Everything You Need to Know About Multifamily Syndication
Multifamily syndication is the process of gathering capital from a group of investors, sometimes known as a “syndicate,” to invest in a multifamily property. Whether you’re an active real estate investor or are looking to take on a more passive role, understanding exactly how multifamily real estate syndication works is essential.
In this article, we’ll discuss everything you need to know about multifamily syndication, including how to start your first multifamily syndication deal as an active investor, the legal requirements around real estate syndications, and what passive investors should look for in multifamily syndications.
What is a Multifamily Syndication?
A multifamily syndication is a type of real estate deal in which active investors raise money from passive investors in order to acquire, purchase, or rehabilitate multifamily properties. Multifamily syndications can range from small deals with only a few investors to massive deals with thousands of investors. Syndication allows investors to invest in bigger real estate deals than they could individually or through smaller partnerships, helping build wealth for passive and active investors.
Getting Started in Multifamily Syndication
Multifamily syndication can be complex, but there’s a first time for everything. Since this type of real estate investing can be complex, in most scenarios, a first-time syndicator should already have some experience investing in single-family or small multifamily properties on their own or should already be a (somewhat) experienced commercial real estate professional. In general, these are the steps that an investor can take to initiate their first syndication.
Network: Meet as many people as possible in commercial real estate. You never know who might be your next business partner, investor, or sponsor. Real-life meetups and seminars, online groups, and even forums like BiggerPockers are your friends here.
Get Investor Interest: Before getting close to buying an investment property, you should drum up a long list of potential investors who may want to work with you in the future. You’ll be on a timeline and competing with other buyers for prime properties, so you may have to raise money fast, and you don’t want to have to start from scratch.
Set Up Your Legal Entity: As we’ll get into later, having the correct legal entity is essential to a successful syndication, so you’ll want to consult with an experienced lawyer to ensure you’re doing everything right.
Select a Property: Finding a property can be a challenge, but there are many ways to do so, including working with a commercial real estate agent, tapping into your network of fellow investors, looking for properties that are “for sale by owner,”and making independent offers on attractive properties.
Raise Funds: Raising funds fast enough to close a deal can be a challenge, but if you’re prepared and have a strong network, you should be up for the task.
Get Financing: Unless you want to do a deal with 100% cash (you probably don’t), getting the right financing is key, and getting approved can be a complex process.
Buy Your Property: When you have all your investor funds and have locked in the financing, it’s time to pull the trigger and buy your property.
Manage Your Asset: Once you and your investors own the property, you’ll be responsible for either self-managing or overseeing the property management company, taking care of distributions to investors, annual tax obligations, insurance, and any other financial tasks necessary to effectively manage the investment.
Sell Your Property: After your desired holding period, it’s time to sell your property and send your final distributions to your investors.
Repeat: Once you’ve finished your first syndication, you may want to repeat the process. If your investors got a good return and good customer service, they may be more than eager to join you on your next deal.
In addition, it should be noted that many experts suggest that a syndicator, if possible, become a limited partner in one or more syndications before they start doing their own deals, as this will help them better understand the needs of their investors while also growing their network.
General Partners (GPs) vs. Limited Partners (LPs) in Multifamily Syndication
Real estate syndications generally have two types of partners, general partners (GPs) and limited partners (LPs).
General partners (GPs) take an active role in the investment process and are responsible for raising money, selecting and purchasing one or more multifamily properties, providing any disbursements to passive investors (LPs), and determining when (or if) to sell the property in question. In addition to any regular disbursements, they also are responsible for giving the passive investors back their initial capital, plus any profits, at the end of the deal. GPs take on most of the risk and liability of the deal, in exchange for additional fees and, depending on the property’s performance, (potentially) a larger return on investment.
In contrast, limited partners (LPs) simply invest their money into the syndication and receive a stream of passive income. Unlike GPs, they do not actively participate in the real estate investment process. LPs are generally not legally or financially liable for anything involved with the syndication and only face the loss of their initial investment should anything go wrong.
Legal Structures and Accredited Investor Requirements for Multifamily Syndication
In the United States, the two most common types of real estate syndication structures are equity offerings made under rule 506(c) or rule 506(b) of the Security and Exchange Comissions’s (SEC’s) Regulation D. Both of these rules allow private funds (including real estate funds) to make private stock (i.e., equity) offerings without officially registering with the SEC.
If a multifamily syndication has the status of 506(c), investing will only be open to “accredited investors,” individuals who are allowed to invest in unregistered private investment offerings. As of 2023, the SEC defines accredited investors as:
Individuals who have earned more than $200,000 per year (or $300,000 with a spouse or spousal equivalent) for the last two years and are reasonably expected to earn a similar income during the current year.
Individuals who have a net worth of more than $1 million, excluding their primary residence (either alone or with a spouse or spousal equivalent).
Individuals who hold a Series 7, Series 65, or Series 82 license in “good standing.”
In contrast, multifamily syndications utilizing the 506(b) rule are open to accredited and “sophisticated investors.” The SEC defines sophisticated investors as individuals who “must have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of the prospective investment.”
Using the 506(b) rule greatly increases the pool of potential investors who are legally eligible to invest in a real estate syndication, but it can also bring additional risk, as the true definition of a sophisticated investor is rather flexible.
Legal Entity Structures for Multifamily Syndication Deals (LLCs, SPEs, and SPVs)
When deciding how to structure a multifamily syndication investment, setting up the correct legal entity structure is essential. Most syndications function as limited partnerships, but they generally aren’t traditional partnerships, at least in the legal sense. In most situations, it makes sense for the real estate to be held within a limited liability company (LLC), which can have both limited and general partners.
Ideally, this LLC will function as a single-purpose entity (SPE) and/or special purpose vehicle (SPV), as it’s only designed for one purpose; to hold a specific piece of real estate. This helps shield both the limited and general partners from liability and is often required by lenders. Syndicators should always consult with a highly experienced commercial real estate lawyer when setting up their corporate structure, as investing a little in legal help can help prevent serious issues in the future.
Investment Strategies and Timelines for Multifamily Syndications
When it comes to multifamily investing (and real estate investing in general), there are multiple investment strategies that real estate syndicators can pursue, including core, core plus, value-add, opportunistic, and ground-up development. Each of these strategies has a different risk-return profile, with the riskiest investments generally providing the highest potential returns.
Core: A core investment strategy is typically the most conservative and will involve buying high-quality Class A apartment buildings (generally less than 5-10 years old) in strong markets. Fore core investments, relatively little debt is used-- sometimes as little as 40%. Core investors accept a very low risk level and can often get a return of 7-10%, somewhat less than average stock market returns.
Core Plus: Core plus investing involves buying medium-quality investment properties (sometimes up to 10 years old) in a wider variety of markets and making light improvements. It’s still relatively low-risk but offers slightly higher potential returns.
Value-Add: Value-add investing typically involves purchasing medium-quality stabilzed assets (often Class B or higher-quality Class C apartments) that are between 15-20+ years old), and making substantial (but often surface-level) improvements that allow the investors to substantially raise rents and “add value” to the investment. Value add is slightly riskier than Core Plus investing but generally much less risky than Opportunistic investing.
Opportunistic: Opportunistic real estate investing involves a significant level of risk but a high potential reward profile. This investing strategy can involve buying highly distressed properties and substantially improving them, repositioning office or retail buildings into multifamily developments, and other similar endevours. Opportunistic investors often use as much leverage as possible, often 70%+.
Ground-Up Development: Ground-up development (which some may consider a variant of opportunistic investing) is the riskiest but potentially most rewarding real estate investment strategy. For ground-up developments, the GPs must develop and initiate the project from the earliest stages, buying land, hiring architects and engineers, and acquiring construction financing. Ground-up developments are either sold once completed or refinanced (often using bridge financing or mini-perm loans) and leased up. Successful development projects can sometimes yield up to 25%+ for investors, but they also have a chance of failing completely.
In addition to general investment strategies, syndications also have different holding periods. The average holding period for syndication varies significantly, but can often be between 3-10 years, with many syndications hovering around the 5-7 year range. As private investments, synidcations are relatively illiquid; the only way to exit early is to get another private investor to buy you out, which may or may not be feasible.
Fees for Multifamily Syndications
Being a general partner in a multifamily syndication deal can be hard work, and GPs are compensated in several ways, including by charging the LPs various percentage-based fees. Some of the most common types of syndication fees include:
Acquisition Fee: This fee compensates the GPs for doing the legwork of acquiring the property and is often a one-time fee of 1-2% of the property’s acquisition price.
Financing Fee: This fee compensates the GPs for arranging the financing for the property and is also usually a one-time fee of 1-2% of the total loan amount.
Asset Management Fee: An asset management fee is usually an annual fee of 1-2% of the “assets under management,” or AUM, which is usually the current fair market value of the property. The asset management fee compensates the GPs for “managing the asset,” including choosing and monitoring the property management company, filing corporate taxes for the syndication, dealing with any regulatory or legal issues, and sending any monthly, quarterly, annual, or final disbursements to the LPs.
Disposition/Sales Fee: In many cases, selling a multifamily property can be as work-intensive as buying one. A disposition fee, or sales fee, compensates the GPs for selling the property or properties at the end of the deal. This fee is also usually a one-time charge of between 1-2% of the property’s sale proceeds.
Sponsorship Fee: While the GP or GPs of a deal are also known as sponsors, in many cases, a deal will actually be sponsored by a third-party real estate sponsor, generally a high-net-worth individual who will co-sign the loan on the multifamily property. In some situations, the sponsorship fee will actually come out of the GP's profits instead of being charged to the LPs. Sponsorship fees are generally 1-2% of the total loan amount.
Entrance Fee and Exit Fee: In some situations, GPs will charge LPs an entrance fee for investing in the deal, as well as an exit fee when they get their final disbursement. In many cases, GPs that charge these fees will not charge acquisition or disposition fees, as a very high fee structure can turn off a lot of potential investors.
Real Estate Syndications and Multifamily Financing
Getting financing for a deal is another essential part of the syndication process. General partners want to work with lenders directly, or, instead, with a commercial mortgage broker to help guide them through the loan application and approval process.
Common types of lenders for multifamily loans include:
Banks: Banks generally offer recourse apartment financing with LTVs up 75% and terms of 5-10 years. Credit and net worth requirements are relatively strict. Banks may also provide construction loans to highly-qualified borrowers.
CMBS: CMBS or conduit lenders typically offer low-cost, non-recourse multifamily financing with leverage of up to 75%, and terms are also generally between 5-10 years. Credit and net worth requirements are somewhat relaxed compared to other multifamily lenders. The closing process, however, can be a challenge. Loans start at $2 million.
Hard Money: Hard money or private money loans have high interest rates and fees, but they offer the most flexibility when it comes to borrowers with poor credit, legal issues, or those trying to purchase distressed properties or other high-risk investments.
Fannie Mae/Freddie Mac Multifamily: Fannie Mae and Freddie Mac multifamily loans provide low-cost, non-recourse loans with LTVs up to 80%, and terms between 5-25 years. Loans start at between $750,000 to $1 million and generally require a high net worth and excellent credit.
HUD Multifamily: HUD multifamily loans offer the lowest rates and the longest terms in the industry, with the HUD 221(d)(4) loan for ground-up construction and substantial rehabilitation providing 85-90% LTV, 40-year, fixed-rate, fully-amortizing, non-recourse financing, with an addition 3-year interest-only construction period. Their 223(f) program for acquisitions and refinances provides similar terms. However, HUD apartment loans are only for extremely well-qualified borrowers with a lot of patience; 221(d)(4) loans can take up to one year to close, while 223(f) loans often take between 5-8 months.
Other types of financing include mini-perm loans and bridge loans, which may be offered by banks and private lenders. These types of loans are ideal for situations where a property is not quite fully stabilized, particularly after the property has just been built or has just undergone substantial rehabilitation.
Measuring the Profitability of a Real Estate Syndication
Real estate investment deals can measure profit or return on investment (ROI) in several ways. This is important to understand, as the return metric(s) used in the syndication’s marketing materials will also generally be used to split any profits from the syndication between the general and limited partners (as we’ll get into more later). ROI metrics can be calculated for a certain year, but in terms of syndications, they are usually calculated over the life of the deal and include the sales proceeds.
Some common real estate ROI metrics include:
Internal Rate of Return (IRR): IRR uses the time value of money (TVM) to measure an investment’s profitability over a specific period of time and is expressed as a percentage. IRR, which calculates the “percentage rate earn on each dollar invested for each period it is invested,” can be compared to the annual percentage yield (APR) of a bank account or bond, as incorporates compounding into the calculation process.
Cash-on-Cash Return: Cash-on-cash return compares the amount of initial cash invested into a deal compared to the amount of cash that comes out. Unlike IRR, cash-on-cash return is usually calculated as an annual metric.
Equity Multiple: Equity multiple is defined as the total cash distributions from an investment divided by the total amount of equity invested. Unlike cash-on-cash return (and like IRR), equity multiple is usually calculated as a ratio beginning at the life of the investment. For instance, a property’s equity multiple might be 1.5x after a few years but might end up being 2.5x or more when the property is finally sold.
When Do Limited Partners in a Syndication Get Paid?
Limited partners in a real estate syndication are generally paid in two ways. Provided the property is profitable, they will generally get monthly or quarterly disbursements derived from the property’s rental income. In addition, when the property is sold or refinanced (with cash out), the LPs will get a larger, one-time, lump-sum distribution.
Profit Structures for Multifamily Syndications
Just as there are multiple legal structures for multifamily syndication and multiple ways to calculate the profits from syndications, there are also multiple ways to split these profits. Some of the most common profit split structures include:
Preferred Returns: Perhaps the most common form of profit structure, the preferred return ensures that the limited partners (LPs) receive their initial investment and a specific return before the sponsors get paid anything. Many preferred returns are between 6-8%. A preferred return structure is good for risk-averse passive investors, as, depending on the situation, they could still earn a small profit, even if the deal ends up going sour. This structure, conversely, is less ideal for the GPs, as they could end up losing all their initial capital if the syndication loses money.
Waterfall/Promote: A waterfall structure involves various profit hurdles that, if met, mean that the general partners (GPs) will receive a higher portion of the profits. For example, the GPs and LPs may receive the same return up until the deal reaches a certain criterion, say, an IRR of 8%. After the 8% hurdle is reached, all additional profits will be split 70/30 (i.e., 70% to the general partners and 30% to the limited partners). A deal can involve an unlimited number of waterfalls. For instance, the same deal could have a 12% hurdle with an (85/15) split, and a 15% hurdle with a (0/100) split, meaning that the GPs would earn all profits above a 15% IRR.
Straight Split: A straight split is another popular type of real estate syndication deal structure. This structure uses one percentage rule to split the profits between the GPs and the LPs. Common straight split deal real estate syndication deal structures involve 70/30 or 80/20 splits, with between 70 or 80% of profits going to the LPs and the remaining 20 or 30% of profits going to the GPs.
Tax Implications of Syndications
Syndications have a variety of tax benefits for both active and passive investors. The amount of tax benefits an investor can utilize is proportional to their ownership in the property. Some of these include:
Depreciation Deductions: Just like owning multifamily or commercial real estate individually, investors in syndications can take annual depreciation deductions, lowering their federal income tax burden. They can also speed these up by getting a cost segregation study, which can “acclerate” the depreciation processing, allowing investors to take larger deductions faster.
Cash-Out Refinancing: A real estate syndication may involve a cash-out refinance during the holding period. In this case, if the cash is distributed to investors, it may be considered a loan (i.e., debt) rather than a gain.
Mortgage Interest Deductions: Investors can take tax deductions equal to the amount of mortgage interest on the property.
1031 Exchanges: 1031 exchanges allow investors to defer their capital gains taxes when they sell a property by exchanging that property with another “like-kind” property of equal or greater value. Doing a 1031 exchange into a syndication is not very common, as it adds a lot of regulatory issues and requires a lot of paperwork, however, sometimes, an investor will 1031 exchange into a syndication as a tenant-in-common (TIC) in which the passive investor is not a GP or LP, but rather a direct owner who owns an interest in the property through the tenancy-in-common structure.
Offering Memorandums (OMs) for Multifamily Syndications
An offering memorandum (OM) is a document presented to potential investors during the syndication process. If you’re a syndicator, it’s important to present a quality, thorough OM to investors, and, if you’re a passive investor, it’s important to read through OMs carefully to ensure they provide enough information to keep moving forward with the investment process.
A good OM includes many of the factors we’ve previously discussed, including information on the property, the investment strategy, the holding timeline, how the project will be financed, expected returns, tax implications, and other essential information that potential investors need to know before making an informed choice.
What to Look For In A Multifamily Syndication Company
If you’re a passive investor, it’s extremely important to vet a real estate investment company and do sufficient due diligence before deciding to invest in a real estate syndication. Here are a few things you may want to look for and questions you may want to ask:
Reputation/Experience: Does the company have an online presence and good reviews? Do the principal GPs have real estate investing experience? Do they have experience doing the specific type of deal you’re considering investing in? Can you speak to current LPs to see how the process worked for them?
Return History: How have the firm's previous syndications performed? Did the real performance match or exceed the expected performance in the initial offering memorandum? Did they sell the property within their planned timeline?
Risk Tolerance: What is the company’s specific business plan for the syndication you want to invest in? What is the property’s current occupancy level, and what kind of repairs does it need? Are the current tenants paying their rent on time and in full? How much leverage do they want to use?
Customer Service: A high level of customer service and communication is essential for passive investors to feel comfortable with their investments. How will the company achieve this? Are they easily accessible by phone? Do they send out monthly or bi-monthly investor emails informing them about the property’s current condition/occupancy level and the improvements they plan to make? In general, if a company is not communicative with potential investors during the sales process, they’ll generally be much worse when you’ve already put down your money, so poor communication is definitely a red flag.
Syndication vs. Crowdfunding for Real Estate Investments
While syndication is the most popular way to allow a group of investors to put their capital together to buy or develop real estate, it’s not the only way. In 2017, the Tax Cuts and Jobs Act legalized regulation crowdfunding, a method of raising capital in which regular members of the public can participate as investors. Real estate GPs looking to set up a deal via crowdfunding do not have to register with the SEC, providing they sell no more than $5 million of shares in a specific project and utilize an SEC-regulated crowdfunding portal/platform or broker/dealer to raise money.
Syndication does have additional rules, regulations, and requirements, but it can be a great way for newer real estate investors to raise money from the public, particularly for smaller projects.
In Conclusion: Syndication Is An Incredible Tool For Multifamily Investors
Whether you’re an active or a passive investor, multifamily syndication is an excellent tool. Active investors can invest in much larger deals and grow their careers as real estate investment professionals, while passive investors can access deals with (potentially) far higher returns than the stock market or individually owning residential properties. However, the syndication process can be complex, which is why it’s important for both potential GPs and LPs to do a significant amount of research before making any important business or investing decisions.