Part II – What are the Seven Steps to Syndicating Real Estate?April 11, 2019 | By Erik Lincoln
In Part I of this article, we covered the first three steps to syndicating real estate. In this second part of the article, we cover the remaining four steps as follows:
6. Repositioning Investment, and
7. Exiting Investment.
A discussion of each follows.
4. Acquisition – This phase involves a large amount of legal work and includes negotiating and preparing the following documents.
Letter of Intent (elective)
Purchase and Sale Agreement (“PSA”)
Various Closing Documents
Once you identify a good investment, you should work with your attorney to draft a Letter of Intent and/or PSA. The PSA should provide a period where you can perform due diligence. And, if during the due diligence period you find an issue that cannot be resolved, the PSA should allow you to cancel the transaction.
After the PSA is complete and all parties have signed it, you should begin working with your lending institution. It will take some time for the lender to complete its internal due diligence efforts and prepare the loan documents. The lender will work closely with your attorney in working through due diligence and the documentation required.
Also during this time, you should reach out to your potential investors who you previously lined up and who are prepared to evaluate the real estate investment opportunity for which you have entered a PSA. To help your investors evaluate the investment and then execute appropriate investor documents, should provide them with an Investor Package. An Investor Package often includes: (1) an introductory letter, (2) a Private Placement Memorandum that describes the details of the real estate investment and potential risks, (3) an Operating Agreement for the entity that will own the real estate and for which the investors will invest, (4) a Subscription Agreement which provides that investors agree to invest a specified amount of capital, and (5) an Accredited Investor Questionnaire which is used for complying with certain securities regulations for private placements.
In addition to all of the legal documents that must be completed during this phase, you should perform thorough due diligence on the property, some of which can be completed by you, your commercial real estate attorney, environmental specialist, lender, and other advisors.
5. Operations – After you have closed on the real estate investment, you will move into the operations phase. This phase involves property management, asset management, and investor relations, among other things.
Property management involves running the day to day business activities with respect to the property such as finding tenants, onboarding tenants, collecting rent, hiring and supervising maintenance, and maintaining good tenant relations. You may want to hire someone to handle the property management.
With respect to asset management, this involves managing the value of the property and taking action to keep the property at top revenue producing levels. It also involves developing a plan to increase the revenue and NOI of the property.
In addition to managing the property, you will need to communicate with investors and make distributions as required according to the Operating Agreement.
This phase also involves maintaining accounting records, filing tax returns, obtaining appropriate insurance, and other operating activities.
6. Repositioning Investment – Repositioning a real estate investment is where you try to change the position of the property in the market place with the goal of adding value to the asset. Changing the position often means making upgrades to the property so you can justify higher rents.
In addition to raising rents, you may also look for ways to lower expenses. An increase in rents or a reduction in expenses increases the property’s net operating income (NOI). This will have a direct impact on the value of the property. This is because commercial properties generally are priced at a CAP rate (e.g. NOI / CAP Rate). So, if the market CAP rate is 7% and you increase the NOI of your property by $1, the value of the property goes up by $14 ($1/.07).
7. Exiting Investment – The strategy for many syndicated real estate investments is to acquire projects where they can create a liquidity event in the first 4 to 10 years. This comes from one of the following three events:
Refinance: If the property is refinanced, the new loan proceeds can be used to pay off debt and acquire another asset. The additional asset investment creates more cash flow and equity growth while still maintaining the original asset. This results in increased cash on cash return and more equity over time with no incremental capital from the original investors.
1031 Exchange: The property can be sold via a 1031 Exchange and all proceeds can be deployed into a similar or larger asset. This event will not return cash to the investor immediately, but will in most cases increase their overall cash flow and returns by deferring capital gains taxes. If an investor desires to sell its interest following the exchange, you could work with the investor to locate a buyer for their interest.
Sale: The property can be sold and all proceeds – principal and equity gain – disbursed back to investors. This will provide for a 100% principal return to the investor plus capital gains.
Should you have any questions, please do not hesitate to contact LINCOLN, Business Law, M&A, Commercial Real Estate and Tax Attorneys.