Preparing to venture into real estate investing involves a critical initial step: defining your investment objectives. What do you aim to achieve with your investments? Are you seeking passive income to match your current earnings, or are you focused on building a retirement fund?
Are you seeking additional passive income to supplement your earnings, or are you looking to build a substantial nest egg for retirement?
Your investment capital and time availability are critical in selecting the most fitting real estate opportunities.
Investing in a real estate syndication entails relinquishing some control over the investment while pooling funds with other investors to acquire substantial properties, such as a 300-unit apartment complex. Although syndication relieves you of typical landlord responsibilities, the structure of the deal significantly influences how returns are distributed.
So, when evaluating real estate syndication deals, what factors should you consider, and how do you determine the most suitable deal structure? Let’s delve into the key component of syndications—the deal structure—and its implications for passive investors.
Why Real Estate Syndications Are Structured Differently
Just like snowflakes, each real estate syndication deal is unique. Factors such as market conditions, asset types, sponsor preferences, and property location contribute to variations in syndication structures. Before committing to an investment, it’s essential to ensure that the deal structure aligns with your investment goals and risk tolerance.
There are two common real estate syndication structures: The Straight Split and The Waterfall.
Real Estate Syndication Structure #1 – The Straight Split
In this type of deal, all returns, including cash flow and profits from property sales, are distributed at the same percentage. For instance, an 80/20 split means that 80% of all returns go to limited partner investors (passive investors), while the remaining 20% is allocated to general partners (the syndication team).
Example of The Straight Split: Imagine an investment that generates $100,000 in profit. Under an 80/20 split, you as a passive investor would receive $80,000, while the syndication team gets $20,000.
Real Estate Syndication Structure #2 – Waterfall
The waterfall structure involves a preferred return (“pref”) arrangement. Passive investors receive all returns up to a specified percentage—often referred to as the preferred return—before general partners receive distributions. Beyond this threshold, returns are split according to predetermined percentages, activating a new split for each incremental return.
Example of The Waterfall Structure: Suppose there’s a 6% preferred return on a $1,000,000 investment. The first $60,000 is distributed entirely to investors. Beyond this, if there’s an additional $40,000 in profit, it might be split 70/30, with investors receiving $28,000 and the general partners getting $12,000.
Choosing the Best Real Estate Syndication Structure
Neither the straight split nor the waterfall structure is inherently superior; the choice depends on the specific deal and your investment objectives.
When The Waterfall Structure is Better
If you’re eyeing bigger gains at sale, a Straight Split could be more appealing, offering a larger share of the eventual profits.
For investors prioritizing ongoing passive income, a deal with a preferred return (waterfall structure) may be preferable. While such deals offer greater cash flow distributions throughout the project lifecycle, returns at the asset’s sale may be lower.
When the Straight Split is Better
If steady income is your aim, a Waterfall structure with a preferred return might suit you better, providing consistent payouts throughout the project.
Investors focused on long-term appreciation and profits at the asset’s sale may favor syndication deals with a straight split. While these deals may offer higher profits upon exit, ongoing cash flow distributions may be lower.
Using Your Investing Goals to Determine the Best Structure
If your goal is to generate consistent passive income, a deal with a preferred return (waterfall structure) might align better with your needs. Conversely, if you prioritize long-term appreciation and profits from asset sales, a straight split deal may be more suitable.
Ultimately, there’s no one-size-fits-all approach, and the choice between syndication structures depends on your unique investment situation and objectives. By aligning the deal structure with your goals, you can maximize the potential returns from real estate syndications.
As always, consider various factors and prioritize your goals when evaluating syndication deals.
