What is Apartment Syndication?
Apartment syndication—how does it work, and why do investors use this strategy to buy apartment buildings and accomplish the goals outlined in their business plan? It's simple. Apartment syndication allows individual investors the opportunity to pool their resources and invest in more significant apartment buildings or communities. Without a group of investors coming together to complete a deal, it would be too risky or expensive for an individual to purchase by themselves.
That's why apartment syndication is an incredible opportunity for qualified investors to participate in large real estate deals. People who would like to be passive investors can benefit from other investors' expertise and financial resources. Plus, they achieve steady returns that may not be possible with smaller residential apartment deals. Let's discuss everything you should know about apartment syndication and how you can start on your journey to becoming a passive investor in a group investment opportunity. Let's begin!
The Fundamentals - Who Are Qualified Investors?
By law, every individual cannot passively invest in an apartment syndication deal. It's a unique opportunity that's only available to certain types of investors. If you are an accredited investor or a sophisticated investor, then you have more opportunities to invest in real estate syndication deals.
Limiting passive syndication investment opportunities to these classes of investors ensures that non-experienced investors don't take too much of a financial risk for their income or skill level. What exactly are accredited and sophisticated investors, and how are they different from your average person who invests in a 401(k) for retirement? Here are the definitions of both types of investors:
Accredited investors have an annual income of at least $200,000 for individuals and $300,000 for couples. You must have earned that amount for at least the last two years. Additionally, to become an Accredited investor, your net worth must exceed $1 million.
On the other hand, sophisticated investors may or may not meet the exact requirements of accredited investors. Typically, they differ in the level of experience. Even if sophisticated investors do not meet the financial qualifications of an accredited investor, their knowledge or experience as an investor gives them enough skill to complete the deal. Therefore, a sophisticated investor must prove that they have the financing and business skills to determine whether an apartment syndication deal is an appropriate investment.
Without experience as an apartment investor, a proven track record, or a solid financial base, apartment syndication as a passive partner is too risky for those not already accredited or sophisticated investors. How does an apartment syndicator determine which limited partners can join the deal? Let's cover how investors structure apartment syndications and discuss how these options impact the types of investors who can participate in different deal structures.
Types of Apartment Syndications And Why It's Important To Understand The Business Rules
There are several ways that a general partner, or the individual responsible for overseeing the apartment syndication deal, can structure the investment opportunity. Usually, they follow one of two rules, known as Rule 506(b) or 506(c), while selling private securities to passive investors. What are these "rules," and how can they impact the deal? Here's what to know about 506(b) and 506(c) securities laws set by the federal government.
What is a 506(b) Offering?
The Securities and Exchange Commission (SEC) works to protect your average investor from making risky investment decisions. One way they do this is by limiting how a business presents and sells securities to individuals. Typically, a business must register with the SEC when they issue securities. However, Rule 506(b) helps companies avoid the investment registration process in certain instances.
Because there are fewer legal requirements to join an investment that's exempt from registration requirements under the Securities Act, more investors can participate in an apartment syndication deal without verifying their investor status with the government. However, Rule 506(b) outlines how principal investors must structure their deal to protect the average investor from avoiding the registration process.
A company can qualify to complete a Rule 506(b) deal if they follow several rules. For example, to avoid securities registration with the SEC, a business must limit its syndication deal to accredited investors and fewer than thirty-five unaccredited investors. Additionally, the securities issuer legally cannot solicit, or advertise, their deal to the public. Instead, they must find passive investors who already have an existing relationship with the firm.
Because there are no registration requirements for passive investors working on the deal together, the principal investor doesn't need to check everyone's investment status. Instead, they must reasonably believe that anyone participating in the agreement meets the qualifications of a qualified or sophisticated investor. Typically, the principal investor has the passive investors complete a questionnaire. It's up to the main investor to review qualifications and ensure that everyone can legally participate in the 506(b) apartment syndication opportunity.
506(c) Offerings: Another Opportunity to Structure the Deal
While there are many reasons why a company might want to sell securities using a 506(b) offering, it's not the only way to structure a deal. Another way to create an apartment syndication deal is by selling private securities under Rule 506(c). Here's how 506(c) differs from 506(b):
Rule 506(c) allows companies to solicit, or advertise, apartment syndication deals to the general public.
However, unlike 506(b) deals, only accredited investors can participate. Therefore, sophisticated investors cannot join apartment syndication deals with this structure.
Finally, general partners must verify with a third party that a passive investor meets the accredited investor status.
As you can tell, with a 506(c) offering, there's more room for creativity while sourcing passive investors. However, the rules are more strict for general partners, who must verify investor status to protect other members of the general public from investing in a deal that's too sophisticated for their resources or amount of knowledge on the subject. Both offerings provide their pros and cons as an investor. So, always be sure to know what type of offering your principal is using while structuring a deal and understand how it can influence your ability to participate in the opportunity.
Since you now understand the typical structures of most apartment syndications, let's discuss the various roles of investors who participate in the deal. From there, you'll have a better understanding of how each party comes together to achieve a more prominent and potentially more profitable deal by pooling resources and skills.
Which Parties Typically Participate in an Apartment Syndication?
Whenever you invest in an apartment syndication deal, you should expect involvement from five different parties. There are general partners, limited partners, property management companies, real estate brokers, and attorneys working together and getting the job done. Here are the individual roles each party completes and why they're essential team members in an apartment syndication deal.
What's a General Partner?
Every business idea starts somewhere, and in apartment syndication, the ones pulling all the parties together are the general partners (GP). GPs have a lot of responsibility while planning, structuring, and completing an apartment syndication deal. Not only does the GP manage day-to-day business operations, but they'll also have unlimited liability as a partnership owner. You may also hear the GP referred to as a "sponsor" or "syndicator."
As you can tell, there's a lot of risk, and potential reward, for the GP. But the job responsibilities don't end by selecting the right people to invest together. Instead, the GP must complete all the steps in the deal. The GP is therefore responsible for tasks like:
Scouting different investment markets.
Selecting a profitable apartment building.
Selection and hiring of team members to complete the deal.
Finding passive investors to support the project with their capital.
Conducting the apartment project from beginning to end.
Now, it's evident that this is a lot of work, which only scales in complexity as GPs target more lucrative deals. However, most GPs are a group of members rather than one individual overseeing the project. By working as a partnership, the GPs can designate different tasks among themselves. Therefore, one sponsor may source passive investors, while the other acquires and manages the assets. Some GPs also include other individuals who complete the deal, such as listing brokers, attorneys, or even property management companies. Thus, GP groups can be as simple as one individual overseeing everything or as complex as several businesses and entities participating jointly in the project.
What Should You Know About Limited Partners in Apartment Syndication Deals?
Suppose you're planning to join apartment syndication as a passive investor, making you a limited partner (LP). LPs provide equity and, in return, receive a share of ownership for the complete project. Unlike general partners, LPs protect their financial interests to some extent. Essentially, an LP-only has liability for the portion of capital they invest in the business.
Yet, this protection comes at the cost of business control. LPs have no control over the business plan and leave all the hands-on business management to the GP and other syndicate partners. There is active participation in the syndication deal while reviewing investor reports and completing taxes. LPs, therefore, must be comfortable enough with the GP and the syndication team to leave investments in their hands. Giving up control is the right choice for some investors but incredibly challenging for others if they're uncertain about the team behind the deal.
How The Property Management Company Fits Into The Deal
When it comes to completing an apartment syndication deal, few partners are as valuable to GPs as their connection with a property management company. Property management companies handle the day-to-day operations within a community and provide additional services throughout the deal. For this reason, locating a property management company that can work before, during, and after a building is placed under contract is essential to apartment syndication success.
A property manager can go above their typical role to help property syndication deals by locating neighborhoods, advising on apartment buildings, and projecting apartment finances using tools like pro forma budgets. And these tasks occur before the agreement is ever under contract. After placing a deal under contract, a property manager can help the GP complete their due diligence by inspecting the property, reviewing capital expenditures, and searching for ways to increase revenue and lower costs.
In this way, property management companies act nearly like the following type of role on the real estate brokers. Both are advisors to the GPs, so let's discuss how they're alike and where they differ.
Real Estate Brokers and Their Roles in Apartment Syndication
When it comes to putting a property under contract, that's the commercial real estate agent's job. An exceptional broker will help GPs locate deals that are available on and off-market. Once they find a few outstanding opportunities, they'll work with the GPs to make property offers and get to the closing table once a seller accepts their offer. However, after closing, the real estate broker's job is rarely done. The agent will usually be the person who lists the property for sale once the GP is ready to exit the deal.
Working With Real Estate and Securities Attorneys
The final party you'll always see in apartment syndication is attorneys. There are usually at least two, if not more, who specialize in real estate and securities, respectively. The attorney's role is to oversee the creation and review of significant syndication contracts. As an LP, you'll sign one of several types of operating agreements, which outline syndicate roles and responsibilities, while also detailing ownership percentages.
In addition, attorneys also oversee other contracts, such as purchase and sale agreements, a contract between the apartment seller and the GP. However, there are also two contracts that the LPs should know, called the private placement memorandum and the subscription agreement. Both these agreements have legal disclaimers that explain the number of shares an LP will receive for their equity and what they risk losing if the deal falls through.
In Conclusion - What is Apartment Syndication?
Overall, apartment syndication deals involve several parties collaborating to achieve specific end goals. All parties come together to find, fund, purchase, and manage a profitable commercial apartment building. There's a lot to learn as someone considering joining an apartment syndication as a qualified or sophisticated investor.
For more information on real estate syndication and to learn about investing with Thomson Multifamily Group, visit our Investor Club. We'll be happy to help you begin your journey as a passive real estate investor, whether it's something you've done in the past or an action you're looking to take as a beginner. Learn more here.