Crowdfunding, Steroids for Investors
- February 09, 2017
- Author: Tom K Wilson
Crowdfunding has become a hot topic. And for good reason. It allows an investor to participate in an investment that is normally reserved for the wealthy. However it is far from new.
It is simply syndicating, a popular investing technique before crowdfunding for real estate ever was a term. Syndicating and crowdfunding is the pooling of capital with other individuals for a common purpose or a common goal. In real estate, that common purpose is the purchase of a real property of any kind; in fact, a high percentage of large real estate investment ventures are syndications.
What most have been talking about is what the SEC just enacted on October 30, 2015 called Regulated Crowdfunding. Yes, I know, most thought it had been off and running for years. In the headlines, yes. Legally, no. It allows smaller syndicators and investors advertise, including on the internet, to pool funds up to $1,000,000 in 12 months in small amounts (typically $2-20K) from non-accredited investors. However, it has many tight restrictions on how much one can invest and the requirement that they use a licensed SEC dealer or portal. Not the panacea that everyone thought it was going to be.
When a syndication is offered to the public:
The SEC considers it a security, and for initial public offerings (IPOs) and subsequent large corporate offerings, the requirements and costs are significant ($100-250K). However, for smaller offerings to dozens of investors in the promoter's active database, rather than to thousands in the general public, the SEC allows exceptions (Reg D), the most common of which for decades is section 506 that allows the syndicator to raise unlimited funds as long as the number of non-accredited investors is no more than 35.
For non-accredited investors one must file and provide a strictly defined Private Placement Memorandum (PPM), although, most syndication attorneys recommend providing this document of disclosures and proformas to all investors for transparency and liability protection. A good PPM will be more than 100 pages and should provide all of the pertinent information that an investor needs to make a good informed decision on investing.
Prior to September 2013, one could not advertise to the general public, however, the new 506c (vs the old retitled 506b) allows general solicitation as long as the investors are accredited and are vetted by the syndicator. These requirements have significantly restricted the popularity of 506c so far.
Types of Syndications:
Large: Registered IPOs; unlimited raise; 1000's to general public requires full SEC extensive registration and cost.
Medium: 506b; unlimited raise; dozens to 100's; only to syndicator relationships; accredited and nonaccredited (35max).
Medium: unlimited raise; 506c; dozens to 100's, general solicitation allowed; accredited only; requires vetting by the syndicator.
Small: $1,000,000 max raise (Regulated Crowdfunding) dozens to 100's general syndication $1,000,000 max per 12months; tight restrictions; must be offered through SEC agent or Specialized Portals.
The term syndication has no legal significance. The responsibility, obligation and relationship of the syndicator to the investment group and the investors to each other are determined by the form of organization, most commonly an LLC. Anyone or any entity can syndicate a deal, and yes, you do need to be careful with whom you team and invest with.
Why do people invest in real estate syndications?
Most investors do not have the time, knowledge, or experience to search hundreds of properties to find a gem to acquire and underwrite. But there are real estate companies who do this for a living. By getting involved through a good real estate syndication, investors have access to larger and higher quality investments than they could on their own and gain the ability to invest in real estate without the burden of acquisition, operations, and disposition. One gets the expertise, management and borrowing power of a team of proven experts.
Advantages of Syndications
- Enables an investor to participate in larger and higher quality investments.
- Utilizes the syndicator's ability to find the best products at the best value.
- Utilizes the syndicator's ability to get the best loans including non-recourse.
- Reduces the investor's risk.
- Distributes the investment risk.
- Utilizes the syndicate's ability and experience to manage the acquisition and product throughout the investment hold period.
- Liability limited to the investors contribution.
Easier for an investor to get into a non-local market.
The first ingredient for a real estate syndication is a "syndicator" (also called "sponsor" or "promoter"). This individual or company is in charge of finding, acquiring and managing the real estate. They have a history of real estate experience and the ability to underwrite and perform the due diligence on the real estate. The other party is the investors. These are the individuals who invest with the syndicator and own a percentage of the real estate as a result. They get all the benefits of property ownership, but they are not involved with acquiring the property, arranging financing, and doing the day-to-day management or disposition at the end of the hold period. Professional management is crucial to successful commercial or multifamily ownership and is usually provided by the syndication.
What is the process of a syndication?
There are many moving parts to a commercial or multifamily acquisition, operation, and disposition. In a multifamily or commercial syndication the due diligence and loan process steps are enough to choke a horse. Hundreds of hours are generally invested by the syndicator and his team to secure the product including the research and projections for the regional market economics, the specific product business, the demographics, many inspections, and bids for any improvements. Then there is the legal process and finding the best loan source and terms along with the extensive application and qualification. It makes a home loan look like a visa charge at the convenience store.
And that is just the starting point. Once the property is purchased, optimum professional property management, both the strategic and the day-to day-operations, is critical to maximum the returns for the investors. This can make or break the projections.
When it is time to sell, the syndicator has excellent knowledge of the market in that region for that type of product and can maximize the sell price and terms. Having a syndicator who can synergize all of these parts increases the return/risk ratio.
The Three Syndication Components:
- Origination: planning, due diligence, acquiring property, satisfying registration and disclosure rules, and raising the capital for the investment.
- Operation: the sponsor usually has the expertise to optimally manage the property
- Liquidation or disposition: resale of the property at the end of the hold period.
How does a syndication make money?
Rental income from a syndicated property is typically distributed to the investors from the syndicator/manager monthly, quarterly, or annually according to the terms set forth within the entity. A property's value usually appreciates over time as rents escalate which increases the NOI (net operating income). When the property is sold, the increased equity is first distributed to the investors according to the preset preferred rate of return, then the additional equity above that is distributed according to the terms of the contract between the investors and the syndicator. The syndicator, therefore, to the advantage of all, is highly incentivized to manage the investment to outperform the proforma and projections.
The only thing that matters is what you do next.
If control and liquidity are top priorities, then syndications may not be for you. If leveraging the experience and capabilities of experts to maximize the return to risk ratio of a large real estate investment with minimal involvement is a priority, then it may be very worthwhile to find a great syndicator and metro to invest with.