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Syndication - A Useful Tool for Raising Real Estate Capital

By James Speakman          May, 2002

Money.

In the real estate context, it’s the fuel which feeds the engine of investment or development activity. Having money allows an investor or developer to tie up a property, complete due diligence, obtain development approvals, close the purchase and build the project. Without it, the developer or investor is simply someone with a good idea, a lot of energy and time on their hands, but no project.

However, we all know that "money doesn’t grow on trees", and it remains a continuing challenge for real estate entrepreneurs to obtain the capital necessary to do their business. One way to do so is through a syndication.

What is syndication?

Syndication is the process of fractionalizing property ownership into several partial interests in order to divide the required equity into smaller parts. The intent of syndication is:

  • to allow the real estate entrepreneur to expand the pool of potential investors by offering them a smaller, more affordable equity investment unit, and
     
  • to provide investors who have limited capital with the opportunity to participate in the ownership or development of properties which would otherwise be too expensive for them to acquire or develop on their own.

Syndication is nothing new. Any development or investment, whether of real estate or any other type of business or asset, in which one party acts as agent on behalf of a group (or syndicate) of investors owning undivided interests in the asset, is a syndication. Syndication groups raised several hundred million dollars in British Columbia in the 1980s and 1990s for investment in real estate in Canada and the United States. Local properties which have been syndicated in the recent past include Arbutus Gardens Apartments in Vancouver, which was syndicated in the late 1980s, and the Terminal City Club in downtown Vancouver, which was the subject of a sophisticated prospectus offering under the Securities Act in the mid 1990s.

Increasing popularity

In today’s real estate environment, syndication is becoming more prevalent. In previous economic cycles, lenders were willing to lend higher proportions of the cost of a project, reducing the amount of equity required from the developer or investor. As well, ongoing inflation in the 1980s and more attractive tax regimes allowed many real estate developers and owners to retain income from completed projects, building up a war chest for future acquisitions. Without inflation and with a tax system which is less beneficial to real estate, today’s developer and owner are more likely to require at least part of their equity from a passive, third party investor.

Further, with current stock market volatility and low interest rates available on fixed income investments, many investors are looking for the sort of secure, moderate yield investment which is offered by a well-structured investment in a revenue-producing or development property. The success offered by investments some of the many REITs now listed on the Toronto Stock Exchange is indicative of investors’ concerns for conservative and stable investments.

Low interest rates also provide the real estate investor with nearly unprecedented levels of positive financial leverage – that is, the rate of return on investment in many properties is higher than the mortgage interest rate, allowing the property owner to make money from the outset on the funds borrowed from the lender.

Forms of Syndication

A syndication of equity typically takes the form of a general partnership, limited partnership or joint venture. The partnership or venture brings together the real estate developer or owner (with expertise, ideas, energy, and a property under consideration) and the investors (with money). The investors are generally passive, in that they take no role in the day-to-day operation of the development or investment, although they retain votes on major issues such as financing, sale, and the selection of management. The developer / owner takes on the active role of developing or operating the property.

Investors typically receive:

  • a priority (or preferred) return on their invested capital – that is, they receive some stated annual return on invested capital prior to the developer / owner receiving payment. In some cases, this may be a guaranteed minimum return, which is guaranteed by the developer / owner;
     
  • a priority of repayment of capital in the event of a sale or re-financing of the property;
     
  • a percentage share of the profit from the property’s operation or sale; and
     
  • the right to vote in major decisions affecting the property

The developer / owner typically receives:

  • fees for services provided to the partnership / venture, which may include any or all of structuring the syndication, identifying the property, managing the development of the property, providing property management for the finished property, managing the partnership / venture, managing the disposal of the property;
     
  • a share of the profits after payment of a preferred return on the investors’ capital and the return of their capital;
     
  • a return on whatever equity it has contributed to the venture.

Syndicated mortgage or debt offering

A syndication can also take the form of a mortgage or other debt offering. In these cases, investors act as lenders of a portion of a mortgage loan for a real estate development or investment purposes. The return on investment is a fixed stream of interest payments to the investor, and is generally secured by a charge on real estate, giving the investors at least a limited security for their investment. In these cases, however, the investors’ return is limited to the interest rate on the loan, and any appreciation in the value of the real estate will accrue to the developer /owner, and not to the syndication investors.

Note that if the underlying property is in Canada, then these offerings are eligible for investment by RRSPs and RRIFs.

Securities Act matters

Note that in most cases the offering of an investment in a real estate syndication requires compliance with the terms of the Securities Act. Real estate syndications rarely require the filing of a Prospectus, and are typically offered under one of the many exemption provided for in the Act, using an Offering Memorandum. All developers / owners intending to undertake a syndication should seek legal advice regarding the Securities Act prior to offering investment units to potential investors.

Process

For an developer or owner wishing to raise funds through a syndication, the process is typically as follows:

1. Identifying the property / project

Responsibility: The developer / owner

2. Creating an ownership / management structure

Responsibility: Developer / owner with legal, accounting and tax advisors

Issues to consider:

  • partnership vs. limited partnership vs. joint venture
     
  • how much debt should be taken on
     
  • will the debt be conventional mortgage or syndicated
     
  • what level of preferred returns to the investors
     
  • is the developer / owner contributing any equity
     
  • what fees will be charged by the developer / owner

Note that the answers to many of these issues depend on the sophistication of the investor and how much each investor is contributing. Generally, the more an investor is contributing to a development or acquisition, the lower the fees payable to the developer / owner will be.

3. Preparing the legal framework (Partnership Agreement, Management Agreements, etc.)

Responsibility The developer / owner’s lawyers

4. Preparing any disclosure required pursuant to the Securities Act and related documentation (Offering Memorandum or Prospectus, Subscription Agreement, etc.)

Responsibility: The developer / owner’s lawyers

5. Preparing financial projections

Responsibilty: The developer / owner or its accountants

  • if the developer / owner will be quoting financial returns in marketing the investment units, then disclosure in accordance with the Securities Act is required, including an audited Future Oriented Financial Information
     
  • based on lots of assumptions

6. Identifying potential sources of funds

Responsibility: Developer / owner

  • Institutional investors
     
  • broker network
     
  • high net worth investor
     
  • low net worth individual

7. Raising capital from investors

Responsibility: Developer / owner and brokers / agents

8. Closing the syndication offering and the property purchase

Responsibility: Developer / owner and lawyers

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BCRELinks.com is a reference service developed by the Commercial Real Estate group at Clark Wilson LLP. The information and links posted to this website should not be treated by readers as legal advice and ought not be relied upon without further, detailed legal counsel being sought.



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