Syndication Series #002 – What is a “Sponsor” in Real Estate Syndications?

The Sponsor of a real estate syndication is the party that organizes the deal. Unlike passive investors, the Sponsor takes an active role in the identification, inspection, and management of real estate.

If you’re just getting started, check out Syndication Series #001: What Is a Real Estate Syndication?

What Does a Real Estate Syndication Sponsor Do?

The Sponsor of a real estate investment takes an active role throughout the entire life-cycle of the deal. It’s the Sponsor’s job to find a great asset, buy on favorable terms, and manage real estate efficiently. Let’s walk through each of the Sponsor’s responsibilities.

1. Find the Deal

It may surprise you that attractive real estate deals don’t fall from trees. Instead, the Sponsor must go out and hunt for leads.

Finding great deals takes more than going on Zillow or LoopNet and adjusting parameters. Many of the best real estate deals are “off-market” — they aren’t actively marketed by real estate agents.

How do Sponsors find off-market properties?

Leveraging personal relationships
Direct mail campaigns
Calling landlords
Working with wholesalers
Auctions

By focusing time and energy on deal-finding activities, Sponsors are able to uncover the best investments.

2. Analyze the Deal

Do you have a fear of Excel formulas? Not to worry. Your Sponsor loves them.

After initially reviewing a wide array of potential deals, the Sponsor will take a closer look at select properties. This in-depth analysis is called underwriting.

Underwriting is a detailed and complex process, during which the Sponsor considers a wide range of factors, such as:

Property financial statements
Market rent of comparable properties
Projected renovation budget
Property age
Market cap rate
Neighborhood characteristics
Demographic shifts and migration patterns
Existing leases and rents
Cost of financing

The list goes on and on — the process of deal underwriting probably deserves its own article. Stay tuned.

3. Organize Financing

Real estate costs money! While some syndications buy assets with cash, most use a combination of debt and equity financing to buy properties.

Debt

Syndications often secure debt financing to cover the majority of a property’s purchase price. A conventional commercial bank might lend up to 70% of the cash required to close. Other lenders might offer a higher loan-to-value ratio, requiring less equity from the syndication.

Debt terms vary widely based on the deal and lender. Agency debt, bridge loans, and seller financing are just a few of the ways Sponsors use leverage to purchase properties.

Equity

If a bank will loan 70% of the purchase price, that means the syndication must come up with the other 30%. Most of the equity portion of the purchase price comes from passive investors (also called limited partners or LPs).

Alongside the LPs, Sponsors typically invest a portion of the purchase price themselves. The “Sponsor co-invest” can range anywhere from 2-3% to 15-20% of equity.

So, on a $10 million property, a Sponsor might raise $7 million from a bank (debt), secure $2.7 million in commitments from LPs, and invest $300,000 itself as a Sponsor co-invest.

A final note: Make sure to include closing costs and rehab estimates in your calculations. While some lenders will finance a renovation budget, in many cases equity investors are responsible for the funds to update the property.

4. Make an Offer

After running the numbers and arranging financing, it’s time to make an offer! The seller can accept, reject, or make a counteroffer.

The Sponsor has several levers to pull during negotiations. For example, all of the following are up for discussion:

Purchase price
Seller financing
Closing costs
Inspection period
Closing date
Credits to be paid by the seller at closing
Personal property (like furniture)

Sponsors can get pretty creative during negotiations, working to find a solution that benefits everyone.

5. Perform Due Diligence

Once the Sponsor’s offer is accepted and the deal is under contract, the real work begins. One of the Sponsor’s primary roles is to carefully inspect the property to confirm it’s a good deal.

After signing the purchase agreement, the Sponsor immediately undertakes the following:

External property inspection
Lease audit
Detailed analysis of comparable properties
Environmental assessments
Utility audit
Property survey
Unit-by-unit walkthrough
Detailed financial review
Vendor audit

In short, the Sponsor carefully reviews every aspect of the property, looking for red flags and opportunities to boost value. In some cases, if the Sponsor finds something unexpected during the due diligence period, it may negotiate a lower purchase price or credits for repairs.

6. Renovate the Property

Once the deal closes and the syndication officially owns the property, it’s time to add value. During the underwriting process, the Sponsor should have identified several ways to improve the property.

Potential value-add opportunities include:

Renovating apartment units
Updating the exterior
Adding new amenities
Implementing tenant utility-sharing
Streamlining management

Renovating the property helps in two ways.

Cash flow: First, nicer units will command higher rents. Higher rents mean more monthly cash flow to distribute to investors.
Property value: Second, higher rents improve a property’s value. Multifamily buildings are often valued based on net operating income (revenue minus operating expenses). So, a 15% increase in net operating income boost’s the property’s value by 15%.

7. Manage the Property

The Sponsor is responsible for managing the property, which includes finding tenants and keeping them happy. In many cases, the Sponsor might hire a third-party property manager to handle day-to-day issues like leasing, maintenance, and tenant interaction. However, the Sponsor is ultimately responsible for the property’s performance.

Managing the property effectively is crucial. Minimizing expenses while increasing tenant satisfaction helps reduce turnover and boost net operating income, which supports monthly cash flow and a higher property valuation.

8. Exit the Property

In some cases, a syndication might keep a property forever, enjoying the tax-sheltered cash-on-cash return after year.

Other times, a Sponsor might aim to sell the property once the property is stabilized — that is, after the renovations are complete and the building is leased up. If the syndication is a success, the property should be worth significantly more after stabilization, resulting in large profits for investors.

An alternative strategy involves refinancing the property. Refinancing allows the syndication to pull cash out of the deal without selling.

Remember that a bank might loan up to 70% of a property’s value. Let’s say that the purchase price of the building was $10 million, with a $7 million loan and $3 million of investor equity.

After stabilization, the property is now worth $15 million. The Sponsor might go back to the bank and refinance the property with a loan of 70% of the property’s value. Here, 70% of $15 million is $10.5 million. That $10.5 million is enough to pay off the initial loan ($7 million) AND pay back all of the investors’ initial investment ($3 million). The result is that the investors got their money back but the syndication still owns the property, enjoying monthly cash flow and an infinite return on investment.

Who Can Be a Real Estate Sponsor?

Technically anyone can be a real estate Sponsor. However, limited partners should invest with Sponsors who have experience in every stage of a real estate investment’s life-cycle, including underwriting, financing, construction, and property management. The most successful sponsors also have a network of relationships and boots-on-the-ground knowledge of the market where they operate.

What is the Sponsor Called in Syndication Documents?

Throughout this article, we’ve used the term “Sponsor” to refer to the party organizing and managing a real estate syndication. However, a Sponsor might also be called other names, depending on the deal.

Examples include:

General Partner (GP)
Manager
Managing Member
Syndicator

Fundamentally, the Sponsor is the active investor, while the main job of the other investors (often called limited partners) is to help the Sponsor fund the project.

Have Questions About Real Estate Syndications?

If you’re interested in learning more about real estate syndications, feel free to reach out. I’m always happy to talk about real estate!