Real estate syndications can be powerful avenues for single investors to increase their portfolios and build passive income. Syndications are formal groups of investors who pool their funding in pursuit of a single project. For example, a real estate syndication may purchase an apartment complex, improve the property, and ideally sell at a profit. Real estate syndication structures offer many advantages compared to managing a property as an individual investor. Learn about two common real estate syndication structures to explore your options, see the advantages of each structure, and choose the best investment plan for your situation.

Common Elements Of Real Estate Syndications

Every real estate syndication is slightly different. These arrangements are designed with different priorities to make the most of opportunities in various market conditions. Some syndications may be designed to reduce risk while also offering a more conservative return on investment. Other syndications can aim for a higher ROI but also take on heavier risk. These considerations are built around the investors’ experience, track record, and preferences. Outside elements such as market conditions and potential properties also influence a syndicate’s structure.

A syndication’s structure determines how investors are paid, among other considerations. Two of the most common structures are straight splits, where investors receive the same benefits, and waterfall syndicates, which utilize a preferred return structure.

What Are Straight Split Real Estate Syndications? 

Straight split syndications are simple to understand because these arrangements offer the same cash flow and profit split at all times. In a straight split syndication, the structure is given as a ratio, such as 75/25. In this scenario, 75% of the return on investment is split among the limited partners, or the passive investors in the syndicate. The general partners, the people or agency who manage the syndicate, receive the remaining 25%.

When Is A Straight Split Better?

In straight split syndications, the amount of profit doesn’t impact the arrangement. Whether there is a high, low, or expected ROI, investors receive their split according to the basic agreement. Straight splits can be very profitable for passive investors in projects with high returns. Since passive investors have a higher percentage of profits, they can receive a better return on investment from these large sales.

What Are Waterfall Real Estate Syndications?

Syndications with a waterfall structure use a preferred return system. Preferred returns or “prefs” prioritize the limited partners over the general partners, up to a certain amount. For example, investors in syndications with a 9% preferred return receive the first 9% of the cash flow or profits from the investment. This amount is fully split among the limited partners, with 100% of that first 9% return belonging to the passive investors. 

If you invested $50,000 into a syndication with a 9% preferred return, let’s take a look at what you could expect. In the first year, returns meet 9%, so you and the other investors hit the full 9% pref. You would receive 9% of your $50,000 investment, or $4,500. General partners only receive returns when the ROI goes beyond 9%, so they wouldn’t receive any of the proceeds the first year.

Waterfall syndications don’t guarantee investors will receive the full ROI of the preferred return. If your syndication only makes 7% returns in its second year, you’ll receive a 7% return on your investment. However, waterfall structures do motivate the general partners to produce profits. After all, they don’t receive anything themselves until returns beat the pref.

Going Beyond Preferred Returns In A Waterfall Syndicate

As an investor, what can you expect when a waterfall syndication earns more than the preferred return rate? In most syndications, higher ROIs trigger a different split rate. For example, returns in your syndication between 10% and 15% might be administered with a 75/25 split. Just like in straight split syndications, this split means 75% of returns go to limited partners and 25% to general partners.

If returns continue to increase, most syndications offer another split for higher percentages. Our example syndication might move to a 50/50 split for returns at 16% and above.

Waterfall syndications can be vital partnerships that benefit both passive and general investors. Real estate investors should never take on a property when they’re not confident of its opportunities. Waterfall structures reinforce this framework. The various return structures encourage managing partners to make their properties as valuable as possible. If the property is poorly managed, then the passive investors are guaranteed a higher share of the profits—but if the property is well managed, everyone comes out ahead.

When Is A Waterfall Syndication Better?

Waterfall syndications tend to be better for passive investors when the preferred rate approaches the ROI.

Let’s look at our example syndication, which has a 9% preferred return, then a 75/25 split from 10% to 15%, and a 50/50 split at 16% and above. If investment returns have been at 10% for five years, a waterfall syndication will be more profitable than a straight split. A 10% return is close to the preferred rate, so the passive investors receive most of the profits in this scenario.

Which Real Estate Syndication Structure Is Best For You?

Real estate syndications encompass many different arrangements, partnerships, and contracts. Various syndications use different strategies to manage risk, improve properties, manage tenants, and determine goals. Investors tend to be very happy with waterfall syndications since these structures prioritize passive partners and offer more of a guaranteed ROI. Straight split syndications expose passive investors to more risk, but can also generate higher returns.

With any real estate investment, your personal goals, preferences, and risk tolerance should guide your decisions. If generating a steady passive income is a priority, waterfall syndications have the potential to create constant cashflow throughout the syndication. Investors who would rather receive all profits at the end of a project will be well-served by straight split syndications. Both waterfall and straight split syndications can be profitable investments. Consider your overall financial priorities to determine the structure that’s best for you.