Recently we discussed Apartment Syndication and offered a quick summary of what it is and the two main entities(ie- General Partner and Limited Partner) involved. You can read that here.
Now that you know the "what" you are probably wonder "but how". Well we're here to help with that too!
As we discussed, before, Apartment Syndication has two main entities that make up the Deal Maker and Operational Execution of the Business Plan; the General Partner(GP) and the passive investor with limited liability; the Limited Partner(LP).
But this is a "deal" right? Some sort of business agreement with a goal to make money?. Yes, that is correct. And in any good deal, or business agreement, there need to be terms. Let's start there.
How are Apartment Syndications structured and How the partners make money
The truth is, an Apartment Syndication can be structured in many, many ways. So let's focus on the most common. Since there are two main entities involved, let's also focus on how each of those make money.
General Partner(GP): The GP makes money based on the value they bring to the deal. That value is usually expressed in a percent ownership of the deal. A more experienced GP, with a track record of success, usually brings more value to the partnership and would likely command a higher percentage. Less experience, lower percentage. For example, if a GP has a track record consisting of 10 successful deals with 12-18% Cash on Cash Returns and an Equity Multiple of 2x, inside 5 years, they will probably command 50% ownership of the deal. Similarly, a GP with 1 or 2, or even 0 deals, might command, less. Something like 30% of the deal. A question I often get, at this point in the process, is "If the GP did not invest in the deal, why such a high percentage". A good and fair question. What it comes down to is the GP is paid for finding the deal, putting it together and the work required to execute the business plan. Which involves a great deal of work lining up resources, building a team to execute the plan, manage that team, manage expenses, etc. More detail on that below. The take away here is that the GP has equity in the deal which is based on the work they do to make the whole thing happen and the experience they bring in ensuring that it happens well. The GP's equity incentivizes the GP to make sure the whole deal executes efficiently and maximizes profits so that everyone, including the LP, maximizes their return!
Limited Partner(LP): The LP makes money in a number of ways. They can make money through a Preferred Return, Profit Split and Refinance Proceeds. Refinance Proceeds are not uncommon but are not the most common terms provided to an LP. So let's focus on the other two. Preferred Return, is a return that the LP receives before the GP receives any payment. This is usually around 8% or so and is paid to the LP before any other profit distributions occur. Profit Spit, is the overall percentage each partner type owns. In a 50/50 profit split both the GP and LP are each entitled to 50% of the profits. In a 70/30 deal the LP is entitled to 70% of the profits while the GP is entitled to 30%. It's unusual for the LP to receive less than 50%. Let's take an example where the the LP has a preferred return of 8% and the profit split is 50/50. If the apartment cashflows more than 8% the LP receives their 8% distribution and any monthly profits remaining, after the 8%, is split 50/50 between the LP and GP. If the apartment's monthly cashflow is 8% or less, the LP receives a preferred return, up to 8%, but nothing would be left over to be distributed towards the profit split. In which case, the GP receives no distribution that month.
So that's how Apartment Syndications work from a money distribution standpoint. But what goes into putting a deal together and then executing on the business plan? Quite a bit actually. There is a great deal of work, performed by the syndicator, or GP, before the deal is ever presented to investors. Let's take a quick look at those in the typical order they occur.
Typical Apartment Syndication Steps:
Market Selection- The GP will research and zero in on a market with apartment investment potential. They will do this through a number of research methods.
Building a Team- After market selection the GP will line up Property Management, potential investors, commercial brokers, construction contacts, etc. In some cases the GP may have an "in-house" team they utilize for most of their deals. In some cases the GP must leverage connections to build the team from scratch after interviewing and vetting all potential resources and team members.
Find the Deal- The GP will utilize connections and resources to find a deal that meets their investment criteria. This can be accomplished through cold calling, county property searches, connecting with other landlords and syndicators, via brokers and agents, wholesalers, online listings.
Underwriting- The GP will look at any potential deals and perform a screening analysis. If the deal makes sense, based on this initial screening, the GP moves onto the next stage.
Make an Offer- Based on the screening the GP will submit a Letter of Intent(LOI) to the seller or seller's agent. This is an initial offer contingent on more in depth due diligence.
Due Diligence- If the LOI is accepted the GP has 60-90 days to close and will perform a much deeper analysis of the property by going through the detailed financials. Depending on what is found during this phase, additional negotiation may take place. Sometimes deals stop here and don't move forward if the GP finds that the deal no longer meets their target investment criteria.
Secure Investors- This is a little bit misleading actually. Any good GP will line up potential investors before ever finding the deal. Many experienced GPs have a network of past investors and potential investors whom they work with regularly. But at this point in the process the GP is securing formal commitments from any investor who wants to participate in the deal. A GP might look at 100s of properties before finding the one that meets the criteria and can be presented to investors to secure commitments.
Secure Financing- Like investors, a good GP will usually have lending options identified well before this phase. They will have established relationship with brokers, banks, private lenders and hard money lenders. At this stage they are securing the financing from the network of financial resources.
Closing- If the deal makes it this far then lending and investors are in place, the syndication agreement has been signed and agreed upon, and the property has passed all due diligence. The GP will now close on the deal and take ownership of the property and it's day to day operations.
Execute on the Business Plan- Once the GP assumes ownership it's time to execute on the business plan. This might include upgrades, renovation, adjusting rents, replacing property management, evaluating expenses for saves, marketing, etc. All aspects of managing and stabilizing an apartment complex are now the responsibility of the GP to ensure happen in a timely and efficient manner.
Sell- In most syndications the object is to stabilize the property, increase its value and then sell at this new, increased value. Syndications will share a timeline, in the "secure investors" phase that pays out the projected hold period of any given property. A number of factors can influence that hold period but the general goal is to provide cashflow returns, during the hold period, and then sell the property, sometime down the road which is when the LP would be paid out their remaining equity and all remaining profits are distributed to the GP and LP.
So that's generally how Apartment Syndications work.
They are a great way to invest in real estate and offer a very scalable solution, to real estate investing, while providing great returns with lowered risk. If you have a great GP team then you stand a very good chance at success. In fact, at Harvest Properties Group, our team of mentors and partners have never lost money on a deal. The team is experienced in putting together strong deals that bring 12-18% annual returns and regularly realize 2x Equity Multiples inside of 5 years.
If you want to know more or are interested in taking part in one of our Apartment Syndications contact us!