How to Structure a Real Estate Syndication

Syndications allow sponsors to pool capital from passive investors and participate in bigger real estate projects. Choosing the right structure for the syndication can be a daunting task, as there are many factors to consider.

If you're thinking about setting up a real estate syndication, there are a lot of things you need to consider. How to source and get the deal under contact, how to diligence your underwriting and how to pull the capital together. 

One thing that is often an afterthought but critical to investment success is your real estate syndication structure going to look like?

In this article, we will explore the key parties involved in a real estate syndication, the different available structures, how they impact returns of the project, and their relative pros and cons to help you decide what's best for your syndication.

Who's Involved in a Real Estate Syndication?

A commercial real estate syndication is a form of investment that allows multiple investors to pool their money together to participate in a normally bigger, high quality real estate that then could do on their own. 

There are two main parties involved in a real estate syndication: the General Partners (GPs) and the Limited Partners (LPs).

How to Structure a Real Estate Syndication

General Partners

The General Partners (also known as sponsors) are responsible for managing the day-to-day operations of the real estate investment. They are responsible for finding, negotiating, and closing real estate deals, as well as overseeing the property management and ensuring any renovations or improvements go to plan. 

The structure and fees charged by the General Partner are typically outlined in the operating agreement (OA) which is a contract between the GP and the LPs. The OA outlines the governance and management of the investment as well as the fee structure and details on how the fees will be calculated and distributed.

General Partners in a real estate syndication typically make money in three ways:

  1. Acquisition fee: one-time fee paid to the General Partner for their role in finding and negotiating the real estate deal
  2. Operating fees: ongoing fees that are paid to the General Partner for managing the property and overseeing the day-to-day operations
  3. Promote: a share of the profits that are paid to the General Partner based on the terms of the operating agreement. It is typically a percentage of the profits above a certain threshold and is intended to align the interests of the general and limited partners and incentivize the General Partner to maximize the returns on the investment.

Limited Partners

The Limited Partners are passive investors who provide capital to the syndication. 

They are passive investors, and providing capital allows them to participate in real estate without having to go through the hassle of finding, managing, and financing a property on their own. 

Limited partners do not play an active role in the management of the property and rely on the General Partners to make all the decisions. In exchange for their capital, the Limited Partners receive a share of the ongoing passive income generated by the property and are also entitled to a portion of the capital gains when the property is sold.

Structuring

The legal structure of a commercial real estate syndications can vary, but most commonly, they are set up as a Limited Liability Company (LLC) or a Limited Partnership (LP). 

  • In an LLC, the owners, known as members, have limited liability for the debts and obligations of the business. The members also have the flexibility to participate in the management of the company and share in the profits, making the LLC a popular choice for small business owners and real estate investors.
  • A Limited Partnership (LP), on the other hand, is a legal structure in which one or more partners have unlimited liability for the debts and obligations of the business, while others have limited liability. 

LLC offers greater flexibility and control to its owners, while a LP offers a more passive investment opportunity with limited liability. Both structures have their own advantages and disadvantages, and the choice between an LLC or LP will depend on the specific needs and goals of the real estate syndication.

Real Estate Syndications versus other structures

While real estate syndications are the most popular structures due to their flexibility, there are several other structures that can be used in real estate investing, including Joint Ventures and Tenant-In-Common (TIC) structures.

What is a Joint Venture?

A Joint Venture is a business arrangement in which two or more parties agree to pool their resources and work together to achieve a common goal. 

In the context of real estate, a Joint Venture is a way for multiple investors to pool their capital to purchase a property and share in the profits. Joint Ventures are typically structured as a separate legal entity, such as a limited liability company or a partnership.

This structure has been used in many large and well-known projects including Tishman Speyer and BlackRock’s failed joint venture at Stuyvesant Town, and the Hudson Yards development in 2008 by The Related Companies and Oxford Properties Group.

What is a Tenant-In-Common?

A Tenant-In-Common (TIC) is a type of ownership structure in which multiple individuals own a fractional interest in a property. Each owner holds an undivided interest in the property, meaning they have a right to use and possess the entire property, not just their fractional share. 

TICs are often used in commercial real estate investments, allowing multiple investors to pool their resources and purchase a property together. In a TIC structure, each owner holds a separate deed to their fractional interest and is responsible for paying their own property taxes and expenses.

Two well known examples of this are the Rockefeller Center in New York and Embarcadero Center in San Francisco. Both investment structures allowed investors to pool their resources and purchase the property, with each investor holding a fractional interest in the property.

Real Estate Syndication Compensation

There are two main structures for compensating the general and limited partners in a real estate syndication: the Straight Split and the Waterfall Structure.

Real Estate Syndication Structure #1: Straight Split

In a Straight Split real estate syndication, the returns from the investment (including monthly cash flow distributions and profits from the sale of the property) are divided among the investors based on a fixed percentage. 

Real Estate Syndication Structure: Straight Split

For example, if the split is 80/20, 80% of all returns would be distributed to the Limited Partners (passive investors), while the remaining 20% would be paid out to the general partners (the syndication team responsible for sourcing, acquiring, and managing the property).

Example Real Estate Syndication Straight Split

In this example, 74% of the project’s total returns was returned to Limited Partners, with the remaining 26% captured by the General Partner. The reason it differs from the 80/20 is due the growth in the returns over the project's life.

Real Estate Syndication Structure: Straight Split Example

This type of deal structure ensures that the Limited Partners receive a consistent and predictable percentage of the returns, regardless of the amount of returns generated by the property.

Pros of Straight Split:

  • Simplicity: The Straight Split structure is straightforward and easy to understand for both the general and limited partners. It eliminates the need for complex calculations or negotiations over profit distribution.
  • Predictable returns: The Limited Partners know exactly what percentage of returns they will receive, providing certainty and stability for their investment.
  • No incentive alignment issues: With a fixed profit split, there's no need for the general and limited partners to negotiate over profit distribution, reducing the risk of alignment issues or disagreements.

Cons of Straight Split:

  • Limited flexibility: The Straight Split structure is not as flexible as other structures, such as the Waterfall structure. If the property performs better or worse than expected, the profit split remains the same, potentially resulting in either the Limited Partners receiving a lower return than they expected or the General Partners receiving a smaller share of profits than they would have under a different structure.
  • Limited alignment of interests: The General Partners do not have an incentive to maximize profits, as they receive a fixed percentage of returns regardless of the performance of the property. This can lead to less motivation to actively manage the property and optimize its performance.
  • No preferred return for Limited Partners: In the Straight Split structure, the Limited Partners do not receive a preferred return, which is a common feature in other structures and can be important for attracting and retaining Limited Partners.

Real Estate Syndication Structure #2: Waterfall Structure

In a Waterfall Structure, the profits from the real estate investment are distributed based on a predetermined allocation of profits at different levels. 

This structure usually includes a Preferred Return for the Limited Partners, which is a minimum rate of return that they receive before any profits are distributed to the General Partners. 

Real Estate Syndication Structure: Waterfall Structure

For example, let's say Limited Partners invest $1m into a project and the preferred return is 8%. The Limited Partners would receive a return of 8% on their investment before any profits are distributed to the General Partner. The remaining excess returns would be split between the general and limited partners according to the terms of the operating agreement (assuming 80% / 20% in the below illustration).

Example Real Estate Syndication: Waterfall Structure Split

In this example, 86% of the project’s total returns was returned to Limited Partners, with the remaining 14% captured by the General Partner.

Real Estate Syndication Waterfall Split Example

Pros of a Waterfall Structure:

  • Aligned incentives: The Waterfall structure provides a clear alignment of interests between the general and limited partners. The General Partners have an incentive to maximize profits, as they only receive a larger share of profits after the Limited Partners have received their preferred return and a predetermined split.
  • Preferred return for Limited Partners: The Waterfall structure typically includes a preferred return for the Limited Partners, providing a minimum level of return for their investment and reducing their risk.
  • Flexibility: The Waterfall structure provides more flexibility than the Straight Split structure, as the profit split can change based on the performance of the property. This allows for a more equitable distribution of profits in the event of unexpected returns.

Cons of a Waterfall Structure:

  • Complexity: The Waterfall structure can be complex and difficult to understand for both the general and limited partners. It requires detailed calculations and negotiations over profit distribution, which can increase the risk of misunderstandings or disagreements.
  • Lack of predictability: The Limited Partners do not have a guaranteed percentage of returns, as the profit split can change based on the performance of the property. This can result in a lack of certainty and stability for their investment.
  • Incentive alignment issues: If the general and limited partners have different expectations or interpretations of the Waterfall structure, it can lead to alignment issues and disputes over profit distribution.

Waterfall structures can become increasingly complex as different levels are introduced, each with its own promote structure. For example, a common structure might involve an 8% preferred return for investors, followed by a promote structure that kicks in once a certain level of IRR (internal rate of return) is achieved, such as 10% or 15%. 

At each level, the promote structure may shift, potentially increasing the percentage of profits allocated to the sponsor of the deal, or introducing other performance hurdles that must be met to unlock the next split. As a result, navigating these structures can require a thorough understanding of the various promote structures (as well as knowledge of the underlying real estate investment and risks).

Tax Considerations

Tax planning and outcomes will vary depending on the specific circumstances of the real estate syndication but it's important to keep in mind that straight split structures provide a consistent tax treatment for both the general and limited partners. 

Each partner receives a fixed percentage of the returns, which can simplify the tax calculation process. However, the General Partners do not receive a carried interest, which is a share of profits that is taxed at a lower capital gains rate. This can result in a higher tax bill for the General Partners.

Which Real Estate Syndication Structure Is Better?

The choice of structure will depend on the goals and objectives of the individual syndication. 

The Straight Split structure may be more suitable for a simpler, smaller deal where the general and limited partners are more closely aligned. The Waterfall Structure may be more appropriate for a larger, more complex deal where the interests of the general and limited partners need to be more carefully balanced.

In almost all institutional quality commercial real estate investments, waterfall structures are used to better align investors and sponsors on the project's success.  

Here are some general guidelines:

You Should Use the Straight Split Structure When...

  • The deal is simple and straightforward
  • The general and limited partners have a close relationship
  • The General Partner is confident in their ability to generate a high return on the investment

You Should Use the Waterfall Structure When...

  • The deal is larger and more complex
  • The interests of the general and limited partners need to be more carefully balanced
  • The Limited Partners require a guaranteed return on their investment

The Bottom Line

Real estate syndications provide a way for passive investors to participate in real estate investing without having to go through the hassle of finding, managing, and financing a property on their own.

The choice of structure will depend on the goals and objectives of the individual syndication, and both the Straight Split and Waterfall structures have their advantages and disadvantages. 

Ultimately, the most important thing is to carefully consider the needs of all parties involved and structure the deal in a way that aligns their interests and provides a fair return for everyone.

If you’re looking to set up a real estate syndication and raise money through private investors for your next deal, GP Flow can support any syndication and help you onboard the right investors to participate.

About the Author

Andy Crebar

Andy Crebar is the Co-Founder & CEO of GP Flow which is on a mission to unlock the potential of commercial real estate.

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