What is an apartment syndication?

An apartment syndication is the pooling of resources, such as time, money, and skills, from multiple individuals or companies to purchase and manage an apartment community. An investor uses a syndication to purchase a larger community, often those with 40 or more units, that he or she could not purchase alone. These larger properties can have reduced risk and produce more cash flow than smaller properties, which makes them attractive to more experienced investors.

Before going into the roles of the partners in a syndication, it is important to understand what they intend to do with the property to generate a profit. This overall approach is often called the business plan. One popular business plan is a value-add play, in which the general partners buy a property that is underperforming due to high expenses, deferred maintenance, or below market rents, and improve the property by lowering expenses, renovating the buildings, increasing rents to market rates, or adding new sources of income. When executed well, this plan can produce good cash flow and forced appreciation to sell the property at a significantly higher price. Other business plans include building a new apartment community and buying a performing property for stable cash flow.

Roles

Since the business plan requires the combined resources of the members, each person has a different role and a different way to make money according to their contributions. The two main roles in a syndication are the general partner (GP), also called the sponsor or syndicator, and the limited partner (LP). Other members of the investment team include a property management company, mortgage and real estate brokers, attorneys, lenders, contractors, and accountants, all of whom the general partner will find and bring together.

General Partner

The general partner is responsible for doing or managing the work on the property. This work includes finding a target market and property, completing due diligence, or research, on the property to determine that it is a good deal, finding investors and raising capital from them, securing financing to buy the property, buying the property, renovating the property, managing the property manager, and selling the property at the end of the business plan. Since the GP has a lot of responsibilities, the role may be split among multiple people who form the GP team, with each person handling one or more of those responsibilities. It is common for one or more general partners to raise capital from investors and keep them updated on the progress of the business plan, another partner to find and acquire the property, and another to manage the property.

Limited Partner

The limited partners are the investors bringing the initial money, or capital, to fund the purchase of the apartment property. Most of an LP’s work happens before the general partner purchases the property. This work includes finding and vetting a GP to invest with, reviewing deals the GP has, choosing to invest in a particular deal, and sending funds to the GP for that deal. Once the GP closes on the deal, the GP should send out monthly updates to the limited partners, so that the limited partners stay informed about the progress of the business plan. The limited partners are not responsible for purchasing or managing the property, and their liability is limited to the amount of capital they invest in the deal.

There are two types of LPs who can invest in apartment syndications: accredited investors and sophisticated investors. An accredited investor is a designation the Securities and Exchange Commission (SEC) uses to describe a person with an annual income of at least $200,000 for the past two years and an expectation of earning at least $200,000 in the current year, or has a net worth above $1 million, not including a primary residence. For couples, the income requirement is at least $300,000, and the net worth requirement is the same. A sophisticated investor does not meet the requirements to be an accredited investor, but has sufficient experience and knowledge in business, financing, and investments to evaluate the risks and rewards of an investment. 

The difference is important because some apartment syndications operate under an SEC rule called 506(b) and some operate under rule 506(c). In short, only accredited investors can invest in a 506(c) syndication with no limit to the number of investors. Up to 35 sophisticated investors can invest in a 506(b) syndication with no limit of accredited investors. Investors who do not qualify as accredited or sophisticated cannot passively invest in syndications as limited partners at all, but can start to build the capital and knowledge necessary to qualify as a sophisticated or accredited investor. There is no certificate that says whether an investor is accredited or sophisticated, but the general partners should, and for 506(c) deals must, verify the qualifications of all potential limited partners.

Making Money

Now that the main roles are defined, how do all the partners make money in a syndication? The limited partners earn money on the investment returns. The general partners can earn money through fees on the work they do, the investment returns, and/or on a split of the investment returns.

Limited Partners

The limited partners can earn money on the profits from monthly cash flow and/or on the profits from the sale of the property, depending on the type of deal. Value-add deals usually provide both of these sources of profits. The profits from monthly cash flow is the money remaining from the rental and other income after all operating expenses and the debt service (mortgage) have been paid. General partners will usually distribute this money monthly or quarterly to the investors. The percentage of the profits the investors get depends on the deal. Many deals contain a preferred return and a GP/LP split. A preferred return pays the limited partners first until they receive the agreed upon amount, such as an 8% annual cash-on-cash return. Any profits on top of the preferred return could be split with the general partners anywhere between 50% LP / 50% GP to 90% LP / 10% GP. The ratio depends on the general partner and the deal. On the sale of the property, the general partner may pay the limited partners first until some internal rate of return value, such as 18%, is reached, then split the rest of the profits in the same ratio as the distributions.

As an example, say the limited partners put up $1,000,000 on a deal that has an 8% preferred return and a 70/30 split on the rest of the profits with a 3-year ownership period. The projected profit each year the partnership owns the property is $100,000. The property nets $800,000 after the partnership sells in year 3. For simplicity, this example does not have an internal rate of return target on sale. In years 1 and 2, the limited partners would receive $80,000 from the preferred return and $14,000 from the 70/30 split for a total of $94,000 each year. In year 3, the limited partners would receive the $94,000 from the cash flow, $560,000 from the profits from sale, and their original $1,000,000. Their total increase in capital would be $842,000.

General Partners

The general partners can earn money by investing capital in the deal as a limited partner and from the split described above. Passive investors usually want to see their general partners invest some capital in the deal to show that the GPs have skin in the game. If the deal loses money, then the GP loses money too. In the example above, the GP could receive some of the $842,000 in limited partner returns if the GP contributed their own money to the $1,000,000 investment. The GP would also receive the 30% portion of the split. From the yearly cash flow, the GP would receive $6,000 per year, since the split does not apply to the preferred return. They would also receive $240,000 from the sale of the property. If the general partners did not contribute capital to the deal, they would receive $258,000 over the three years.

A lot of work goes into finding, purchasing, and managing a property to produce a good return for the investors, but as shown above, most of the return for the general partners comes from the profits of selling the property, which can be 3, 5, 10 years down the road. Many general partners charge a set of fees to help cover their upfront costs and to fairly compensate them for their work implementing the business plan. The most common fees are acquisition fees, asset management fees, refinancing fees, and disposition fees. 

An acquisition fee helps to cover the upfront costs, such as lending fees, due diligence reports, and attorney fees, and it compensates a GP for providing and securing an investment opportunity for their investors. This fee can range between 1-5% of the property purchase price, depending on the experience of the GP and the merits of the deal. 

An asset management fee compensates a GP for following through on the business plan and delivering the projected returns to investors. It can range between 1-3% of the gross income, though some general partners may charge a flat fee per unit. 

A refinancing fee compensates the general partner for the work to refinance a property and return capital to investors. It can range between 1-2% of the refinance loan amount. 

A disposition fee compensates a general partner for the work to sell a property, ideally for a large gain. This fee can range between 1-3% of the sale price.

Returning to the example above, assume the property purchase price was $3,000,000, and the property has an annual gross income of $360,000. If the general partners charged an acquisition fee of 2% and an asset management fee of 2%, then they would receive $60,000 at closing and $7,200 each year they owned the property.

Each syndicator structures their deals differently, so they may not collect all of these fees or they may collect other types of fees. It is important to review which fees a syndicator collects, and to make sure those fees are collected for services that add value and are aligned with the interests of the limited partners. For instance, percentage rates align interests better than flat rates because the general partner makes more money when the limited partners make more money.

Conclusion

By now you should have a good idea of who the general and limited partners are, what they do, and how they make money in an apartment syndication. For general partners, syndications can be a great way to grow a real estate business and earn more money than with single family houses, though there is more responsibility. For limited partners with little time or real estate experience, syndications can be a great way to earn better returns than other investment asset classes, such as stocks and bonds, with little effort after vetting a syndicator and a deal. Syndications can be a win-win for all the partners involved in the deal.