At its most basic, a syndication is a group of investors coming together to partner on a real estate investment. From that perspective, it is like you getting together with your friend to buy a rental property down the street. However, the deals are much bigger (typically, syndications are used for commercial real estate with purchase prices well over $1M) and the people coming together don’t necessarily know each other well. To make sure everything runs smoothly, it is important that everyone understands the role they have to play in the deal, that the details of the deal are understood by everyone, and everything is well documented so expectations are clearly defined. As a result, the process, rules, and documentation required are more complicated than what you would see if you were doing it just with your friend. In fact, for most syndications, there are SEC rules that must be followed because of the passive nature of some of the investors. While this can seem intimidating the first time, it isn’t that hard to learn what you need to know – especially once you have a team established.
Before we get into the documentation (part 3), it is important to understand what the primary roles in a syndication are (this article) and whether or not you are a good candidate for this type of investment (part 2) as there are pros and cons with syndications that mean that they are not a good fit for everyone.
There are two major roles that an investor may play in a syndication: General Partner (GP) or Limited Partner (LP).
The GPs or sponsors are the team responsible for finding and executing the deal. There are generally only a small number of GPs on any given deal, although they may have larger teams supporting them behind the scenes. The GPs makes all of the decisions about the deal – they determine the structure of the company and hire lawyers to create the legal documents, find the property, determine the investment strategy, negotiate the loan terms, bring in equity investors (LPs), and select the operator who will manage the property (or they manage the property directly). Once the property has closed, they determine what renovations or updates are required, manage contractors to do repairs, and handle any unexpected issues that come up. They also decide what distributions are made to investors and define how and when the syndication will exit – for example, when the property will be sold and what price to accept. A specific GP may be involved in only one or two of these functions, or they may cover all of them, it depends on the size of the team and the individual’s skill set. Because the GPs control all aspects of the deal, they are the single most important factor in determining whether or not the syndication is successful – even more important than the property. And having a GP that communicates with the other investors regularly is important – everyone wants to know what their investment is up to. I will talk more about researching the GP in a future article, but unless you have complete confidence in the GPs managing the deal, you should not be investing with them. There are plenty of other sponsors out there, so be selective.
The Limited Partners (LPs), or equity partners, provide the capital required to make the deal happen. They have decided to provide cash based on their analysis of the deal, based on the information provided by the GPs, and expect a return on their investment over time. However, the LPs have no say in the management of the syndication or the property – they are strictly silent partners in the deal. A GP may also invest in the syndication as an LP, but as a general rule, LPs do not have the option to become GPs on a deal unless they are already involved.
You should expect to be an LP in any syndication you are involved with – if you are looking to be a GP this blog is probably not the best place for you as it isn’t going to go deep on that side of things :). The remainder of this article and most future articles are written for an audience of LPs.
Next week, I will talk about what you should consider when determining if your investment philosophy aligns with syndications or not.
If you have any questions about this post, please email them to me at terence@mbc-rei.com, I will reply to the questions that are straightforward and will turn the questions requiring more detailed answers into future blog posts.