Syndicating Debt VS Equity

Multi-Family and Apartment Investing
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Syndicating Debt VS Equity

Tyler Bobo
Realtor · Wasilla Alaska · Member since 2019 · 129 posts · 94 votes

Several people on here recommended the Best Ever Syndicating book, which I a halfway through and had a question I wanted to get out before I forget.

He mentioned you can syndicate for debt as well as equity.  In my smaller deals I use debt investors all the time, usually just 1 deed of trust to fund a distressed single family.  If I have more than one, there's more than one deed of trust and in case of default the 1st position is a way stronger position.

How does this work for a syndication, like if there's 30 debt investors there's not 30 liens correct?  Is there just one and they would end up owning the company/property together in case of default?  And since they're debt investors they're not owners so are they not limited partners in the deal like equity investors would be?  

Thanks for your time!

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Brian BurkePro Member
Investor · Santa Rosa, CA · Member since 2012 · 2k+ posts · 7k+ votes
6y

If a secured note is syndicated, typically the investors would own fractional interests in the note.  For example, if ten people each contributed $100,000 on a million-dollar note, each investor would own an undivided 10% interest in the note.  This avoids the problem with one investor being subordinate to another on the title chain.  If there was a foreclosure, they'd all own a 10% interest in the property.  It can get really messy.

This is why, in addition to securities laws, some states have additional laws related to fractional note sales, so be sure to get good legal advice before taking on this strategy.

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  • Brian BurkePro Member
    Investor · Santa Rosa, CA · Member since 2012 · 2k+ posts · 7k+ votes
    6y

    If a secured note is syndicated, typically the investors would own fractional interests in the note.  For example, if ten people each contributed $100,000 on a million-dollar note, each investor would own an undivided 10% interest in the note.  This avoids the problem with one investor being subordinate to another on the title chain.  If there was a foreclosure, they'd all own a 10% interest in the property.  It can get really messy.

    This is why, in addition to securities laws, some states have additional laws related to fractional note sales, so be sure to get good legal advice before taking on this strategy.

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  • Tj Hines
    Specialist · Tampa, FL · Member since 2012 · 933 posts · 492 votes
    6y

    @Tyler Bobo everything @Brian Burke said. He hit it right on the head

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  • John Corey
    London · Member since 2019 · 722 posts · 386 votes
    6y

    @Tyler Bobo, Brian covered your question rather well. 

    Something you did not ask needs to be highlighted. Having conversations with investors about pooling funds for a project could be a regulated conversation. Failure to comply with the state and SEC regulations will be a criminal act even if you did not take any money from the investors you spoke with.

    Master the state and SEC requirements before talking about any investment.

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  • Todd Dexheimer
    Rental Property Investor · St. Paul, MN · Member since 2016 · 3k+ posts · 3k+ votes
    6y

    To avoid fractional debt, you could set up an equity structure and pay a preferred return with a cap. For instance, you could pay 6-8% preferred on the cash flow, with 100% profit the the GP after the preferred and then pay an additional 4-6% preferred on a sale with 100% to the GP after the pref. This would give the investors a blended 12% annualized return, with the GP keeping 100% of the profit above that. 

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  • Tyler Bobo
    OP
    Realtor · Wasilla Alaska · Member since 2019 · 129 posts · 94 votes
    6y

    Thanks everyone!  Yes @Todd Dexheimer, I'm not sure if fractional debt is a way I'd want to go anyways I just wanted to have a better understanding.  I thought it would be something like Brian explained and glad he verified that for me.  Todd, thanks for showing me how to get to a similar endpoint by using the debt and equity with different preferred returns.  I'm still in the earlier stages of planning and research and very much appreciate everyone's experience.  Have a great day!

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  • Ley Nezifort
    Rental Property Investor · Brooklyn, NY · Member since 2019 · 106 posts · 47 votes
    6y

    @Tyler Bobo May I ask which book you’re referring to ?

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  • Tyler Bobo
    OP
    Realtor · Wasilla Alaska · Member since 2019 · 129 posts · 94 votes
    6y

    @Ley Nezifort "Best Ever Apartment Syndication Book", by Joe Fairless and Theo Hicks.  It was recommended by several people on a previous post and I am listening to it on Audible:)  

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  • Alina Trigub
    Rental Property Investor · Glen Rock, NJ · Member since 2015 · 3k+ posts · 2k+ votes
    6y

    @Tyler Bobo 

    In addition to discussing the legal structure options with an attorney as @Brian Burke and @Todd Dexheimer suggested, you'd also want to run it by a CPA that is well versed in real estate syndications as the tax implications for debt vs equity will differ significantly for GPs and LPs, which entails that the overall bottom line will be impacted. Hence, depending on the structure you'll implement,  you will need to attract different kind of investors (E.g. some seek cash flow, others long term appreciation, etc...) So keep that in mind as well. 

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  • Scott Morongell
    Investor · Charlotte, NC · Member since 2017 · 791 posts · 479 votes
    6y

    @Tyler Bobo Brian is correct. Syndicating the debt is also very rare. If the deal is stabilized, Fannie and Freddie are tough to beat when it comes to debt. The only way I see someone exploring this would be to go after an extremely distressed asset that even bridge lending wouldnt make sense. At that point you could be better raising the deal in 100% equity since the debt for such a high-risk deal would most likely cost you more and you'd have to start paying at least the interest back on it right away. You'd be better off raising it 100% equity and not paying out any distributions till it's stabilized and refinanced or sold.

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  • Paul MoorePro Member
    Commercial Real Estate Fund Manager · Lynchburg, VA · Member since 2015 · 1k+ posts · 1k+ votes
    6y

    I would like to hear @Jay Hinrichs comment on this post.  I know he has experience in this area.  I seem to recall that syndicating debt has the same SEC rules as equity.  

    There is another structure I am researching that has one PPM (private placement memorandum) with two classes of equity that can "imitate" mezz debt and common equity. That may be something to consider. 

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  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    6y
    Originally posted by @Paul Moore:

    I would like to hear @Jay Hinrichs comment on this post.  I know he has experience in this area.  I seem to recall that syndicating debt has the same SEC rules as equity.  

    There is another structure I am researching that has one PPM (private placement memorandum) with two classes of equity that can "imitate" mezz debt and common equity. That may be something to consider. 

    Paul in this context and this was specific to CA.. as a HML we could and would fractionlize debt for our first position loans Just as Brian described above.. and you can do this if your a real estate broker in CA which is how I did it.. every loan I ever did in CA was fractionlized.. even in the mid 80s when I started loans were already 200 to 500k in the bay area.. so it was not feasible to have one investor with that much cash.. we have 250 investors and about 50 million that we ran through the company.. rule of thumb was 10 investors or less and you did not need any security offering..

    Now in Oregon its illegal to fractionalize debt WITHOUT a securities offering.. so in that state we did what was called a real estate PAPER offering.. and this was more to solve Howry test.. 

    When I worked for a big bay area syndicator prior to going into Hard money ( and I was in the acquisitions side of the company not money raising) but I did glean how they did their deals..  they had 3 class's of investors.. one would get all the tax breaks one would get tax and cash flow the other would get all cash flow.. but there was still senior debt.. this was for the equity.

    But I put a few land deals together that was all Debt IE no 3rd party lender.  These were larger land subdivisions were we busted up lots and sold to builders..   that's about all I can add to What Brian commented on.. and since we are both Bay Area guys we have done a lot of the same things back in the day.

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