Most of us have been there – or they are there right now. You are dying to invest in real estate because you know it’s one of the best, least-risky ways to amass wealth.
But you also know that it “takes money to make money.” And you don’t have the money. So, what do you do?
Whoever said “it takes money to make money” was right. But that person held back a big secret from you:
It doesn’t have to be your own money!
People who make big money don’t use only their own funds. They are bankers who borrow money to lend it. They are fund managers who invest other people’s money and make big fees. They are business owners who take investor money to grow their companies.
And they are real estate professionals who use debt and equity from others to make money for themselves.
We’re going to put the debt (mortgage) aside today and focus on the equity. Debt is easy to get if you have the equity.
So, where do you get the equity if you don’t have enough of your own funds?
You do what’s called a “syndication.” A syndication is when you pool investor money together to fund the downpayment, closing costs, reserves, and up front capital expenses, and you use that money to buy and fund the deal.
Here’s how a syndication works.
- You (the “sponsor”) find the deal and get it under contract.
- You form a company, usually a limited liability company (LLC), which will actually own the property.
- The LLC is the borrower for the mortgage. The sponsor signs on the mortgage (even if it’s non-recourse).
- The sponsor sells shares in the LLC to the investors. The investor’s ownership of the LLC is proportionate to their percentage of equity contributed.
- The sponsor may or may not contribute equity. Some investors want the sponsor to have “skin in the game”; some investors don’t care. If the sponsor also contributes equity, it is treated the same way as other investor money, earning a return, etc.
And, now, the good part – how the sponsor (you) make money!
- First, you earn an “acquisition fee,” which you are paid at closing. This compensates you for the work you did up front. Second, you earn what is called a “promote,” which is the ability to share in the profits of the enterprise after the investors are paid the agreed “preferred return” (i.e., “preferred” because they are paid first). Finally, the sponsor gets a “carried interest,” which is a share of the profits when the deal is sold, after the mortgage and sale costs are paid and the investors’ equity is returned.
Syndicators who read this blog: Did I leave anything out? What would you add?
Everyone else: Do you want to learn how do this yourself? What else do you need to know?
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Feature post photo by Nichlas Andersen on Unsplash.com