Apartment syndication is a structured way of pooling together money to buy large apartment building/s or communities and execute the project’s business plan.
Apartment syndication is quite useful because it allows investors, would normally be unable to purchase a large asset individually, to pool together resources and share the risks and returns that the asset generates.
The person tasked with raising the money is generally called the general partner (GP) or sponsor. The qualified investors from whom money is raised are known as passive investors or limited partners (LP).
In this guide, we will discuss the various aspects of apartment syndication. We will look at the various types of apartment syndications, the syndication process, the various parties involved in apartment syndication, the compensation of the various parties involved, and the qualifications of investors who participate in apartment syndications.
Who are qualified investors?
In order to participate in apartment syndication and become a limited partner, one has to first be classified as a qualified investor. Qualified investors can either be further classified as accredited investors or sophisticated investors.
Accredited investors are those investors whose annual income for the two most recent years is at least $200,000 ($300,000 for joint income with a spouse) or whose net worth exceeds $ 1 million. Note that the $ 1 million threshold cannot include the value of an investor’s primary place of residence.
Sophisticated investors are those who have reasonable knowledge about business, finance, and investing. They may not meet the requirements of an accredited investor, but they still have enough knowledge to be able to evaluate the merits and risks of any investment proposal.
The major types of apartment syndications
Apartment syndication most often involves the sale of private securities for a building or project by the general partner to the limited partners. These securities are sold under Rule 506(b) or Rule 506(c).
Rule 506(b): Rule 506(b) allows for unaccredited investors to participate. Up to 35 unaccredited (but sophisticated) investors can become limited partners in an apartment syndication project. Rule 506(b) also mandates that the general partner cannot advertise or solicit the deal.
Because of the second requirement, many general partners only work with accredited investors when selling securities under 506(b). That way, they can show that they got onboard investors whom they knew prior to finding out about the investment opportunity in an apartment building.
General partners need to show that they did not explicitly solicit investment from any of the limited partners.
General partners do not have to conduct any third party verification for non-accredited investors. In fact, the interested investor can self-verify that they are sophisticated investors and that they are capable of evaluating the investment deal.
However, if general partners choose to only work with accredited investors, then that verification is an addition to the rest of the processes.
Rule 506(c): Rule 506(c) allows the general partner to solicit investment and advertise the deal to the public. Rule 506(c) also mandates that only accredited investors can participate in the apartment syndication.
Hence, general partners have to independently verify if interested investors are indeed accredited investors.
Third party verification is carried out, tax returns are analyzed, bank statements are verified, and written confirmation from a certified accountant/attorney/broker is sought to establish that any interested party is classified as an accredited investor.
The process of apartment syndication
There are nine major steps in a typical apartment syndication cycle.
Step 1 – Select the target market
The first thing a GP has to do is figure out what market he/she wants to do the deal in. The research for analyzing markets can be done online or in-person by actually traveling to select markets.
Online research can be a starting point for short-listing locations and on-the-ground work can be used to go in-depth and really understand a market’s potential.
Step 2 – Putting together a team
After figuring out the target market, the next step is to assemble a team of skilled people who can drive the partnership work forward. The main people that the GP has to put in place are the Limited Partners (the investors), a property management company, real estate brokers, a real estate attorney, and a securities attorney.
It is crucial for the GP to get a verbal commitment from potential LPs on how much they are willing to invest in the syndication deal. Such a commitment gives the GP an idea of whether the business venture is worth pursuing.
Having funding commitments also strengthens the GP’s hand when he/she sets out to speak with mortgage lenders, potential property management companies, and brokers. It also gives the GP an idea of the size of the deal that he/she should be chasing given the availability of funds from LPs.
Step 3 – Finalize deal, underwrite, and make an offer
Once the GP goes over multiple deal options with the broker, he/she needs to finalize the best deal. The process of analyzing the financials and ascertaining the intrinsic value of the property is also known as underwriting. It involves carefully analyzing various aspects of the property such as the location, the number of apartment units, the age of the construction, and any value-add potential.
The basic idea is to understand if these parameters meet the investment criteria of the GP. Various historical trends and data are used along with rental comps and other assumptions to prepare a financial projection for the property.
Based on the cash flows that the GP feels the property can generate, an offer will be made for acquiring the property. If the offer is accepted, then the deal is placed under contract.
Step 4 – Due Diligence
Now that an offer has been made and the deal is under contract, the clock is ticking. The GP would normally get anywhere between 60 and 90 days to conclude all legal and business due diligence on the property.
Due diligence is the time to verify if the underwriting assumptions are in fact correct. This is also the time to finalize the future business plan for the property.
Step 5 – Secure investments from LPs
As the due diligence process happens, the GP will schedule a call with all passive investors or LPs and get a firm commitment from each one of them regarding the investment in the property.
The due diligence report and financials are presented to the LPs and funding for the property is secured. This is the time for LPs to decide whether the opportunity is right for them and whether they would like to commit money to the syndication partnership.
Step 6 – Secure mortgage
Since syndication deals involve large apartment properties, LP money may not be enough to cover the funding requirements for the entire project. In many cases, the majority of the funding is provided by a lender.
Ideally, the GP would have already spoken to a few lenders before making an offer for the apartment property. During the due diligence phase, the GP will work towards completing the process of getting a lender onboard.
Step 7 – Complete the transaction
After completing the due diligence and securing funding, the GP will sign the acquisition deal and take over the property.
Step 8 – Execute the business plan
This is the time when every stakeholder in the syndication performs his/her duties. The GP will manage the entire operation. The property management company will run the day-to-day operations and help with marketing and leasing.
The LPs will remain passive investors and become active during regular update meetings. The attorneys will help with the tenant agreements. The rental income will provide the projected cash flows which will hopefully meet the return requirements of the GP and the LPs.
Step 9 – Execute the exit plan
The syndication will hold the apartment property for a certain pre-planned duration. These durations can be short or long depending on the goal and vision of the GP. Once that time is over, the GP will execute the exit strategy.
The exit strategy in most cases would be to sell the apartment property. If the market conditions are right, then the GP will hire a broker to find a buyer. Upon receiving the proceeds from the sale, the money is distributed to the LPs as per their shares in the partnership.
The main parties involved in apartment syndication
Apartment syndication involves multiple parties. Each of them is discussed below:
General Partner (GP):
The general partner is the syndicator and the main driver of the deal. He/she is involved with the day-to-day operations of the business. The GP has unlimited liability and plenty of responsibilities.
The GP puts together a team, evaluates the market and selects a target area/project, raises money from investors, and manages the apartment project from beginning to end. Given the range of responsibilities to be carried out, the general partnership can either be one person or a team of people.
One general partnership member can look after fundraising, one member can manage the project development work, one member can sign on to the loan, and so on. Some general partnerships have an attorney or real estate broker as part of the GP team. The size and structure of general partnerships vary across the board.
Limited Partner (LP):
Limited partners are the investors who hold shares in the apartment syndication project. The LPs pool in their individual funds to create a large corpus which can be used to purchase or execute apartment building projects.
The liability of an LP is limited to the extent of his/her share in the partnership. Even though LPs fund the initial equity portion of the investment, they do not have control over the business plan. Their investment is passive and “hands-off”. Hence, Limited Partners are also sometimes known as passive investors.
There can be a single LP or multiple LPs in a partnership. The latter is usually the case. The alignment of interests is generally the best when both LPs and GPs fund a syndication project. That way, even the GPs have “skin in the game”.
Property Management Company:
General Partners find a property management company to be one of the most helpful and valuable partners in any syndication setup. A property management company generally does the day-to-day work of running the operations in an apartment building/community.
Some property management companies go a step further and offer value-add services like market analysis, prospective property presentation, due diligence of the property, and financial forecasting.
A good property management company will aid the GP in identifying the right property for acquisition/development, figuring out capex and ongoing cost structures, and running the show at the property once it is ready.
A property management company will also host tenant events and resident appreciation parties. It will help with marketing and sales for the property and also analyze the competition to figure out the maximum rent rates that can be sustained by the property.
Normally, a property management company is a 3rd party service provider. However, there are some instances where the property management company is also a part of the GP team. This is actually a good thing for the LPs because there is a strong alignment of interests for the LPs, the GPs, and the property management company.
Sometimes, a property management company may also invest in the syndication partnership as an LP. Sometimes, the GP may offer the property management company equity in the partnership in return for a reduction in the management fee charged by the property management company.
Real Estate Broker:
The next important party in apartment syndication is the commercial real estate broker. This person/company drives the acquisition process. The broker will source deals and properties.
The deal can either be advertised to the market or it can be kept off-market and shared with GPs who have an established relationship with the broker.
Once a deal is identified, the broker creates an offering memorandum and then manages the entire transaction. The broker has to be in touch with the seller and the potential buyers throughout the process. Ultimately, the broker has to make sure that the deal reaches its conclusion.
GPs and property sellers tend to work with multiple brokers in the initial stages of a deal. Once a deal looks likely to happen, then a broker is placed under contract and then that broker alone will take the transaction to its conclusion.
Real estate attorney:
The fifth and one of the most crucial parties in a syndication deal is the real estate attorney. There are two types of attorneys who are likely to be involved, real estate attorneys and securities attorneys.
The attorneys are the ones who create and review the four most important documents in a syndication deal. These documents are as follows:
- The Purchase Sale Agreement (PSA): This piece of document is the contract between the buyer of an apartment community/building and the seller of that property. The property seller’s real estate attorney would generally draft the PSA. The buyer’s real estate attorney would review the draft and suggest any changes.
In the future, if the GPs and LPs wish to sell the property that they acquired, then they will have their real estate attorney draft the PSA.
- Operating agreement: The operating agreement outlines the share ownership as well as the responsibilities of each member or partner. There are two types of operating agreements, one between the GP team members (if there is more than 1 person in the GP team), and another between the GP and the LPs.
The operating agreement is prepared by a real estate attorney. Every time there is a new apartment building or property, the GP forms a new LLC and then the LPs purchase a share in that LLC. The GP remains the owner of the LLC. Operating agreements are drafted for every such LLC.
- Private Placement Memorandum (PPM): Every business has its risk. The PPM is the document which highlights the risks or ways in which an LP can lose his/her money. The PPM lists out various legal disclaimers along with a summary of the offering, description of the assets, and the minimum and maximum investment amounts.
The PPM will also outline how the GP and the LPs will get paid. Since there are plenty of disclosures in the PPM about the partnership as well as the risks associated with the offering, it is prepared by a securities attorney. A PPM is created for every apartment deal and LLC that is created by the GP.
- Subscription agreement: The subscription agreement, as the name suggests, outlines the terms of the shares of partnership which the LLC subscribes to. It outlines the price at which the LP will receive shares in the partnership as well as the number of shares that the LP will receive.
The LP will also commit to paying the price that is mentioned in the subscription agreement. This agreement is signed between the GP and every LP who comes on board the syndication partnership. The subscription agreement is prepared by a real estate attorney.
How does every party in apartment syndication make money?
GPs get their compensation from the profits that the apartment property generates. The standard ratio of profit-split is 10% to 20% to the GP and the rest to the LPs. Some very experienced GPs might be able to negotiate a 50-50 split of profits between the GP and LPs.
Some deals will be structured such that once a pre-determined hurdle rate is achieved (say 15% annual IRR), then till that rate, the split may be 80 LP and 20 GP. But, beyond that rate, the profits get split 50-50.
GPs also charge an asset management fee to the partnership for overseeing the operations of the apartment property. This fee is normally 2% of the total income generated from the property.
There are some other event-driven fees that the GP may earn. For example, if the property has to refinance its mortgage, then the GP may earn a 1% to 3% fee on the loan amount upon refinancing.
Similarly, the GP may also earn a loan guaranty fee, a 0.5% or 1% fee because he/she becomes a guarantor to the loan that is needed to execute the business plan.
Lastly, there can be an acquisition fee payable to the GP as well when the apartment property gets acquired.
LPs normally insist for a preferred return. That basically means that the LPs will get paid first until the preferred rate of return is achieved (say 10%) and only after that rate of return is surpassed, the GP gets paid.
Effectively, the GP does not receive any share of the profit until the preferred rate of return is breached.
The second way of an LP getting compensated is a profit split, as discussed above. A ratio is predetermined that will split the profits into two buckets, one for the LPs and one for the GP. Normally, the ratio is 80 LP and 20 GP, but it may vary from deal to deal.
This profit sharing can either be the only basis of compensation for the LP or it can come in after the preferred rate of return has been breached.
Sometimes, LPs may receive a portion of a refinanced or supplementary loan, if either of those two events occurs. The proceeds from such refinancing or supplementary loan are considered to be part of any hurdle rate thresholds. Such proceeds are distributed as per each LPs share in the partnership.
Property Management Company
The property management company earns a management fee which is normally 3% or 5% of the total rental income. However, this fee can be as high as 10% also. It all depends on the size of the property and the responsibilities of the company.
There are a variety of other fees that the property management company may charge. Some examples are lease fees, eviction fees, marketing fees, referral fees, etc. If the company is carrying out construction or renovation work, then any relevant construction fees would be extra as well.
As pointed out above, property management companies sometimes participate in the syndication as a limited partner. If they hold equity, then they get compensated just like the rest of the LPs.
Brokers normally get a commission for every deal that they close. This principle also applies to apartment syndication deals. Brokers get a commission of 3% to 5% on the purchase price of the apartment property.
Sometimes, brokers may do a deal with the GP wherein the broker invests his/her commission as equity in the partnership and becomes an LP.
Attorneys earn money for making the four contracts mentioned in the section above. Depending on the complexity of the contract, the size of the property, and the time it takes, attorneys can make a few thousand dollars.
Many attorneys charge by the hour but some may charge a fixed amount per contract drafted. Any revisions to the original draft would have additional charges.
We hope that you found this guide useful. If you are planning to execute an apartment syndication, then the information discussed above should give you the right head start in commencing the process. Good luck.
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