OVERALL SYNDICATION LIFE CYCLE
You may understand what your role is in a real estate syndication as a passive investor but there is still some fog about what exactly happens in a real estate syndication. You may be thinking “what are the active investors doing and why are they charging fees for that service?” Or, you may be wondering “what happens before I get presented an investment opportunity?”
Knowing the overall real estate syndication cycle is important as it gives you the big picture of what is happening during the deal. As a beginner investing in real estate syndications this is important information. If you understand the full cycle, you can clearly identify what part of the cycle the syndication is currently in and appropriately adjust your expectations and actions to be in line with that phase of the cycle.
So, what are the overall phases of the real estate syndication cycle? The phases of a real estate syndication cycle are split into 2 major sections – The Assessment of the investment opportunity (steps 1-4) and The Operation of the property (steps 5-7). Passive investors join the cycle at step 3. The phases of a real estate syndication cycle are as follows:
The Deal Sourcing
The Business Plan – Stabilization
The Business Plan – Post Stabilization
The Deal Sourcing
Deal sourcing starts long before the passive investor is even aware of an investment opportunity. Deals are sourced via months, even years, of relationships built and work done by the syndication group. Syndicators can get deals via two main channels – brokers or direct from the seller. When a deal is direct from the seller it may be a deal that was marketed to the public at large or based on the relationship with the broker the syndicator was able to get a first look at the deal and purchase it with limited competition from other syndicators. When the syndicator is going direct to the seller the deal is likely “off-market” and not publicized for other syndicators to see. The syndicator likely obtained knowledge of this deal via relationships built or marketing efforts to solicit a ready and willing seller to work with them.
Once the deal is found the next step begins; the syndicator needs to assess if the deal is good or not. The syndicator will perform an initial underwriting (creation of financial estimates about the expected future performance of the investment property based on current knowledge) and visit the property. Based on the underwriting completed by the syndicator, they will make an offer on the property. If the offer is accepted a purchase and sale contract is executed then the syndicator group will do a deeper review to discover if their estimates and expectations are valid based on the current condition of the property.
The discovery phase typically takes 30-60 days depending on the specifics of the deal and the speed of each party involved in completing their tasks. During the discovery phase the sponsor team will perform due diligence on the property which includes reviewing the physical, financial and operational condition of the property. This may require hiring third party companies such as inspectors and appraisers. The sponsor team will also work with their local property manager on site to review their business plan and refine their underwriting based on the results of the due diligence. If necessary, the sponsor team will renegotiate the purchase price to account for issues identified during due diligence. If due diligence goes well and the sponsor team decides to move forward with the purchase, the syndication moves to the next phase of bringing in passive investors.
The offering stage of a syndication takes 30-60 days. Once the syndicator is certain that they plan to move forward with the purchase of the property they will engage a securities attorney to create the legal documents needed for a syndication. This will include the Private Placement Memorandum, Company Operating Agreement and Subscription Agreement.
Private Placement Memorandum (PPM) – this is the official offering for investment in the syndication opportunity. It is a lengthy legal document of over 100 pages about the investment opportunity. Some of the important sections you should review are the related syndicator fees, business plan details and risks associated with the investment.
Company Operating Agreement and Articles of Incorporation – this shows you the entity that is being set up for the purchase of the property and the related rules it will operate by.
Subscription Agreement – This agreement details the “securities” or “shares” of the company you are going to buy as investment in the syndication.
The syndicator will also create a marketing package called an Offering Memorandum (Offering Circular or “OM”) that highlights all the pro’s and con’s of the market, the investment opportunity, the business plan and the sponsor team leading the deal. This OM will be used during an online investor webinar (usually available for playback) where the investors will have the opportunity to learn about the syndication opportunity and to ask any questions they have.
At this point passive investors can make an initial non-binding indicator of interest called a “soft commitment.” During the offering stage the passive investors will have time to ask questions of the sponsor team, visit the property or whatever they need to do in order to become comfortable and ready to invest in the offering. Once the investor is ready to invest, they will execute the legal documents (PPM, Company Operating Agreement and Subscription Agreement) and then wire in their investment funds to an escrow account as indicated by the sponsor team. Most syndicators request that funds be in the escrow account 30-14 days prior to close so that the close process can occur smoothly.
The expected closing date is disclosed in the offering documents once this date occurs the funds in escrow are used to complete the purchase of the property and ownership exchanges hands. At this point the action is just getting started. The syndicator will have to work with their property management group as they take over the property from the previous property management company and start to implement their business plan.
The Business Plan – Stabilization
It is very likely that the property that was purchased was underperforming or in need of some sort of repairs. Based on the plan discussed during the offering stage the sponsors will work with their property management team and oversee the execution of the business plan to get the property to their desired state. This may include an extensive interior and exterior rehab plan, change over of tenant base, implementation of new revenue generating or expense decreasing programs or other activities. Even if the property is in good shape at take over at a minimum there will be some stabilization time needed as the property transfers from one management company to the other.
During this stabilization passive investors may receive cash flow distributions month 1 or even later after several months to a year depending on the nature of the business plan discussed in the offering stage. There is no work required of the passive investors; they will receive periodic (monthly or quarterly) updates on the property. Updates will usually occur more frequently during the stabilization period as there are more significant changes occurring on the property.