Syndication is a vehicle for people to pool together their funds in order to invest in a real estate project. Such deals are often too expensive or complicated for any single investor to manage on their own.
If you’ve just heard the term, it may bring to mind something sinister. Like a crime syndicate. But “syndicate” simply means an organized group of individuals or entities formed to transact specific business. In this article we’ll examine the type of syndicate that applies to commercial real estate.
And these property syndications are strictly regulated by the SEC.
The Two Types Of Partners That Make Up A Property Syndication
A real estate syndication has General Partners and Limited Partners:
General Partner (GP)
- can also be called a Sponsor or Syndicator
- there can be one or several GPs
- the GP(s) put the syndication together
- they find and analyze the property, develop a business plan, hire a property manager, arrange and secure financing, raise capital, oversee the operation of the property according to the business plan, communicate with Limited Partners, and (eventually) sell the property
Limited Partner (LP)
- can also be referred to as simply “passive investors”
- typically there are several LPs
- they invest their capital in return for equity in the project
- LPs fund most of the capital, but do not have any responsibility to manage the property, nor any liability
Limited Partners can be legally defined as different types of investors. And that is where the SEC rules come in.
Understanding The Difference Between 506(b) And 506(c) Syndication Rules
To keep it simple, let’s define two types of investors: Accredited and Sophisticated.
Very generally — in the eyes of the regulators — Sophisticated Investors likely have enough capital and experience to participate in advanced investment opportunities. However, they are one step below the Accredited Investors.
The Accredited Investors have actually met legal requirements that allow them to buy/invest in unregulated, unregistered securities. An accredited investor has a net worth of $1million or more, not including their primary residence OR has an income of $200k+ per year ($300k jointly if married)
The SEC rules determine which types of investors can participate in the real estate syndication.
Mainly, most syndications are regulated by section 506(b) of the SEC code:
- these offerings may have an unlimited amount of Accredited Investors, and a limited amount of Sophisticated Investors
- all investors must have a substantive pre-existing relationship with the sponsors (at the very least, before a deal is offered, there should be a detailed phone call or in-person meeting discussing the investor’s means, goals, and experience)
- these offerings cannot be advertised publicly
There is, however, another rule that allows for a slightly different type of offering:
- these offerings can only accept Accredited Investors
- the sponsor must verify that investors are actually Accredited
- these offerings can be advertised publicly
So while real estate syndications are an ideal vehicle for individual investors to access properties and deals they otherwise could not, non-accredited investors must remember that there are limited spots available in each 506(b) offering.
The idea behind the 506(b) rule is to protect investors from unscrupulous sponsors.
Regardless of which type of offering it is, all syndications place the discovery, financing, and operational bonus on the General Partners (sponsors). While the Limited Partners simply provide funding and share (passively) in the returns and all the benefits of direct ownership of real estate.
Most large commercial real estate investments are made as syndications. Such partnerships are an extremely significant tool used by the wealthy to secure and grow their net worth.