Syndications: what a limited partner is actually buying

A real estate syndication pools capital from passive investors under a sponsor who finds, acquires and operates the property.

Investors are limited partners with no management role. The sponsor is the general partner, and their competence and integrity determine the outcome more than the building does.

The structure

Typically an LLC or limited partnership holding a single property. Investors contribute capital for a percentage of equity. The sponsor contributes some capital, sourcing, and the operating work.

Returns are distributed according to a waterfall — a defined order of priority.

A common structure includes a preferred return to limited partners, often in the range of six to eight percent, paid before the sponsor participates in profits. Above that, profits split between limited partners and sponsor, commonly seventy-thirty or eighty-twenty, sometimes with additional tiers at higher return thresholds.

The important questions are whether the preferred return is cumulative, whether it compounds, and whether it must be fully repaid before the sponsor's promote is paid.

The fees

Sponsors earn fees in addition to their profit share, and these come off the top regardless of performance.

Typical items: an acquisition fee of one to three percent of purchase price; an asset management fee of one to two percent annually; a construction or renovation management fee; a refinancing fee; a disposition fee at sale; and sometimes a loan guarantee fee.

Individually reasonable, collectively meaningful. Total fees can consume a substantial share of investor returns, and some sponsors earn well even when investors do not.

The question worth asking directly: what does the sponsor earn if the deal returns exactly the investors' capital and nothing more?

If the answer is a substantial sum, the alignment is weaker than the presentation suggests.

Evaluating the sponsor

This is the actual due diligence, and it takes longer than reviewing the property.

Full track record, including failures. Not the highlights. Every deal, with projected versus actual returns, and specific explanation of any that underperformed.

A sponsor with no underperforming deals either has a short history or is not telling you everything.

Experience through a downturn. Sponsors whose entire record falls within a rising market have not been tested. Managing a property when rents fall and lenders tighten is a different skill from buying in an expansion.

Their own capital in the deal, and how much relative to their net worth. A sponsor contributing a token amount has limited downside.

References from previous limited partners, including from deals that did not perform. Ask specifically about communication during difficult periods.

Background checks. Litigation history, regulatory actions, bankruptcies. Public records searches are inexpensive and occasionally very informative.

Reading the documents

The private placement memorandum, operating agreement and subscription documents govern everything. Read them, and have an attorney read them.

Specific things to locate:

Capital call provisions. Can the sponsor demand additional capital? What happens if you decline — dilution, and on what terms? This has been a significant issue in recent years.

Distribution discretion. Sponsors typically have discretion to suspend distributions. Many did.

Removal provisions. Can limited partners remove the sponsor, and what threshold is required? Usually the answer is effectively no.

Transfer restrictions. You generally cannot sell your interest. Assume your capital is locked for the full hold and possibly longer.

Reporting obligations. Frequency and content of financial reporting.

The hold period, and the sponsor's discretion to extend it. Five-year deals routinely become eight-year deals.

The risks, stated plainly

Total illiquidity. Complete dependence on the sponsor. No control over any decision including sale timing. Leverage risk at the property level. Potential capital calls. And the possibility of losing the entire investment, which has happened to limited partners in recent years, particularly in deals financed with floating-rate debt.

Note that many syndications are offered under exemptions requiring investors to be accredited, and these are private securities with limited regulatory oversight compared with public offerings.

The reasonable position

Syndications provide access to larger institutional-quality assets, professional management, and genuine passivity, with tax benefits flowing through.

They are appropriate for investors who want real estate exposure without operating, who can afford total illiquidity, who can lose the invested amount without consequence, and who will do the sponsor diligence properly.

They are not appropriate as a first real estate investment, as a substitute for understanding the asset class, or for capital that might be needed.

And the single best predictor of outcome remains the sponsor, which means the diligence effort should be allocated accordingly.

General information, not investment, legal or tax advice. Private real estate offerings involve substantial risk including total loss of capital and are illiquid. Consult qualified professionals before investing.