Real Estate Syndication

Real Estate Syndication

There are a number of ways to invest in real estate but there is one absolute requirement regardless of the vehicle used for that investment…readily available capital.

Creating a program to acquire properties through ’syndication’ can be one of the surest ways to make a real estate investment program successful.

Syndication in real estate investment is a way to channel private money into property acquisition and development when other financing such as an institutional, conventional mortgage is not available. It is particularly popular for use in dealing with properties in the higher price ranges.  It is generally used in connection with commercial, industrial or development properties, but with the increase in residential property values over the past 10 years it is becoming attractive in that arena as well.

A  “syndication” has no precise legal standing. It is a term used to describe a group of investors who pool capital for investment…in this case in real estate. The responsibility, obligation and relationship of the syndicator to the investment group and the investors to each other are determined almost entirely by the form of organization used for syndication purposes (limited company, partnership etc.)

Syndication Pro-forma

The pooling of funds in a syndication…through numerous investors…with those funds to be used for real estate projects gives rise to various ways in which a syndicator can realize income.

  • Acquisition Fees

A syndicator of real estate project can usually expect to be compensated for finding the property to be acquired, conducting appropriate due diligence, and structuring the deal for the investors.

An acquisition fee can be in the form of a flat amount (i.e. – $100,000) or it can be a percentage (i.e. – 3% – 5%) of the property acquisition cost.

Fees are generally negotiable with the investors but must be managed appropriately to avoid alienating any of those investors who might interpret and overly large fee to be a ‘cash grab’.

 

  • Management Fees

It is common for a management fee to be paid to a syndicator who then must manage not only the property but the syndicate entity as well.

Generally a management fee will be in the range of 1% – 2% of gross value calculated annually and paid monthly, again subject to approval by the syndicate investors.

Managing the property means ensuring that all ongoing operating costs are looked after in a timely fashion, or if the property is undergoing build-out or renovations, that these costs are completed on time, in accordance with specifications and within budget (hopefully).

Managing the property is only one responsibility…the syndicator must also manage the syndicate.  This means regular informational contact with investors, payment of all required compensation on a timely basis etc.

  • Equity Participation

Oftentimes a syndicator will have a carried “equity” participation in the property and the resulting project.

This participation is subject to negotiation with, and agreement by, all of the syndicate investors and gets paid when the project completes and is crystallized…usually through a sale.

In almost all cases, investors receive a preferred rate of return (typically 8% – 12%) on their invested capital. This return is paid on an ongoing basis through the term of the project based upon whatever terms and conditions the investment carries.

Any surplus (cash flow and/or equity) remaining after all investor capital, investor interest and other priority costs have been paid will be split between the syndicator and the investors on whatever basis was agreed when the syndicate was established.

 

Example:

A property purchase with a development project over a term of 3 years

Property purchased                              $20,000,000

Acquisition Fee 5%                                 $1,000,000

Management Fee 1% x 3 years               $600,000

Construction costs (incl. fees)             $30,000,000

Investor Interest

(8% on $41,667,000 avg. x 3 years)  $10,000,000 (rounded)

Total Project Cost                            $61,600,000

Property sale price                                $75,000,000

Project Profit                                           $13,400,000

Investor split @ 50%                               $6,700,000

Syndicator split @ 50%                        $6,700,000

Total Syndicator Revenue                     $8,300,000

Total Investor Revenue                                    $16,700,000

Investor ‘cash over cash’ Return                13.36%

The foregoing example is for illustrative purposes only.  It uses arbitrary numbers, it does not consider the “time value” of money, and it does not consider tax or other regulatory issues that might affect absolute return. It is designed primarily to reflect the expected cost elements of a project and the potential revenue sources for a project syndicator.

One element to the syndication process that has to be paid particularly close attention is the Securities Act requirements in each jurisdiction in which investors will be sought.

Care will have to be taken that the investment instrument…most likely an Offering Memorandum (“OM”)…has the blessing of the Securities Commission in each Province in which investors are sought and it is almost certain that a seasoned securities lawyer will have to provide a formal opinion that the OM passes muster.

In addition each investor will have to comply with the investment restrictions in his/her Province of residence

It is most probable that there will be reliance upon the “accredited investor” as that term is defined under the Securities Act in the various Provinces.  Documentation will have to be executed and due diligence undertaken in order to ensure that the accredited investor exemption is properly relied upon.

Now, having said all of that, I believe that there are currently…and there will be for at least the next 5 – 10 years…some significant syndication project opportunities in the South Surrey, North Surrey, Langley and Abbotsford markets.

I am less enthused about the markets north of the Fraser River…New Westminster, Coquitlam, Maple Ridge, Mission etc.

 

Future Opportunities

If we are serious about finding opportunities to create and operate one or more real estate syndications we have to start preparing as quickly as possible.  We have to create a “game plan” for activities to develop all facets of the first syndication.

  • Development

Looking at Surrey alone there are three primary future development areas recited in the 2016 OCP – South Port Kells, Clayton and Grandview Heights.

These areas primarily feature development as follows:

  • Port Kells –           commercial/industrial
  • Clayton –           commercial/residential
  • Grandview –           commercial/residential

 

  • Transportation

The 2016 OCP features proposed development/redevelopment or improvement of transportation (i.e. – rapid light transit or SkyTrain along:

  • Fraser Highway
  • King George Boulevard

It stands to reason that there will be significant redevelopment opportunities along both of these routes, particularly in the areas adjacent to proposed stations.

  • Town Centres

Several town centres in Surrey are the focus for future development/redevelopment, including:

  • Cloverdale
  • Fleetwood
  • Guildford
  • Newton
  • Semiahmoo

A quick look at the existing improvements in each of these town centres reveals stock that is in serious need of upgrade or replacement over the next several years, meaning significant opportunities.

Summary

There is a fairly well-defined protocol for setting up a real estate syndication.  The steps in this protocol are generally:

  • Research and find an available property, or a number of properties that could be part of a land assembly, in a particular neighborhood and arrange to purchase it or them.
  • Prepare a preliminary property analysis including its operating history (if applicable), physical condition, title status, environmental or natural hazards, neighborhood characteristics, the local and national economies, and future development opportunities as recited in the municipal OCP
  • Option the property(ies) to gain control with the ability to assign the options to a successor entity (the new syndicate group).
  • Conduct a complete and thorough due diligence. Analyze applicable financial records and confirm all disclosures including the condition of the property, its improvements, location, title, and operations. Use the services of a commercial lawyer to be absolutely sure respecting title, encumbrances, etc.
  • Apply for new debt financing (or assume the existing financing) in the event that the purchase will not be all cash. The amount of financing being sought should be a function of the contract purchase price, not any other value.
  • Create the ownership entity (the syndicate) and choose the form of that entity (i.e. – limited company). Make sure the entity is properly created, has a fully detailed minute book and uses the service of good accounting and legal advisors.
  • Prepare the Offering Memorandum, Subscription Agreement, Articles of Organization and Operating Agreement for the limited company, pertinent exhibits, and Addenda. Ensure that the syndicator is named as the Manager of the project in these documents.
  • Market the Offering Memorandum to potential investors in the manner approved by the relevant Securities Commission. Take advice from an experienced securities lawyer as part of this activity.
  • Pool all of the investors. Once you have approved the investor’s suitability, (the “Know Your Client” requirements) get Subscription Agreements and their purchase amount delivered on an “In Trust” basis.
  • When syndicate funding is complete, get ready to complete the property purchase, executing loan documents if part of the purchase price will be financed.
  • The Syndicator, in whose name the property is purchased, now assigns the right to purchase the property to the syndicate entity in an amendment to the purchase contract prior to the close. The property now vests in the name of the syndicate entity and the Syndicator gets his ownership percentage in the entity (to be crystallized on liquidation of the project).
  • The Syndicator sends copies of the closing documents to all of the members of the syndicate, along with other organizational documents .
  • The Syndicator now assumes the role of the partnership manager. The Syndicator oversees the property on behalf of the syndicate, executing the business plan.
  • Distribution of cash flow and regular reporting is delivered to all the investors on regular periodic periods. Regular meetings are held to inform and update investors on the status and progress of the investment property and to make major decisions, such as add or replace investors, refinance, or sell the property.
  • When the property is finally sold, the Syndicator manages that process including:
    • Hiring a real estate broker  to sell the property
    • Negotiating purchase offers and coordinating closing proceedings
    • Providing disclosures and reports during the closing
    • Making final profit distributions to investors
    • Winding down and terminating the syndicate entity.

 

Any undertaking of this sort will require a “war chest” to cover all preliminary costs as part of getting the syndicate formed, running and the project funded properly.

The war chest will represent “risk” money at the outset but arrangements can be made to have the funds repaid in priority to all other settlements when the project is crystallized and the property sold.

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