What is Apartment Syndication?
You are about to read the ultimate guide on apartment syndications.
Simply put, an apartment syndication is the pooling of money from numerous investors that will be used to buy an apartment building and execute the project’s business plan.
Typically, an apartment syndication is best used when buying large apartment buildings or communities that would be difficult or impossible for the parties involved to purchase and handle individually, which allows companies to pool their resources and share risks and returns.
The syndicator – also commonly referred to as a sponsor or general partner (GP) – is tasked with raising money from qualified investors – also commonly referred to as passive investors or limited partners (LP) – and then using that money to buy apartment buildings.
By the conclusion of the post, you will learn:
- What a qualified apartment syndication investor is
- The two main types of apartment syndications
- The major parties involved in apartment syndications and their responsibilities
- How each of the major parties are paid
- The 11-step apartment syndication process
- How to get started as a general partner or limited partner in apartment syndications
Let’s do this!
What is a qualified investor?
Only qualified investors are permitted to passively invest as limited partners in apartment syndications. To qualify to invest in apartment syndications, you must be an accredited investor or sophisticated investor.
An accredited Investor is a person with an annual income of $200,000, or $300,000 for joint income, for the last two years or an individual with a net worth exceeding $1 million.
A sophisticated investor is a person who does not meet the accredited investor requirements but has the knowledge and experience in financing and business matters and is therefore capable of evaluating the merits and risks of the prospective investments.
If you do not meet the qualifications of one or both of these investor types, you are not eligible to passively invest in apartment syndications at this time.
What are the main types of apartment syndications?
Most likely, the general partner is either selling private securities to the limited partners under Rule 506(b) or 506(c). One key difference is that 506(c) allows for general solicitation or advertising of the deal to the public, while 506(b) offerings do not. But the other difference is the type of person who can invest in each offering type. For the 506(b), there can be up to 35 unaccredited but sophisticated investors, while 506(c) is strictly for accredited investors only.
If the general partners are doing a 506(c) offering, they must verify the accredited investor status of each passive investor with a 3rd party, which requires the review of tax returns or bank statements, verification of net worth or written confirmation from a broker, attorney or certified account.
If the general partners are doing a 506(b) offering, they are not required to verify the accredited investor’s status with a 3rd party – the passive investor can self-verify that they are accredited or sophisticated. However, some general partners only work with accredited investors even though they do 506(b) offerings. In addition, for the 506(b) offering, to prove that the general partners didn’t solicit the offering, they must be able to demonstrate that they had a relationship with the passive investor before their knowledge of the investment opportunity, which is determined by the duration and extent of the relationship.
Overall, for 506(c), the general partner is allowed to advertise their offering to the public and only accept verifiable accredited investors. For 506(b), the general partner is allowed to accept up to 35 sophisticated investors and must be able to demonstrate an existing relationship with the investors.
Who are the major parties involved in apartment syndications?
There are five main parties involved in apartment syndications.
- General Partners (GP)
First are the general partners (GP). The GP is an owner of a partnership and has unlimited liability. The GP is the managing partner and is active in the day-to-day operations of the business. For apartment syndication, the GP is also referred to as the sponsor or syndicator.
The GP is responsible for selecting a target investment market, selecting and hiring the various team members, sourcing capital from passive investors, and managing the entire apartment project from start to finish.
While it is possible for the general partnership to be a single individual, most likely, the general partnership is made up of multiple individuals. For example, one member of the general partnership may be responsible for investor relations and raising capital; one member may be responsible for acquisitions and asset management; one member who has a high net worth may sign on the loan; another member who has previous apartment investing or apartment syndication experience may also sign on the loan. Other partnerships will have the property management company, listing real estate broker, or attorney as a part of the general partnership. In other words, GPs come in all shapes and sizes.
- Limited Partners (LP)
Another major party involved in apartment syndications are the limited partners (LP). The LP is a partner whose liability is limited to the extent of the partner’s share of ownership. For apartment syndication, the LP is also referred to as the passive investor.
The LP is responsible for funding a portion of the initial equity investment. They do not have control over any aspect of the business plan. It is a strictly passive investment and is completely hands off except when reviewing investor reports and doing taxes at the end of the year.
Similar to the GP, the LP may be a single person or multiple people. For some syndications, one large investor funds the entire equity investment. For others, one large investor funds the majority of the equity investment and members of the GP fund the rest (which is beneficial to the LP because it promotes an alignment of interest since the GP has their own skin in the game). But, for the majority of apartment syndications, the LP is made up of multiple investors who come together to fund the equity investment.
- Property Management Company
For the general partner, one of their most valuable team members is the property management company. The property management company’s main responsibilities are to manage the day-to-day operations of the apartment community and execute the GP’s business plan. But a great property management company will offer additional services.
For example, pre-deal, a great property management company will advise on attractive or struggling neighborhoods within a market, offer locations of prospective properties based on the GP’s business model, and provide a pro forma (i.e., projected financials) on prospective properties based on how they would manage them.
Once a deal is placed under contract, a great property management company will aid the GP during the due diligence process, like inspect the property and its operations to create due diligence reports and help the GP finalize the capital expenditures and ongoing budget.
Finally, post-closing, a great property management company will host resident appreciation parties, implement the best marketing and advertising practices, and frequently analyze the market and the competition to maximize the rental rate.
Typically, the property management company is a 3rd party provider and is not a part of the GP. However, there are some instances where the property management company is a 3rd party provider and is on the GP, which is beneficial to the LP because of the added alignment of interest. Examples are when the GP offers the property management company an equity stake in the GP for a reduce ongoing management fee or when the property management company brings in their own investors. Also, the property management company may invest in the deal themselves as a LP.
For some apartment syndications, typically for larger firms, the property management company is brought in-house and is a part of the GP.
- Commercial Real Estate Broker
Another major party involved in apartment syndications is the commercial real estate broker. A commercial real estate broker actively sources apartment deals in a specific market. When a deal is identified, they either create a marketing package (i.e. offering memorandum) and list the deal for sale on-market or offer the deal off-market to GPs they’ve worked with in the past. For on-market deals, a commercial real estate broker manages the offer process, which typically includes one or multiple calls to offer and a best-and-final round of offers. Once the deal has been awarded to an investor, the commercial real estate broker ensure that they deal makes it to the closing table.
Typically, apartment syndicators will work with multiple commercial real estate brokers to source their deals. But once they place a deal under contract, they will typically work with the listing commercial real estate broker until close, and then again once they list the property for sale.
- Real Estate and Securities Attorney
The fifth major party involved in apartment syndications are the attorneys. The two attorneys are real estate attorneys and securities attorneys.
The attorneys are responsible for creating and reviewing all of the contracts. The four major contracts required for apartment syndications are (1) purchase and sale agreement, (2) operating agreement, (3) private placement memorandum, and (4) subscription agreement.
Purchase sale agreement: The purchase sale agreement (PSA) is the contract between the buyer and seller of an apartment community. Typically, the PSA is created by the seller and their real estate attorney. However, the buying party should always have their real estate attorney review the contract before signing. Once the syndicator goes to sell the property, they will work with their real estate attorney to create the PSA for the buyer to fill out.
Operating agreement: Typically, there are two types of operating agreements for apartment syndications. First is the operating agreement between the members of the GP. Second is the operating agreement between the GP and the LP. If the GP is made up of more than one member, the operating agreement outlines the responsibilities and ownership percentages for each member. Then, for each apartment deal, the GP typically forms a new LLC of which they are owners, and the LP purchases shares of that LLC. The operating agreement outlines the responsibilities and ownership percentages for the GP and LP. All operating agreements should be prepared by a real estate attorney.
Private placement memorandum: The private placement memorandum (PPM) is a legal document that highlights all the legal disclaimers for how the LP could lose their money in the deal. Generally, the PPM will have a summary of the offering, a description of the asset being purchased, the minimum and maximum investment amounts, key risks involved in the offering, a disclosure on how the GP and LP are paid, and other basis disclosures like the GP information and a list of all the risks associated with the offering. The PPM should be prepared by a securities attorney for each apartment deal.
Subscription agreement: Simply put, the subscription agreement is a promise by the LLC to sell a specified number of shares to the LP at a specified price, and a promise by the LP to pay that price. Like the operating agreement and PSA, the subscription agreement is prepared by a real estate attorney for each deal.
Then, the GP will consult with their attorneys on an as needed basis.
How do the major parties involved in apartment syndications make money?
Now to the money question – literally! How are the various parties involved in an apartment syndication compensated for their responsibilities?
- How do General Partners Make Money in Apartment Syndications?
The types of fees and the range of each fee will vary from syndicator-to-syndicator and from deal-to-deal. But every fee charged by the GP should be directly tied to a task that is explicitly adding value to the apartment deal. Here are the most common fees charged by GPs:
Profit split: Generally, the GP will structure the apartment syndication such that the total profits are split between the GP and LP. The split can be anywhere from 50/50 to 90/10 (LP/GP), but 50/50 for experienced GPs and 70/30 for less experienced, newer GPs are the most common.
If the apartment syndication is structured such that the LP is offered a preferred return (more on the preferred return later on in this post), the remaining cash flow after the preferred return is distributed is split between the LP and GP.
At the sale of the property, after the LP receives the remainder of their equity investment (and if applicable, the accrued preferred return that wasn’t paid out yet), the GPs receive a catch-up distribution based on the profit split. Then, the remaining profits are split between the LP and GP.
Some GPs will structure the apartment syndication such that the profit split changes after a certain internal rate of return to the LP hurdle is achieved. For example, the profit split may be 70/30 until the LP achieves an internal rate of return of 16%, at which point the profit split changes to 50/50.
Acquisition fee: The acquisition fee is an upfront, one-time fee paid to the GP at closing. The fee ranges from 1% to 5% of the purchase price, depending on the size, scope, experience of the GP, and profit potential of the deal. The acquisition fee is similar to a consulting fee paid to the GP for the behind-the-scenes worked required to put the deal together.
Guaranty fee: The guaranty fee is a one-time fee paid to a loan guarantor at closing. As I briefly mentioned above, a loan guarantor signs on and guarantees the loan, because they meet the liquidity, net worth, and/or experience requirements needed to qualify for financing. Either the main partners in the GP will act as the loan guarantor or they will bring a 3rd party into the GP in order to sign on the loan.
The guaranty fee is an upfront fee paid at closing and/or an equity stake in the GP. If the main members in the GP are acting as the loan guarantor, they will typically charge a one-time fee of as low as 0.5% to 1% or as high as 3.5% to 5% of the principal balance of the loan paid at closing. If the GP brings on a 3rd party, they will likely offer 10% to 30% of the GP in addition to or instead of a one-time fee.
The size of the fee depends on the risk level of the deal, the risk level of the loan, and – if it is a 3rd party – their relationship with the main members of the GP.
Asset management fee: The asset management fee is an ongoing fee paid to the GP in return for overseeing the operations of the property and implementing the business plan after closing. The fee is either a percentage of the collected income (2% to 3%) or a per unit per year fee ($200 to $300 per unit per year). The size of the fee depends on level of work required to implement the business plan and the experience level of the GP.
I prefer the percentage-based asset management fee, because – since it is tied to the actual performance of the deal – it promotes alignment of interest. An additional way to have alignment of interest is when the GP places the asset management fee in a position after the LP’s preferred return, because the LP gets paid before the GP collected the asset management fee.
Refinance fee: The refinance fee is a fee paid to the GP for the work required to refinance the property. Of course, if the business plan doesn’t include the potential for a future refinance, the GP will not charge this fee. At the closing of the new loan, a fee of 1% to 3% of the original loan amount is paid to the syndicator. However, to promote alignment of interest, the fee should only be collected if a specified percentage of the LP’s equity is returned at refinance. For example, the PPM could state that the GP will charge a 3% refinance fee only if the LP receives 50% or more of the equity investment.
- How do Limited Partners Make Money in Apartment Syndications?
The limited partners in apartment syndications are typically compensated in three ways.
Preferred return: The preferred return is a threshold return offered to the LP before the GP receives payment. The standard preferred return is 8% of their current capital account (capital account is initially equal to their equity investment). That is, the LP will receive a return of up to 8% before the GP is paid. If the apartment community cash flows 8%, the LP receive the 8% preferred return and the GP does not receive a profit split. If the apartment community cash flows less than 8%, the LP receives a return of less than 8% (and the preferred return may or may not accrue, depending on what is outlined in the PPM). If the apartment community cash flows more than 8%, the LP receive their 8% preferred return and the remaining profits are split between the LP and GP.
Typically, the preferred return is considered a return on capital. That is, the preferred return distributions do not reduce the LP’s capital account.
Profit split: If a preferred return is offered, the remaining profits are split between the LP and GP. As I mentioned above, the typical profit splits are either 50/50 or 70/30 (LP/GP). The LP will receive their distributions from the profit split on an ongoing basis during the business plan (if the cash flow exceeds the preferred return) and/or at the sale of the apartment community.
Refinance or supplemental loan proceeds: If the GP refinances into a new loan and/or secures a supplemental loan, the LP will typically receive a distribution that is a portion of their initial equity investment.
Similar to the profit split, the proceeds from a refinance or supplemental loan are typically considered a return of capital. That is, the proceeds reduce the LP’s capital account.
- How do Property Management Companies Make Money in Apartment Syndications?
As I mentioned above, the property management company is a 3rd party provider or is in-house and an arm of the GP’s syndication company. Either way, the property management company in apartment syndications are typically compensated in three major ways:
Management fees: The main way property management companies are compensated is from ongoing management fees. One of these fees is a percentage of the collected income. Standard fees range from 2% to 10%, depending on the size of the asset. Additionally, property management companies may also charge other fees that are not covered by the ongoing percentage-based fee, like lease-up fees, renewal fees, eviction fees, application fees, marketing fees, referral fees, or any other fee incurred on behalf of the GP.
Construction management fee: If the business plan involves interior and/or exterior renovations, the property management company may manage the renovations for an additional fee. Typically, the fee is a percentage of the total capital expenditures budget, with the larger projects having a lower fee.
Equity ownership: As I mentioned above, sometimes the syndicator will offer the property management company an equity stake in the GP in return for a lower ongoing management fee or to simply incentivize them to manage the property as if it were their own. Additionally, if the property management company brings on their own investors or invested in the deal themselves, they will likely receive an equity stake in the GP and/or LP based on the amount of equity they secured and/or invested.
- How do Commercial Real Estate Brokers Make Money in Apartment Syndications?
The commercial real estate broker in apartment syndications are paid in two main ways:
Commission: Commercial real estate brokers are mostly paid from the commissions earned upon the closing of an apartment community in which they represented the buyer and/or seller. The size of the fee varies from broker-and-broker and market-to-market, but a good rule of thumb is between 3% and 6% of the purchase price for apartment communities under $8 million and a flat fee of $150,000 for apartment communities over $8 million.
Equity ownership: In some instances, the commercial real estate broker may have equity ownership in a deal. One example would be if they invested their commission in the deal as an LP.
- How to Attorneys Make Money in Apartment Syndications?
The attorneys in apartment syndications make money from preparing the four main contracts and agreements mentioned above. Depending on the size and scope of the deal and the partnership structure of the GP and between the LP and GP, these contracts may costs a few hundred dollars each to tens of thousands of dollars each.
What is the typical process of an apartment syndication from start to finish?
There are 11 main steps for taking an apartment syndication deal through a full cycle. Below is a list of each of the 11 steps, along with a brief description. For more details on each step, I recommend purchasing our book, Best Ever Apartment Syndication Book, which walks you through the entire apartment syndication process in over 450 pages worth of information
- Select a target market
The first step is for the GP to identify a market in which to invest. This involves analyzing multiple markets across the US via online research in order to narrow it down to a handful of potential markets. Then, the GP performs boots-on-the-ground and more detailed research in order to confirm the markets investment potential.
- Build a team
Once the GP has identified and selected a target market, the next step is to create their local team. As I mentioned above, the main team members are a property management company, commercial real estate brokers, and the limited partners.
A smart GP will obtain verbal commitments from potential passive investors BEFORE they begin their search for deals. It is important to have an idea of how much money they are capable of raising, because that will be a determining factor in the size of deal they can acquire. Plus, having an idea of where the funding will come from will strengthen the GPs position when speaking with property management companies, commercial real estate brokers, and mortgage brokers/lenders.
- Find a Deal
With the team in place and verbal commitments from potential passive investors obtains, the GP is now ready to begin searching for a deal. They will receive on-market deals from various commercial real estate brokers and/or off-market deals as a result of their marketing efforts.
Once the GP receives a deal, they will put it through their financial evaluation process. Typically, this starts by initially screening the deal based on their investment criteria (e.g., number of units, construction age, value-add potential, market, property class, etc.). Then, using the historical financials, assumptions for how they will operate the property, and rental comps, they underwrite the deal using their financial model.
Typically, the GP will set certain return thresholds to determine which deals to submit offers on. The two main return thresholds used are cash-on-cash return and internal rate of return. If the deal meets or exceeds their return goals after completing the entire underwriting process, the GP will submit an offer on the apartment community. If the offer is ultimately accepted, the GP puts the deal under-contract.
- Due Diligence and business plan
Once the deal is under contract, the GP usually has 60 to 90 days until close. During that time, they perform detailed due diligence on the apartment community in order to confirm or update their underwriting assumptions and finalize their business plan.
- Secure investor commitments
Concurrent with the due diligence, the GP will officially secure commitments from their passive investors. This typically involves a conference call or webinar where the investment opportunity is presented to the LPs so that they can decide whether to invest.
- Securing financing
The majority of the purchase price is funded by a lender. So, while the GP is securing commitments from their investors, they are also in communication with a lender or mortgage broker to securing the debt financing.
Assuming the apartment community passed the due diligence phase and the funding (both passive investor equity and debt) is secured, the GP closes on the deal and takes over the operations.
- Execute the business plan
Once the GP closes on the apartment community, they perform their duties as the asset manager and implements their business plan.
Most syndications have a projected hold period and exit strategy. Sometimes the hold period is shorter and sometimes it is longer, depending on the market conditions and success of the business plan. But, at some point, the GP will sell the property, return the LP’s remaining equity, and distribute the profits.
How Can I Get Started in Apartment Syndications?
If you are interested in getting started in apartment syndications as a general partner, I recommend enrolling in my FREE apartment syndication course at www.SyndicationSchool.com in order to learn what it takes to become a syndicator and how to break into the industry.
If you are interested in getting started in apartment syndications as a limited partner, I recommend visiting my passive investor FAQ page or go to www.InvestWithJoe.com to learn more about the investment opportunities my company has to offer.
Want to learn how to build an apartment syndication empire? Purchase the world’s first and only comprehensive book on the exact step-by-step process for completing your first apartment syndication: Best Ever Apartment Syndication Book.
Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.