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... Real Estate Syndication Options ...

These are the working notes of a student, not professional financial or legal advice.
Get professional advice when making decisions.

There are plenty of ways to combine investment and management contributions in a real estate syndicate. Some include:
  • Tenants In Common, a.k.a. TIC:
    • Without a separate agreement, the tenants in common:
      • have shares presumed equal among them, unless stated in an agreement.
        • So have an agreement!
      • have equal access and use rights to the property, even if shares are not equal.
        • One can't deny access to another, except by agreement.
      • share income and expenses by proportion of ownership.
        • So if one pays all of an expense it is reimburseable proportionately.
        • Rents after expenses are also distributed proportionately.
      • If one wants to sell and a second does not, a judge upon demand in a lawsuit may order the sale against the wishes of the second, with proceeds after expenses to be distributed in proportion to shares.
        • Better just put that into an agreement and avoid the court costs.
      • upon death, leave their interest to their own estate not to the other tenants in common.

    • Tenants in common *should* have an agreement allocating rights and responsibilities:
      • What proportion or share is owned by each.
      • Income, expenses, loan/mortgage proceeds and obligations to be allocated proportionately
      • Who does the bookkeeping? Are audits permitted on demand by one?
      • If one wants to sell or take a mortgage, is the other required to acquiesce or not? Must the selling party offer the other(s) a chance to buy, and if so at a price decided by what method? (E.g., 1, 2, or 3 independent appraisals by appraisers selected how?)
      • Operational decisions to be made by which one, or to be agreed upon by what method, with what backup decision in case of disagreement.

  • Limited Partnership with a General Partner
    • A General Partner (GP) / Limited Partner (LP) structure separates prime-mover/management from investment and values each with equity. It acknowledges an asymmetry of position, experience, or work and explicitly values each. It also should align the interests of GP and LP by restricting the benefits of ownership from GP until after the system performs for the LPs -- and investors considering joining as LPs should make sure this is the case. Below are two GP/LP scenarios, by Poorvu and myself.
    • Aiming for appreciation within a time window a GP/LP proposal was offered to, and bought into by, William Poorvu, a Harvard Business School professor of commercial real estate. This proposal was discussed (p113ff) in his book, "The Real Estate Game", a required text for the University of Washington Commercial Real Estate program.
      • The LPs put in all the money, and as a group receive 75% equity and 10% preferred interest.
      • The GP puts in no money and receives a 25% equity share with proportionate but subordinated interest in income and sales proceeds.
      • Annual proceeds are income minus vacancies, operating expenses, capital expenses, and ample reserves.
      • Annual proceeds are distributed:
        • First, preferred interest due to LPs (rolling over to another year if not covered).
        • If any is left over, a proportionate return to the GP also as interest.
        • If any is left over then, use it to pay back the LPs initial contributions proportionately.
        • If any is left over then, split the returns per equity shares.
      • Upon sale after 10 years, proceeds are distributed:
        • First, to pay any accumulated preferred interest due to LPs;
        • If any is left over then, split the proceeds per equity shares.
      This Harvard-taught deal offers preferred interest and return of capital, and hopefully appreciation to LPs within a fixed time window.

    • My investment goal is different, to create and maximize retirement income, or in other words, to annuitize rental investment returns, AFTER a time window. This is also known as a BRRRR strategy: Buy, Rehab, Rent, Refinance, Repeat.
      • Buy, Rehab, Rent: A limited upfront investment is used to pay 100% of purchase+redevelopment cost for a property, until value-add redevelopment stabilizes, typically after some rental history.
      • Refinance: Once stabilized, the property is mortgaged, pulling out if possible, >100% of the sunk costs. Take this step only after identifying another property for the next step, Repeat.
      • Repeat (if): Having reacquired working capital through the refinance, the goal is to repeat the process with additional properties, market permitting, as many times as possible. This will come to an inevitable end:
        • If loan proceeds cannot satisfy the budget for the next purchase..
        • And if shareholders cannot agree on adding to contributions to close another deal ..
          • Additional contributions should maintain share proportions and be first offered to shareholders, but if refused, additional shares may be sold with pricing based on a current asset appraisal.
        • Or if the market does not offer a suitable opportunity
          • such that price including repairs is within our resources,
          • such that rents reasonably projected will pay a 100% mortgage within 8-10 years.
          • This might be operationalized by requiring the GP to stop unless an additional criterion-meeting property is identified in 45 days or its purchase closed in 120 days.
        After some number of cycles, as many as possible, the refinance step is skipped, and rents come pouring in from that paid-for property, so as to help more quickly pay off the other properties, and bring up the start date of the annuity-style returns, since not only is less debt service required but all the rent from the last property can snowball against the other mortgages. When one or all are free-and-clear, then the rents from the free-and-clear properties are distributed like an annuity return to the equity shareholders.
    • With this purpose being different, the money flows will also be different from Poorvu's syndicate, suitable to the purpose.
      • Returns are allocated from annual income less operating expenses, capital expenses, debt service, and reserves.
      • Annual returns are again distributed in a certain order of priority on a calendar of dates. The dates are annually on 12/31, and after closing and final availability of sale proceeds. The priority for distributions at each date is:
        • No interest to LPs.
        • No accumulation of unpaid interest to LPs.
        • No interest to GP.
        • No return of LP capital.
        • Simply prepay mortgage ASAP until cleared using internal cashflows.
        • Remaining returns finally distributed to GP and LPs based on their equity ratios.
      • Proceeds from a Sale are distributed:
        • First to return initial capital without interest to LPs
        • Then if any is left over, divided by equity shares to both LPs and GP.
        • Unless market conditions indicate better annuity returns can be achieved by a transaction, a property sale is expected to occur only upon demand of the estate of one of the partners. Since the intent of the partners is to create lifetime income, where the value is in the income not in a final sale price, this is a buy-and-hold investment vehicle. Then sales will be upon demand by all the heirs either of the LPs or of the GP, but in any case after a minimum 5 year time horizon passes and subject to GP's opinion that the market conditions are favorable.
          • Imagine one partner dies and the other lives. If the estate demands a sale, then suddenly the surviving partner has to come up with the funds to buy the other out, which typically will require mortgaging the property with a 50% loan once again, and terminating their income stream until the property finally pays off again after however many years or decades. This isn't as intended, since the continuous income stream is what the whole setup is made for and the reason so many years of effort went into paying it off to be free and clear. So unless all agree, limit sales until after the life of the last surviving investors; only then, any estate can demand liquidation, and then at least that position must be bought out whether by the other partners or by liquidation.
      This structure is designed to capture and retain as working capital or equity the contributions of LPs and the added value developed; neither GP nor LPs can easily pull out working capital. Instead, equity grows as quickly as possible from internal cashflow, arriving at debt-service-free rent returns that should pay regularly for the long term starting at the earliest possible date. Because high-return rentals can still be purchased, in today's market, if rarely, at prices enabling such a virtuous cycle, such a desireable plan is also, for now, achieveable.

  • Per an LLC Agreement: A BRRRR LLC

    Here, investors buy shares under an LLC agreement, treating each equally. A member or hired manager budgets costs to guide the investment amount needed. The LLC agreement specifies member rights and responsibilities, such as property management, repairs, surveillance, etc. and proceeds.

    BRRR strategy applies: Initial invested capital is used to pay 100% of purchase+redevelopment cost for each property until redevelopment value-add stabilizes -- typically with some rental history. Then the property is mortgaged, once stabilized, pulling out if possible >100% of sunk costs to be used to repeat the process with an additional property, identified within 45 days and purchased within 120 days. Additional contributions if not maintaining share proportions (first offered to shareholders) to buy shares to be priced based on a current asset appraisal.

    Free cash is allocated from annual income less vacancy, operating expenses, capital expenses, required debt service, and reserves. Reserves shall be ample: $5k for SFR repairs; OpEx sinking funds for roof, mechanicals, siding, etc.

    A mortgage prepayment reserve will be saved/accumulated/invested if needed to minimize mortgage prepayment penalties. If the mortgage has no prepayment penalty, free cash will be preferentially applied to mortgage principal.

    Thus investors will see cash flow only after the debts are paid off. Then owner distributions per share ratios are made quarterly or annually, tax statements sent annually for income, expense, and depreciation expense.

    Sale for distribution of capital is not to occur before a minimum 8 year time horizon passes. Sale for reinvestment is allowed if market conditions are favorable. Sale proceeds are divided per share % or reinvested in better performing situations, or to buy back shares on shareholder demand if offered to all shareholders.

    This structure is designed to multiply leverage through value add + refinance cycles. The goal of mortgaging the property is to re-use the capital, cycling to own multiple properties -- not for cashing out. Much developed equity comes from value add repositioning but then just sits there as bank-required equity for the re-financing; then after mortgage payoff the purpose of that equity is not to be liquidated and distributed once, but so that the owners can get all the property's free cashflow. The entire goal is to get as big as possible and then arrive at debt-service-free rent returns for the long term as soon as possible, all in return for a limited investment now.


Copyright © 2017-2018, Thomas C. Veatch. All rights reserved.
Modified: December 28, 2017, January 8, 2018