#116 Real Estate Syndications 101 [How It Works]

Welcome to the Passive Income MD Podcast, where we talk about creating your ideal life through multiple streams of income. I'm your host, Peter Kim. If you enjoy hearing about this stuff, make sure to hit subscribe so I can bring it to you every week. Now let's get on with the show. Hey, everyone. Hope you're having another great week. At the time I'm recording this, I just came back from an amazing family vacation. It was such a good time. But I don't know if you're like me, but sometimes you come back from a family vacation and you need a break, like you need a rest and relax. I don't know. When I'm on vacation, I like to always go, go, go. I know that sometimes people love just sitting on the beach. Me, I don't know, I like going to restaurants, I like being active, I like doing all these type of things. And so just coming back home, sleeping in your own bed and is kind of a luxury. And that's where I'm at now. It feels amazing. But, you know, we're going to be going on another one soon. Again, it's just all about collecting life experiences. That's what I told my kids. My kids were like, where did you read that or hear about that? I said, just remember this, kids, like life is about collecting experiences and banking memories. That's the way I told them. And that's really how I'm trying to live these days. And I hope that's the way you're living as well, too. But today we're going to be talking about real estate syndications and basically, like on a basic 101 level. I know I've talked about it before. I've talked a lot about syndications, what they are, but I'm going to talk about some of the basics, the background, and some of the simple ways that you make money and how it all works. So we're going to be talking about that today, so I hope you enjoy. Now, I don't know how many of you actually invest in real estate out there or you're thinking about it. Maybe you're a landlord, maybe you're not. Maybe you have property management, maybe you don't. That's a mistake, I tell you. But maybe you don't like the idea that you have to deal with major decisions. You got to wake up, there's a plumbing issue. Or if you're like me and you've had some properties where there have been fires, unfortunately, some domestic disputes and things you had to settle, deal with. There are some others like unfortunately not. Some great things that you have to deal with as a landlord, sometimes that you have to get involved. If you have a property management, a good property management in place, they'll handle most of these things. But you still have to be involved somewhat, make some big decisions. If that, if the sound of that doesn't sound that appealing to you, then I know that stops a lot of people from investing real estate. But many of you already know, if you've been listening to this podcast, you've read anything on our blog, anything like that, part of our Facebook groups, you know that there is a passive investing strategy for real estate called investing in syndications. Now I know that this whole concept of syndications is, maybe it's new to some people, but it's been going on for quite a while and not many people know what it is or how it works. So just so you know, a real estate syndication at a, again, simple level, it's a group of two or three or whatever it is, more investors or maybe an investment company coming together for a common goal to raise capital to purchase real estate or build a new property. I mean, the advantage of pulling your money together with other investors is that you can invest in a much bigger, maybe even a better location, a more lucrative deal that otherwise might be too expensive for you as an individual investor. If you're like me, you're in a high cost of living area. Even just getting a two bedroom house is pretty expensive. The amount you have to put down yourself type of loan you'd have to get. Now if you're thinking of a 50 or 100 unit apartment building on your own, forget it right in this area. So it's nice when you can sometimes partner with other people. Either you guys run the syndication or you invest as a limited partner to be able to actually get into some of these properties that you'd want to. So to talk about the history a little bit, there's something called the securities act of 1933. Now we're not going to go into all of the history, but you know the sec, which is called the securities Exchange Commission, the sec, you've heard about that, they passed a rule back then to protect investors from fraud. Because I think that's what we're all worried about as investors. We're worried about getting scammed or our money being, being put at risk. So the SEC has been watching over all of that to try to prevent that from happening, to put rules in place to make sure that when people raise money that things are done in a lawful, in a Disclosed in a transparent, as much transparent as possible way to make sure that it is done effectively and people don't lose money. Right. The government doesn't want that. So the SEC actually has made it pretty difficult for people to be able to raise money. You can't just go out there, put a sign out there and just raise money necessarily for these type of deals. Now, there are some exemptions that the SEC put in place that allowed for people to raise money through private solicitation or like just people that you knew that you can avoid some registration going through a lot of these hoops by people that you knew because they expected that if you know someone, you can trust them. Maybe you know where they live, you know, their family that you know. Again, these circles are tight. Then it's okay to maybe raise money from that type of circle. That's why a lot of these deals in the past were known as country club deals where you had to actually know somebody. And these rules were pretty strict, actually, some of them, like you have to know somebody for at least 30 days, blah, blah, blah, like at least document it, these type of things. And so that was one way that the SEC allowed for people to raise money. The other thing is that people would have to register with the sec. They got to wait for approval, do all this type of paperwork, and then they can go out and solicit public funding, meaning they can go out to people maybe that they don't have a tight, close relationship with. Now, the first one, that first option, raising money through people that you knew, always seemed a lot more efficient for sponsors. So that's what typically you saw. So many doctors especially that are not in the real estate world. The only way you'd hear about these things oftentimes were through a friend, somebody who had invested and done well again, or if you belong to a country club and you heard about it in one of these rooms while golfing or these kind of things, because again, these things were not allowed to be advertised publicly, especially not on like things like social media and things like that. Now, the overall solicitation rules that actually changed back with something called the jobs act of 2012 when President Obama was in place, actually it allowed investors to participate in, in these deals as long as certain criteria were met and that each investor was accredited. Now, we've talked about what an accredited investor is in the past, but again, just to do a quick recap, and these are some of the basic rules that you have to have an annual income of $200,000 for the past year. Sorry, for the past two years or $300,000 if you are with a partner. You put that together. Now that's one way to qualify. The other way is to have a net worth of at least a million dollars, excluding your primary residence. Now those are two of the, I mean, there's a bunch more rules, but these are the two basic ones. It's not like they send you a letter of certificate, that sort of thing, but when you go to invest in these deals, they're going to ask you, are you an accredited investor? They're going to ask you, how are you an accredited investor? By how, meaning how do you qualify for it? And then they want that basically validated by some sort of third party, meaning that your accountant, you're, your financial advisor, will likely sign on that little letter. Now if you're with somebody like a financial advisor, an accountant that's very familiar with real estate, they know these letters come and go. They just sign these things off as long as you qualify and you are actually considered an accredited investor. So again with the JOBS act, it allowed for a lot more public advertising and promoting of these deals, which is why so many of you have probably heard about, you know, real estate syndications, like recently. Maybe you're like, I never heard of these things before. Or you never saw ads on Facebook for it, or you never heard of crowdfunding companies Again, a lot of that started with that 2012 act. Now how does the syndication, what's like the box like, how does, what is the framework for how these deals work? Now just so you know, it's a legal transaction between two parties. Now either the sponsor, which is, you know, might be also called the syndicator, or the general partner, that's one side and then there's the, then there are the investors, the limited partners. Just so you know, legally a syndicate might be structured as a limited partnership or what I find more common, something called an llc, meaning a limited liability company. So this deal is all housed within one single new corporation, an llc, limited liability corporation or company. Now who are the sponsors, who are the general partners? Their role is to really scout out that property. They're going to seek funding, they're going to manage day to day operations while the investors provide the majority of the finances, the capital, the investment to actually make it happen. Now this sponsor, they should have the experience in real estate investing and the ability to underwrite, meaning that they're able to look at a deal, understand how it's going to work, come up with a business plan, do the due diligence find all the pieces and the resources necessary to make it happen and then present this as an opportunity to, to likely you. Right. The limited partner. Just so you know, the sponsor usually does invest some of their own money somewhere between 5 to 10 to 15% of the total required equity. Now the rest again is brought to the table by the investors. Now you want to see that the sponsor has some skin in the game. They want to put some money in of their own that they put at risk. Now to be honest with you, the most thing that they have at risk is reputational risk and the fact that if the deal does not go well, they're probably not going to make a good amount of money as well. So they're, they have something at stake no matter how much they put in. But you like to see them put oftentimes at least about 5% into a deal. Now how are you going to know what the structure and the framework for all of this is? You're going to get something called a PPM or a private placement memorandum. You're going to see, it's a huge hundred plus document, a piece of paper that outlines all of the rules in place, all the structures, all the disclosures and everything in there. But all of that should house all of the information that you need to make a good decision, whether this makes sense for you or not, and what your legal rights are as an investor. But just to be honest with you, as a limited partner, you don't have decision making rights. I mean that's really why you're investing with a sponsor, that you trust them to make all those good decisions that you know will work out best for the company which you are a part of and will work out for them and for you and, and that everyone will make money at the end of the day. Hey, I wanted to jump in real quick and let you know that our wait list for Passive Real Estate Academy our next session is now open. We only do this two times a year where we teach people how to confidently invest in real estate syndications and funds in four weeks. And not only that, you join a community of like minded people learning to do this all together. And then you're part of our platinum investor club for life. We share deals, look over deals together, share resources and help each other get where we want to be. If that sounds interesting to you, go to passive real estate academy.com join our waitlist. You'll be the first to be notified when our course goes on sale. And just so you know, there is a discount for our waitlist. Members and some other goodies that we throw in. So go ahead and head over to passive realestateacademy.com join our waitlist. There's no obligation. We love to see you there. Thanks. Now, I know that many of you have heard of something called a real estate investment trust or reit, and you're wondering what is the difference between a syndication and a reit? Just so you know, a REIT is kind of modeled after mutual fund that owns, operates or really funds these income generating properties. They offer a steady stream of income, they pay out dividends to their investors, but oftentimes they're just traded like a stock on the public stock market. They go up and down with the stock market. And if you're looking for diversification from the stock market, you often don't get it with REITs as much because people do sell and buy these things on the public market based on fund parameters. And so you find that these things correlate quite a bit with the stock market. And whereas oftentimes we're investing in real estate because we want that diversification. And just so you know, when you invest in a trust, you don't actually own the property yourself, meaning that you're not part of the ownership. You, you're actually owning a stock of the company that owns these rent, these properties. So it's a little bit different from somebody like investing in a syndication where you actually own a piece of the property. Now if you look at any of my K1s at the end of the year, the tax statement that comes as a limited partner in these investments, you see your actual ownership percentage in that actual building or that fund or whatever it might be. So the way you participate in some of the taxes, the way you participate in the profits and distributions are all a little bit different in a syndication versus a reit. Now, I know many of you have heard of real estate funds. You might be wondering how is a real estate syndication and a fund different? And for those just to make it quite simple, if you think about a syndication as like a single investment in a single property, that's probably oftentimes the easiest way to think about it. And you think of it as a stock. Then a real estate fund is like a mutual fund, meaning that it's a basket of investments. You invest once and you own a bunch of different properties out there and those properties get sold over time and you as an investor have a piece in all of those. So there's a different strategy that a syndicator has to have in place when they run one single property versus run a fund. But for you as an investor, it should feel the same in some ways because you're investing once and you're owning real estate. The big question with syndications, though, is when you make these type of investments, people ask me all the time, how do I make money? Now, when you own your own properties, you're a landlord, you charge rent, you get rent back, you have to pay off all the expenses like the mortgage, maintenance, your property management, and then what's left over for you is ultimately your profit. And I know that that's a little bit easier to conceptualize, but when it comes to these syndications, oftentimes they're advertised or marketed with these numbers called irr, or internal rate of return, an equity multiple. And you're like, how do I actually make money from it and what does it look like? And so I wanted to go through that just for a few minutes to outline what it might look like for you as an investor. And so how do these properties make money? By two ways, really. By income, right? These profits that we've talked about, and then property appreciation or the increase in value. Now, it's important to understand what the goal and the business plan of the sponsor is. You know, is this the development deal where they're going to go in, build a property in a couple years? Obviously there's no cash flow from it because there's no rental income. And three, four, five years down the line, they're going to sell this for a lot of money and distribute it among to all the partners. Is that the strategy, or is it a strategy where they're going to buy an apartment building that maybe hasn't been optimized, hasn't been greatly managed, or the area has gone up quite a bit, Maybe the rents have lagged, where they're going to go in and buy this property, fix it up a bit, bring it up to market rents, you know, increase the operating income. Either they're going to make more money from it, and then ultimately down the line, they're either going to continue to distribute profits to investors or they're going to go and also sell the property somewhere down the line and everybody gets to participate in the profits as well. So I will tell you that most people, I'm going to guess, when you're looking at a syndication deal, they really fall into those two categories. So let's talk about redevelopment deal real quick. Means that you're going to invest your money on the front end and somewhere between three to five to seven years it's important for you to know what that timeframe is. Your money is going to be put to work basically developing and doing the construction of the property. You're going to watch and get reports probably every quarter about how things are moving along with the construction and development and how the area in the market is doing as well. So in terms of expecting any sort of distributions on a quarterly or yearly basis, forget it. When it comes to development, expect that you're going to put it in, and somewhere down the line, three to five, seven years down the line, you're going to, hopefully, when they go to sell this property, you're going to. They're going to have a nice big pot of profit that comes out. It's going to get distributed according to whatever is the waterfall structure, meaning that they have a structure for how the profits get paid out. It's important to note that there are some fees involved. You know, you're going to get your money back. You're going to get paid a something called a preferred return, meaning that they have to promise to at least give you a certain amount of profit first before they start participating in that profit. And then they're going to split it somehow between you and them and you're going to get paid. And at the end of the day, all of that is a projection down the road what that profit margin will be, how much they'll get paid as sponsors when they sell the property, and then how that gets distributed to you as limited partners. And they do all that and put that all together, and they come up with something called an internal rate of return. Essentially, that's a rate of return that comes to you at the end of this entire deal. And they should be able to tell you how much money they expect you to make off your $50,000 or $100,000 investment, whether that doubles in time 1.72 times, whatever that might be. So it's important for you to note that as an investor now, I'm guessing that the majority of you going to be looking at a deal where they have a performing property, meaning that there's a property that's up and running, and they're going to go in there and improve it. And so what's going to happen probably in the first couple years of that property is that the capital that they have, it's going to go into investing into the property, meaning that they're going to have to go in there and they're going to have to do some renovations, they're going to have to fix things up. As people leave, maybe as they increase rents, people leave and find different places to live. They've got to go in there and renovate that apartment unit or whatever it might be. And that takes cash. And so for the first year, year and a half, I will tell you that the majority of these deals don't produce a lot of cash flow for you as an investor. But once they get those units turned, once they get those rents up to market value, then those things start producing income, and then they'll start distributing that to you as an investor. Now, just so you know that over time, even though they're not paying you distributions, so it's not like you're not getting a return, you're actually getting a return, but it's just on paper, they're storing that up for you, and they'll eventually pay you back and may make you whole whenever they start doing distributions. So I'll say the typical timeframe is that for the first year, year and a half, you're, you know, you've invested, you're wondering what's going on. Hopefully they're doing well. They're putting money back into the property to fix it up. And then again, about 12 to 18 months down the road, you're gonna start getting quarterly distributions. And eventually they're gonna continue to increase the property. When the time comes, they're gonna find the right time that makes sense for everyone in the market. They're gonna go ahead and sell this property. So you're gonna have gotten cash distributions along the way, and. And then you, hopefully you're going to get a good pot of money. At the end of the day, whenever they go to sell this property, I will tell you that the market these days for these type of investments, you'll see it marketed at something like a 12 to 15% internal rate of return. You know that you expect to get anywhere between 1.5 to 2 times your money, depending on how long they held this property. Now, development deals oftentimes tout a higher rate of return because there's a little more risk in it. You're not getting quarterly distributions. They're building something from the ground up. They don't know what it's going to be like when it comes time to sell, what the market's going to look like. There's inherently a lot more risk involved in these type of deals. So you can actually see the rate of return match or the expected return match, that higher level of risk. So when you go to build your portfolio of these investments, these limited partnerships, and you go to invest in all these deals, it's important to look at the risk, look at the return, look at what you already have in your basket of investments, and try to put all that together into creating a nice portfolio that ultimately creates the cash flow that you need to live life how you want. Now, what's nice about investing in these syndications is that you just, you can invest a smaller portion in each of these. So you're able to create really nice diversification in your portfolio when it comes to real estate by investing a piece here, investing a piece here. It's important to find great sponsors that you trust, because that's what matters at the end of the day. Do you trust them to go through the business plan? Do they have the track record to be able to do so? And then after you do your due diligence and you invest, really the only thing you're expected to do is to read the quarterly reports, get your distributions, make sure they're coming your way. And then when these deals go full cycle, meaning that they go and actually sell, it's your job to figure out where to put that money next. Obviously, there are some pros and cons to owning your own properties versus investing in these syndications. But it ultimately depends on your goals, your interests, how much time you want to spend on these investments, and then what it looks like in terms of your overall experience, knowledge, and then ultimately what's important to you in terms of your time. Remember, you don't have to choose one way or the other. It can be both, a little bit of both. I'll tell you personally. Now from my own experience, I do own some of my own properties. I have a portfolio that actually has gotten smaller over time. I've actually sold off some of my own investments because it was just taking up too much time. And there's only so much of a box that I was willing to put in terms of allocating my time to some of these investments. But I like my portfolio and current investments. I have it. Many people know that I invest in a short term rental and that was fun too as well. But I only have a small amount of time and energy that I'm willing to really allocate to these things because honestly, I want to be out there. I want to be out there, you know, on vacation. I want to spend my time doing the things I love. I don't want a second job. So I make sure that my own portfolio stays within that little box. And the rest of my capital, honestly is really spent on investing in other syndications. In other deals where I expect total passive investing. Hope that was helpful for you. That was a quick little summary. Like any investing, just so you know, the most important part is making sure that you do the necessary due diligence, making sure that you understand where your money's going and who you're investing with, and then ultimately how that money and how that investment will help you get closer to your goals. I think that's probably one of the biggest mistakes I see in people investing today is that they're investing in all these type of things. When I ask them, I say, is this helping you get to where you want to be? They actually say, I don't know. They don't know how it's going to help them get there, how soon it's going to help them get there. So just make sure when you look at these investments that you know those things, you put everything in terms of that context. In any case, have an amazing week. Let's talk again soon. Enjoy the show. Let me know by dropping a review in the podcast app you're listening to us in. And if you haven't already, make sure to hit subscribe. Are you part of our community yet? Join thousands of physicians who are also on this journey to creating their ideal lives through multiple streams of income. You can join us on our Facebook group PassiveIncome Docs, and you can always learn more at our website, passiveincomemd.com thanks again for allowing me to be a part of your journey. See you next time.