Factors of a Successful Real Estate Syndicate

As the syndicator it is you job to evaluate the factors that will allow the formation of a successful real estate syndication. If most of the evaluating factors are favorable, using your experience and good judgment you can make a determination on forming your syndicate.

Evaluation Factors;

1. An active real estate market.
2. Satisfactory returns from rent in come.
3. Potential for capital gains.
4. Availability of investors.
5. Limited liability for investors.
6. No management issues for inactive investors.
7. Availability of leverage.
8. Tax shelter potential.
9. Benefits of a larger property
10. Syndicator experience.

 Active real estate market:

An active real estate market might take several forms. You might have a growing market with high demand and rising prices. You might have a good market in a bad economy with bargains available from investors who can not meet their obligations. You might have a market on its way up from a slump and you can get in to take advantage of the rising market.

Information about local markets is available from the public records, commercial newspapers, planing and real estate meetings. Talk to real estate agents and attend investors meetings to get a feel for the market. Chambers of commerces and the Internet have information and of course the real estate and business sections of the news papers are invaluable.

An active real estate market means that there is demand for rental units or property in general and that the demand will continue for the foreseeable future.

Satisfactory returns from rental income:

As syndicator you must be concerned with the net income and cash flow of properties your are considering for syndication so that you can offer potential investors a good return on their cash investment. Your property must return more income to the investors then they can get from other investment vehicles.

Net spendable cash flow is the amount available for distribution to investors. This number needs to be 10% or more per year of the amount of cash invested. Reduction in the principal as the mortgage(s) is paid down will add to the investors total return. If 10% is your minimum requirement when you purchase the property and you have plans to improve the property in order to increase the rents, then returns to your investors will be even higher.

Potential for capital gain:

A well selected property in a well organized and managed syndicate can provide exceptional returns of the cash invested while reducing the risk of investing.

The potential for capital gains is influenced by the properties net income and the expected returns of any future buyer. The value of income producing property is most often determined by talking the net income as a percent against an asking price or a cap rate (capitalization rate). For example if a property had a net profit of $24,000 then the value of that property would be $240,000 if the buyer wanted a 10% return on his investment.

Many factors influence returns investors expect. They compare your property to other types of investments that they might make. Your properties net income, condition, location, occupancy rate, amenities, length of leases, quality of tenets and easy of management will all have an effect on the return a buyer will expect.

Inflation effects real estate in two ways. As the cost of construction goes up the cost or building increases making newer rentals more expensive and thus existing building rents can be raised which increases the properties over all value. Higher cost for new construction can make the returns higher on older properties and that makes existing property more attractive. As inflation raises rents in a market, the cost for existing buildings often do not increase in real dollar terms as much as the rents increase. As the net profit returns on the property increase, so does the properties resale value.

In the current market at the start of 2010 we are in or just exiting a economic recession. Prices are depressed because of over building and a lack of financing. This has caused lots of foreclosures with more to come. A syndicator can buy foreclosures at bargain prices, get good returns form the rent income and sell at high capital gains returns in five years or so. The lack of financing and capital will be the hurdles to over come.

Capital gains can add another 8% to 20% a year to your investors returns. Be careful to not over estimate the capital gains returns to your investors. Better they should be pleasantly surprised when your syndication out preforms their expectations.

Availability of investors:

Finding investors is one of the key factors that will allow your syndication to move forward. The amount you can raise and the number of investors you attract can effect your operations and the size of the deals you can do.

In the beginning you may well need to acquire a property and then syndicate the deal. It is easier to talk about a property you already control and have your own money in then trying to sell the abstract. In the least you might need to have the property under an option to buy. That will mean you need to have a very good idea of how much you can raise and from whom you will get the money.

As you gain experience and your reputation grows you may well have investors and institutions waiting in the wings for you to bring them deals to invest in. I most certainly hope you reach that point.

Limited liability for investors:

A real estate syndicate can be set up to limit the liability of your investors. Forming a limited partnership under the rules of your state and the SEC can accomplish this goal. The general partner(s) assumes all of the responsibilities and liabilities.

As most real estate notes are non-recourse the property stands good for the loan. That only leaves operating and contractual liabilities to be concerned about. Liability insurance and key man life insurance along with good management will take care of those issues.

That only leaves the liabilities of risk and that is your function as syndicator to reduce and manage the risk so that your investors make money and you in turn.

No management issues for inactive investors:

The ownership of real estate causes management issues for the owners. For this reason many people who like the idea of real estate as an investment do not want to deal with the management.

The investor who invest in a real estate syndicate as an inactive investor avoids all issues concerning management and maintenance of the property. By pooling the investors money the syndicator manages the property and or causes the securing of competent management to mange the syndicate's property.

Within a limited liability partnership syndication the investors liability is limited to his invested capital as it would be in any other investment. Any tax advantages are passed through to the investor. This lack of liability, the potential for capital gains and possible tax advantages all make real estate syndication a powerful investment vehicle.

Availability of leverage:

Leverage or the use of borrowed funds may allow the syndicate to return exceptional returns to the investors. The money borrowed must be at rate that is lower then the rate of return form the properties net income.

Leverage must be used with caution. Highly leveraged properties can get into trouble if vacancies persist and or cost increase. As a rule banks will require 25% to 30% down and this is for very good reason. They want payments not to own your syndicates property. I recommend that the loan not be greater then 75% of the properties value and that you keep 3 to 6 months of payment and expense as reserves. The other controlling factor should be the cash flow return to your investors. The net income from the property should be sufficient to pay your investors 10% or higher rate of return and still make the mortgage payments. This minimum rate of return from net income to pay to your investors will help you determine the amount you can leverage.

Leverage for the syndicator might be as high as 100% as the inactive investors provide the cash needed.

The syndicator brings the experience, knowledge, organizational skills, management and all the other factors necessary for the operation of a successful syndicate. A conservatively financed property offers a reasonable investment risk for the investors.

Tax shelter potential:

Investors that are inactive and who have limited liability have limitations on the deductibility of passive losses against their earned income. A fancy way of saying that your syndicate's depreciation deductions that pass through to the investor maybe of limited value and/or excluded above a certain income threshold. Add to that the nasty alternate minimum tax potential. With all this you should advise your investors to consult their tax accountant if tax sheltering is a concern to them.

All investors will all benefit from the long term capital gains tax rates on the capital gains they get when the property is disposed of. Currently this rate is 15% of the capital gains.

Benefits of a larger property:

Joining with other investors the real estate syndicate can control a larger property then an individual investor can. The investors get away from the active management and reduce the risk of real estate investing.

The larger the property the less effect any one vacancy has on the buildings cash flow. With a single family home a vacancy means 100% of the income is gone, with a duplex a vacancy is 50% of the income and so on. All other operating expenses gain from an economy of scale.

The syndicator is a specialist in the selection, improvement, management and disposition of income properties and as such reduces the investors risk.

Syndicator experience:

The knowledge, experience and judgment of the syndicator(s) is the most important factor in a syndicates potential profitability. Without the syndicator there is no syndicate and thus the capabilities of the syndicator can create a carefree investment for the inactive investors.

The syndicator makes it possible for investors to invest relative small amounts of capital and get the advantages most often reserved for very large investors.