Have you recently been pitched an investment opportunity involving real estate? You may be wondering:
Why are people raising money for real estate investments? What is a real estate “syndication”?
- If it’s such a good deal, why doesn’t someone else invest?
- Is it risky?
- What the heck is an “IRR” they keep talking about?
- Is this a scam?
- How does the organizer make any money? Why don’t they invest their own capital?
All valid questions. Let’s take them one by one, shall we.
Why are people raising money for real estate investments? What is a real estate “syndication”?
Do you ever drive around and wonder who owns these huge apartment buildings? What about those huge industrial warehouses or corporate office parks? It almost definitely is NOT one person. Real estate is a very capital intensive business (aka you need a lot of money). These buildings are huge…
Investing in real estate is a business.
See following (simplified) steps for real estate investment businesses (aka real estate syndications):
- Identify real estate to buy
- Raise money (potentially from you) to buy real estate
- Buy and operate real estate
- Sell real estate for profit
- Distribute profits to you (and then they keep some for themselves)
Seems simple! But this is a lot of work (and requires a lot of money).
So a real estate syndication is when a group of people pool their money together to buy a large property and hopefully make a profit. And then the person organizing the deal, takes a share of the profits for themselves as payment for doing all that work (trust me it’s a lot of work). Also the person that does all this work is usually called the “General Partner” or “GP”.
So why are they raising money? Why not do it themselves?
Many people are barely able to afford the home / apartment they buy for themselves! So the GPs need to raise money from multiple investors to buy such a huge building. 99.9% of people don’t have enough money to buy an apartment complex. Raising money allows investors to buy larger buildings, with more opportunity and generate higher profits.
If it’s such a good deal, why doesn’t someone else invest?
The people raising money are probably trying to get as many people to invest as possible. And a bunch of other people are probably going to invest. It takes many millions of dollars to buy one of these buildings, and they would need a lot of $100k checks to make something like that happen.
You do not NEED to invest in this at all. It is really just another way to invest your money and grow it. It is generally a passive endeavor once you decide on the organizer / operator of the deal.
You also need to decide if it’s a good deal. This is something we are trying to help figure out! Feel free to send over deals / questions to [email protected]
Is it risky?
It depends what you think is risky. Yes, deals can be risky. Real estate uses a lot of debt (because it costs a lot of money to buy). And debt can be risky. But banks don’t just give out debt for fun to lame GPs. They generally lend a large amount of money because real estate is pretty stable.
It can also be risky because you may be investing with someone who doesn’t know what they’re doing. That would be a shame. It’s important to understand the person / company you invest with to better understand the risks.
However, as an investor, the worst case scenario is that you lose all the money you invested. That would be really annoying. But no pain no gain! No risk no reward! For real though, this is typically a much riskier investment than bonds or the stock market, so you should not be putting all your eggs in one basket.
But the returns can be higher!!
What the heck is an “IRR” they keep talking about?
We wrote a whole article on it! Basically just the amount of returns generated in the form of a percentage. The higher the better! Also if it is too high it might be very risky!
Is this a scam?
Depends! Maybe. Probably not, but it could be. It’s important to know who you’re investing with!
How does the organizer make any money? Why don’t they invest their own capital?
I’m sure you’ll be shocked to know the organizer / “GP” is not doing this out of the kindness of his heart! We live in a capitalist society!!
The very simple answer is that they basically take a share of the profits. And the amount of profits depends on the kind of deal. What is somewhat typical is that if a deal makes $1 million in profit, the GP will take somewhere between $200k – $500k in profits and the rest will go to the investors that put up the money for the deal.
Typically there is some minimum return threshold, so the investors profit first. And usually a structure is in place to make sure they get a good return before the GP makes their money!