Real Estate Syndication Structure Types & How They Work

If you’re considering investing in real estate syndication, it’s important to understand that not all projects have the same level of risk and potential reward. Syndications can be structured in different ways, such as waterfall and straight-split, which impact the risk and potential return for investors. Keep reading to learn about these structures and how they can affect your investment.

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Why Does Syndication Structure Matter?

In real estate syndication, the syndication structure is a crucial factor that specifies the order in which investors receive their payouts. There are typically two types of investors: general partners and limited partners. The general partner is the sponsor or entity leading the transaction, while the limited partners are the passive investors.

The syndication structure decides the distribution of returns between the general and limited partners. It is important to carefully assess the structure of any investment opportunity to determine how it may affect the potential return on investment.

Waterfall Structure

In real estate syndication, the structure of the deal plays an important role in determining the order in which investors receive their returns. The most common type of syndication structure is the waterfall structure. It is called a waterfall structure because returns are distributed in a cascading manner through different groups of investors, rather than being divided equally. The limited partners and general partners are usually separate classes, and there may be multiple classes of limited partners.

Under a waterfall structure, the first returns, often referred to as “preferred returns” or “pref,” are directed solely to a specific class, or classes, of limited partners. Typically, the initial percentage for the preferred returns is around 8%. After the preferred returns are paid to the investors, subsequent returns will be split between the investors and sponsor. The split may change over time or based on the amount earned, with the sponsor receiving a larger share as more money is made.

The appeal of a waterfall structure lies in its ability to provide passive investors with the best chance of receiving some return on their investment, even if the property does not perform as expected. This structure is also beneficial for investors as it provides a motivating force for the general partners to work hard and ensure that the project succeeds beyond the preferred returns. The general partners are the last to receive an income, which incentivizes them to put in the necessary effort to make the project a success.

Waterfall structures are often seen as the gold standard for syndication deals due to their ability to protect passive investors’ interests. However, it is crucial for investors to fully understand the terms of the deal and how the structure may impact their potential returns. By carefully examining the syndication documents, investors can ensure they are making an informed decision before investing their money.

Straight-Split Structure

The straight-split structure is a simpler type of real estate syndication structure compared to the waterfall structure. In this structure, investors and sponsors receive returns based on a predetermined split from the first dollar to the last. This structure is easy to understand and requires less mathematical calculations.

The common splits for the straight-split structure are 80/20 and 75/25, with the investors receiving the greater percentage. This structure is advantageous to investors if the property generates significant profits, particularly if the property is sold at the end of the syndication.

Investors should carefully consider the structure of the syndication when evaluating investment opportunities. While the straight-split structure is easier to understand, it does not offer the same incentives for sponsors to work harder to ensure the success of the project as the waterfall structure does. The straight-split structure is most suitable for properties that are expected to perform well and generate substantial profits.

Sponsor Investment & Returns

It’s crucial to evaluate the sponsor’s potential gains and investment in a syndication deal, even if it doesn’t directly impact the payout split for investors. Some syndications offer the sponsor substantial monthly or annual fees that aren’t tied to the syndication’s performance, which may lead to a lower drive to maximize the property’s earnings and value. Furthermore, if the sponsor has only invested a small amount of their own money, they won’t face the same financial risks as the investors in the event of project failure and may lack motivation to ensure the project’s success.

Consideration for Choosing a Syndication Based on Structure

For unaccredited investors, finding a real estate syndication to invest in can be difficult, as these investment opportunities are often filled on a first-come, first-served basis. While it may be tempting to jump on the first opportunity that arises, it is important to take the time to evaluate whether the opportunity aligns with your financial goals.

As with any investment, it is important to ensure that a real estate syndication is a good fit for your needs before committing to it. Syndications typically require a long-term commitment, as your money will be tied up for several years or until the property is sold. Therefore, it is crucial to carefully evaluate the investment opportunity and determine if it is worth the long-term commitment.

Waterfall syndications

If your aim is to earn passive income, a real estate syndication with a waterfall structure may be a better option, as it has a higher chance of providing such income. This structure is also considered more risk-averse than a straight-split structure. However, just like investing in index funds, choosing the conservative option may not result in significant returns.

Straight split syndications 

If your goal is to gain more profit through appreciation on your investment rather than having a consistent income stream, the straight-split structure may be more attractive to you. Investors in straight-split syndications tend to see higher returns when the syndication terminates and the property is sold.

It’s important to remember that the best investment opportunity for you is the one that aligns with your financial goals. Even if a deal appears attractive, it’s not the right one for you if it doesn’t fit into your financial plan.

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If you have any further inquiries, Onbridge Capital is available to assist you and guide you