Real estate syndication is exploding in popularity due to benefits like:
- Access to unique deals,
- Ease of investing,
- High return potential, and
- Professional management of your investment.
If you’re unfamiliar with the term syndication, it is similar to crowdfunding. Multiple investors pool funds to finance a real estate project, which is professionally managed by a project sponsor. However, syndication offers a more stable ownership structure, with each investor becoming an equity partner in the LLC that owns the underlying real estate.
As more investors learn about the opportunities presented through syndication, there is also growing interest in the potential mistakes that can be made when investing in syndication.
In this article, we’ll explore the top five mistakes to avoid in real estate syndication so you can enter this investment model with confidence.
Mistake #1: Assuming All Syndication Sponsors are the Same
The success of your syndication investment largely depends on the competence of your real estate sponsor. The sponsor is responsible for tasks like:
- Pre-vetting projects and choosing only the ones with the greatest potential.
- Forming the property’s ownership LLC or Trust in accordance with SEC requirements.
- Coordinating the team of architects, developers, builders, contractors, designers, and landscapers.
- Securing strategic financing for the benefit of all investors.
- Managing the process by supervising the acquisition, construction, and sale or rental of the completed project.
An incapable or inexperienced sponsor can make expensive mistakes that affect investor profits. But a strong sponsor can use streamlined systems, economies of scale, and industry connections to improve the project’s bottom line and make more money for investors.
- A trustworthy team
- A proven track record
- Transparency in projections and fees
- Solid communication
- Adequate legal regulation and investor protection
Mistake #2: Failing to Evaluate Individual Deals Properly
Once you find a solid sponsor, you can choose a project or multiple projects to invest in from their investment opportunities. Don’t just choose any project. Evaluating syndication deals carefully is critical.
As you analyze the sponsor’s offerings, consider the following:
- Investor requirements. Do you need to be an accredited investor? Can you meet the investment amount minimum? Does the proposed timeline work for you?
- Location. Are you comfortable investing in the neighborhood where the property is located?
- The projected financials. Do the numbers make sense? Do the expenses and profits seem reasonable based on whatever experience you have in the market?
- ROI estimates. Is the estimated ROI (return on investment) satisfactory? If you’re comparing multiple opportunities, pay extra attention to the annualized ROI, which will help you compare returns from investments with different timelines.
Mistake #3: Glossing Over the Investment Structure
The investment structure outlines how the deal is organized and managed. You can’t assume that all syndication deals are structured the same way. Understanding how your chosen investment is structured minimizes confusion and avoids misunderstandings.
There are three key components of the structure to consider:
- Debt vs. equity. Is the deal equity-based or debt-based? If it is equity-based you serve as an owner with rights to share in any profits generated. You may also be entitled to tax benefits of syndication ownership. If the deal is debt-based, you service as a lender rather than an owner, with rights to the predetermined rate of return. Equity is generally a more lucrative deal than debt.
- How ownership is held. A stable ownership structure typically has the property held by a trust or LLC in which investors are limited partners (LPs) and the sponsor is the general partner (GP).
- How profits are calculated and when proceeds are disbursed. The sponsor is typically entitled to carried interest as payment for their service in securing and managing the deal. The deal should outline the sponsor’s fees and show how investor proceeds are calculated. It’s also important to confirm when your initial investment plus any profits will be returned to you and how those funds will be received.
Mistake #4: Failing to Diversify
One impressive benefit of syndication investing is that each project offers comparatively low minimum investment amounts, which allows you to distribute your investment capital across multiple projects.
For example, you might find a multi-family development opportunity with a $25,000 minimum and $250,000 in remaining funding needed. If you have $100,000 to invest in real estate, you could invest the entire amount in this one project. But then all your eggs would be in that one basket. Instead, consider investing $25,000-$50,000 in this project and investing your remaining capital in another project or multiple projects.
This diversification protects your portfolio from an unforeseen underperformance of any single asset.
Mistake #5: Over-Investing (In Terms of Money or Duration)
It is important to make sure you are comfortable with the amount of money you’re investing in a syndication project andthe amount of time you’re committing to.
Many syndication projects offer comparatively short time-frames, providing increased liquidity over traditional real estate investing. For example, a single-family flip might take only 10-14 months to complete, allowing you to liquidate the investment in under two years.
However, there is not typically a mechanism for liquidating a syndication investment before the project is completed. So, if you may need access to your capital before the project can be completed, you may want to look for an opportunity with a shorter time frame or lower minimum investment so you can retain access to the cash you may need.
Avoid Common Syndication Mistakes with Gatsby Investment
Gatsby Investment is a trusted real estate syndication sponsor with a proven track record of success.
Our long-standing industry relationships and propriety software solutions allow us to secure deals with high return potential under favorable terms and complete the projects efficiently for our investors.
You can leverage our experience to minimize your risk and increase your return potential! Avoid making common real estate syndication mistakes by investing with Gatsby today!