 Don’t Bite off more than you can chew
Aaron Fragnito: All right, ladies and gentleman. Welcome back to the Passive Cash Flow Podcast. I’m your host Aaron Fragnito, and we’re going to talk about Real Estate Syndication Structure today. This is for individuals looking to possibly start a real estate syndication. They look pretty cool. A lot of these guys are riding around in fancy cars, Bentleys, and Ferraris, and some of them have jets, and they live these glorious lifestyles.
The truth is, it’s actually a lot of work to run a real estate syndication, but we’re going to break into the structure of it. A day in the life of a real estate syndicator, and what that really means and the decisions you need to make as a real estate syndicator here on the Passive Cash Flow Podcast.
All right, so the first thing you want to do when trying to become a real estate syndicator, or considering starting a business in this space, legal considerations, right? How are you going to structure the syndication? That’s really what a real estate syndication is. It’s a legal structure that allows passive investors to partake in real estate opportunities that they normally wouldn’t have the opportunities to invest in. Maybe you found them off market, you’ve put together the pieces, the contractors, and realtors, and banks, and other investors to make this a reality, but how are you going to structure it?
The SCC actually regulates how you can solicit other investors, the relationships you have to have with them, the disclosures you have to have. Without the right legal considerations for your real estate syndication, you’re really not going to be able to structure the right way. You want to talk to an SCC attorney. They can usually guide you on how you’re going to develop your real estate syndication.
Which type of legal entity is right for you, right? Is it a limited liability, an LLC, a limited partnership, a C Corp, an S Corp. There’s other tax advantages as far as I’m concerned with limited liability companies. We tend to do LLC’s here at Peoples Capital Group, and we offer passive ownership of those LLC ownership to passive investors. That allows us to have the control of the business, control of the property, make the day-to-day management decisions. Also have those investors protected, and get all the tax benefits and legal benefits of owning an LLC without having to make all the day-to-day decisions. That’s our job as real estate operators.
What’s the right structure for you? Talk to your CPA, talk to an SCC attorney, and you can determine ideally the right structure for your LLC or LP, or C Corp, or S Corp, or something different, of course. The general partners, now, their job is to acquire the financing, find the opportunity, make sure the due diligence is completed properly on the opportunity, and basically run everything from A to Z. Manage the management company. Make sure the other investors are there, and the bank is there at closing to make sure the deal closes, and the property goes as planned through the project and the renovation.
It’s very important that the operator knows what they’re doing if you are trying to create syndicate, and you don’t have any real estate investment experience. You want to work with people that do, of course. That might not be the right business for you if you don’t have any experience. Really the name of the game is knowing what you’re doing when you’re buying an opportunity. See I can’t bring the wrong opportunity to my investors. My job is to find a good opportunity. A discounted piece of real estate that has value add.
Maybe we can renovate some of the units, and get more rent for those units. We can work with some of the existing tenants. Renegotiate those current leases, and do renovations to their apartments and make it a better living environment, and then in turn get higher rent for those units. This is going to allow our investors to make more cashflow and allow us to do the refinance, and hit those marks that we put out to our investors. Those targets that we put out to our investors before they even invest in the opportunity when they’re researching the opportunity for themselves.
There’s a lot of moving pieces. You have to know what you’re doing to be able to achieve those marks long-term working with the management company, but also short-term. Identifying the opportunity, red flags, and challenges you’re going to have along the way, so you have to know real estate. You have to know how to manage these projects as well, and work with people that have experience in the space.
Who are the investors, right? Sponsors? That’s what they’re also called, the passive investors. You want to identify who your sponsors are going to be ideally before you find a project. You don’t want to build the airplane in the air as they say. See, I’m always communicating with investors. Whether I have a deal right now to fund or not, because it doesn’t always work perfectly. Seth and I will be looking for deals off of the years, a year. Sometimes we’ll find something two deals at once, and we won’t find something for six months, eight months, and then we find two great opportunities we need to fund quickly.
You always want to have your relationships in place with your investors. You want to be performing and also communicating on current projects, and what’s upcoming, what you’re looking for. You want to identify your investors goals, and of course work with your passive investors to find them those types of opportunities, right? Are they shorter term investments or longer term. Are they focused on tax benefits, or maybe cashflow.
Identify what you plan on putting in front of your investors, and then make sure your investors are looking for those types of opportunities, and build those relationships for long-term. Someone’s not going to invest in you if they just met you, or maybe just read something on your website. You really have to continue to build that value, continue to build that relationship.
I’ve been doing this 10 years. We’re not a one-stop shop. We really focus on making sure our investors have a good experience investing with us long-term. Making sure that people can get access to apartment buildings, and different types of real estate investment opportunities in New Jersey that are professionally managed, and continuously give our clients the right type of service, right type of professionalism as well. That’s going to allow them to continue to come back and invest their money safely in New Jersey assets.
You want to create a good environment for your clients, for your tenants, and for all the people that work with you. You want to be easy to work with as well, so just a general rule of business there also.
Here’s another question when creating a real estate syndication, and how we structure these. Will you offer a security? The Security and Exchange Commission regulates selling a security. Quite frankly, if you’re creating a real estate syndicate. You’re probably selling a security. If you’re offering non-voting ownership of LLC, that my friend is a security. You don’t have to have a license to sell that. You do to sell a security, but you need to build a relationship with individuals, and have private ownership that you’re offering. If you’re offering a non-voting ownership of an LLC, then that is a security.
You want to make sure you have the right things in place to protect yourself and protect your investors. The private placement memorandum is a common document you might find yourself needing. An offering memorandum, and of course an operating agreement for your LLC if that’s what you’re creating to buy these properties and your SCC attorney.
Really, most attorneys can help guide you in this place. Corporate attorneys are good for understanding the corporate structure. SCC attorneys are great for understanding the SCC regulations, and how to abide by those rules and regulations. Essentially, make sure your CYA cover your ass of course. Make sure you have all the right documents in place, so that in the event of not performing on the syndicate, of course are not open to sue from your investors. Making sure that you have the right engagements with those investors, and you’re not soliciting incorrectly for that capital.
Compensation structures, so how are you and your investors going to earn a profit? How are you going to build your wealth? That’s the whole goal, right? To build your wealth, earn cashflow, get tax benefits. Here we have, of course, how do the sponsors get paid? We have an acquisition fee. Peoples Capital Group does charge an acquisition fee because quite frankly, it’s so much work and money to get a large apartment building to a closing table. To get a real estate syndication to a closing table.
You have to line up all the capital. There’s a cost to that. Have the relationship with the bank in place. Of course, there’s a cost to getting the loan in place, and all the fees there, and due diligence cost. Of course, there’s a ton of marketing just to find the deal. Have the relationship with the broker, or the wholesaler, or the landlord that brings you the opportunity. Because of that, we generally charge between a 1% to 5% acquisition fee. That’s pretty common place for real estate operators, real estate sponsors to charge.
You also have an asset management fee. Now, Seth and I– Here at Peoples Capital Group actually don’t charge an asset management fee, and that really is quite different than what I’ve seen out in the space. Most real estate syndications make their money, their primary income through asset management fees. They charge a percentage of assets under management, AUM, and that’s fair. You raise a million dollars, you charge 3% of that every year, and that’s how you make your money, and you give away more equity because of that perhaps.
We don’t really believe in the structure. We think you should get paid when you perform. Not just if you raise a million dollars, you get paid forever. You should get paid on performance. Seth and I don’t charge an asset management fee. We instead take a little bit more equity perhaps than your other companies. We believe instead of charging a management fee, we don’t like the fee-base structure. We believe in equity. We want to get paid when we perform. If we perform, then we do make a profit.
Of course, we have the refinance fee. Now, Seth and I don’t charge here at Peoples Capital Group. This is a fee to refinance the property. There is a lot of work involved in refinancing. Often, you may have to personally guarantee the debt as an operator or a sponsor, so you want to make sure the risks there. Because of that, operators charge refinance fees. Also, a disposition fee. Sponsors can charge a disposition fee.
Now, we don’t do that here at Peoples Capital Group. That’s when you’re selling the property. That’s the sale for the cost of exiting the property. It’s a lot of work to get a property ready for sale, to boost that value up through the renovations and projects you’re doing, so it can be fair for a sponsor to charge a disposition fee. However, here at Peoples Capital Group, we limit our fees to simply an acquisition fee.
Ownership and compensation. You want to understand how much LLC ownership or company ownership are you going to retain, how much company ownership are you giving out to your private investors, the individuals generally bringing the capital to the table. You can do a clean split where perhaps it’s just simple ownership, 70-30, investors owning 70%, Peoples Capital Group owning 30%. That’s a pretty common structure we’ll see here at Peoples Capital Group as the dust settles on our acquisitions and our offerings.
You can also see different types of splits out there. On bigger projects, it could be a 50-50 split. Ground up construction where there’s maybe a lot of day-to-day operations or a lot more risk for the operators perhaps. Maybe you want to do a 90-10 split where the investors are getting the majority of the profits and you charge more of a fee-based structure. That will allow you to ensure you have more of an income incoming in but in those big wins, your investors are going to do quite well and you might not do as well.
You want to make sure that you have a fair split that makes sense to everyone. You want to make sure that at the end of the day, a performance is rewarded and risk is rewarded as well.
Those investing have to be properly protected and properly rewarded, but also those running the operation have to have a incentive to do very well. That’s how we like to structure our operation here at Peoples Capital Group. Not really fee-based structure, more of an equity structure where we have to do well, we have to hit that mark to earn our returns. If we do, we earn a profit but if we don’t make those returns, then we have to make sure they happen, so we could put food on our plate.
Preferred returns. This is a great way to make sure your investors get paid first to protect their investment capital and protect their return on investment. A preferred return on investment might be generally between 6% to 8%. This means that the first positive cash flows of the property after all the expenses are paid will go to the investors so that they get their preferred return on investment or on a sale of a property, they’re going to get the profits as well so they get their preferred return on investment. Then what’s remaining left over will be split up according to the equity split of the company.
You also have distribution waterfall. This means that as the property pays out, the return of capital will be paid in different ways. Sometimes the profits can be paid to investors first, return of capital can be paid, so we want to understand the difference of return of capital and also earning a profit. When you’re paying back someone’s capital, you’re paying back their initial investment. There’s tax benefits to that. You’re not being taxed on that money given back to you. It’s called an ROC, return of capital.
A preferred return, that’s generally paid out based on profit, so this is going to be taxed, generally. You want to make sure your investors understand this. GP catch-up, that means that your investors are getting paid a distribution initially and then you’re getting paid after they’re getting their agreed amount back.
There’s lots of things to consider when creating a real estate syndicate. How are your investors going to be protected? How are you going to be protected? How are you going to work with all the different people involved, the banks, the realtors, the management company, the investors? How are you going to make sure that all these moving pieces are properly compensated and properly protected?
Now, at the end of the day, the most important thing is you create a win-win structure for everyone so your investors understand the value of what you’re bringing to them. They understand that you’re going to do everything in your power to make sure the project works out and you’ve taken the steps to put those people in place to make sure it works out. You don’t have to be the best project manager in the world. Maybe you hire a project manager that’s really good at that. You don’t have to be the best market expert either but you might have a realtor or a market analyst, an analyzer, that can help you with those places.
The banking end of it. Your bankers are going to guide you a lot there but you really have to have the relationship with people that want to invest in you, that trust you. Quite frankly, it takes time to be a good sponsor, a good operator, and a good real estate syndicator because you have to have a track record and you have to perform over time and have integrity over time. If you don’t and you have deals that go south, and you don’t, at the very least, make good to your investors and make sure that they made the returns that you were targeting in the beginning– See, it’s okay to make mistakes but make sure you right that check at the closing table so your investors don’t lose money. You’ll lose money sometimes but make sure your investors don’t.
The most important advice I can give you is don’t bite off more than you could chew. This is a serious business. You’re signing the dotted line for a lot of debt, you’re taking other people’s money often their retirement funds and you’re putting it to work in real estate, so if you don’t know what you’re doing, keep learning, keep working in the space, keep taking advantage of all the free information out there, especially our website PeoplesCapitalGroup.com, and maybe get involved in a deal. Get invested with a sponsor. Get invested with a real estate syndication out there that you’re impressed with, that you like, that you trust. Learn from them.
See all the documents they use. See the way they communicate with their investors, the way they move investment from an idea, an offering memorandum to a reality, pooling the capital together, getting to a closing table, completing a renovation, improving the management of the building, and recognize how they do that, learn along the way, make those profits with them, and then when you’re ready, perhaps start a real estate syndication yourself.
That’s my best advice I can give you. I’m Aaron Fragnito of Peoples Capital Group. Hope you enjoyed our podcast here today about Real Estate Syndication Structure. Enjoy your day. Please hit the subscribe button. Go to PeoplesCapitalGroup.com to enjoy more content here and all types of information about real estate investing and fill out a qualification form if you’re ready to get invested and qualified with Peoples Capital Group. Have a good day.