Recent government changes have made it more difficult for real estate investors to obtain financing, but there could be a solution in a well-known Beatles’ lyric: “I get by with a little help from my friends.”
Pooling your resources with a group of like-minded individuals and partnering up with a third party promoter or organizer, is called a real estate syndicate. This investment strategy gives investors (or Limited Partners) a chance to get in on an investment that they couldn't normally obtain with their own funds. Basically, there's strength in numbers.
“It's basically a joint venture on steroids,” says Thomas Beyer, president of Prestigious Properties Group Corp. “It's a common way for more than a few people to pool their money and buy one or more pieces of real estate.”
Two groups of people are required to form a real estate syndicate: money partners or investors, usually referred to as LPs or limited partners; and managers or experts, usually referred to as the GP or general partner.
Typically hundreds of LPs make up the first group, each investing anywhere from $5,000 to $25,000 and handing the money over to the GP or syndicator who has real estate expertise and is responsible for making the purchasing, managing and selling decisions.
“Basically, investors are pooling their capital together and becoming part of something bigger than they could do on their own and can participate with a syndicator who has knowledge of that industry,” says Zamir Javer, CEO of Skyton Capital in Markham, Ont. “An investor can use that in order for their investment to generate a return instead of going it alone with limited knowledge and funds.”
But Beyer is quick to emphasise that “real expertise is required, and that is where many syndications fail. Many a syndicator is a great fundraiser or marketing guru but lacks real word expertise to execute.”
Finding the right one?
When it comes to finding the right syndicate for you, it takes research and due diligence. A good place to start is the Internet as there are many forums, websites and blogs dedicated to real estate syndicates. Networking with other investors and watching out for advertisements in reputable publications is another way. Just remember, you need an expert in the domain, not just money partners.
“Too often four guys with money who know each other professionally pool their money, but someone has to spend the time to research the market and location, find a suitable asset, negotiate the price, terms and conditions, find a suitable mortgage and property manager, then to constantly monitor everything,” says Beyer. “All this takes time and expertise usually gained over the years and exceeds the expertise of an average guy with money.”
Once you find an expert, promoter or organizer you're interested in, do a little digging and make sure they meet certain needs and have a good track record.
“A good syndicator should be putting up some capital themselves – at least five to 10 per cent,” says Javer. “Make sure they have their skin in the game.”
Javer also advises investors to take a good look at how the deal is structured. This will be a good indicator if the syndicator is the right one for you. For instance, he says it's normal for syndicators to charge a small upfront acquisition fee (usually two per cent of asset value or less and one to two per cent acquisition fee), but if the investors note a bulk of fees upfront, it may be a red flag.
“If the fee structure is geared towards the syndicator taking a lot of upfront fees, their incentive is not to generate the biggest profit for investors but to continue managing their money forever,” says Javer.
How to structure a syndicate
When structuring a syndicate, an investor should have a combination of factors to make it a good deal. As previously noted, the syndicator should have some money in the deal. More importantly though, the fee structure should be geared toward performance, meaning the bulk of the money the syndicator makes should be made at the exit of the deal – the investor makes money when the syndicator makes money.
“For a retail-type syndicate, it should be 70-30 on exit or 75-25,” says Javer. “The average investor puts in $50,000 to $200,000 and the typical syndicator takes 25 to 40 per cent on the back end.”
Drawing up a contract
Proposed contracts will vary and investors will have different priorities and objectives. In general, since the units will not be listed, investors may wish to look for a clear exit, either through sale of units to a third party, subject to a right of first refusal or first offer, or a sale of the assets based on a stipulated percentage vote or clear investment performance criteria.
Since the limited partner investors will not be involved in management, except possibly on an advisory basis, clear detailed and timely financial reporting is essential and investors should be able to influence or control the appointment of auditors.
“In addition,” says Joel Goldberg, partner and associate with Montreal firm, Heenan Blaikie, “the performance criteria and procedure for the investors to remove or change the general partner or facility manager must be clear and reasonable. Investors should also look carefully at the provisions for capital calls and procedures in the event of default to comply with any such calls.”
How to formulate an exit strategy
The syndicator has all the power in deciding when to sell, but it’s important that you must agree upfront when it comes to the exit strategy.
“You let the expert dictate what they think makes sense, say five years from the start or whenever the value has gone up more than 30 per cent, whatever is earlier,” says Beyer. “Or it could be that one person can force an exit – so if a group of four guys partner and one wants out it must be sold, or the other three must buy the fourth out using a pre-determined formula and market appraisals.”
Limited partners have a direct ownership interest in the assets and a pro rata flow through for tax purposes of income, losses, capital gains, losses and depreciation, all subject to restrictions. The liability of the limited partners is limited to their agreed capital contribution on condition that they do not participate in management. The subscription for units is generally structured to take advantage of securities law and prospectus exemptions, which vary from province to province (see sidebar, Provincial Cross Section, for more on this).
“The investors will generally not receive detailed prospectus-type disclosure and the units will not be listed or publicly traded,” says Goldberg.
Return on investment
Depending on the type of syndicate it is, the return on investment can vary. For instance, a land development may come with a higher risk, but it can also come with a potentially higher return. An apartment building or income-generating property can be a safer investment, but with a lower return.
“With an apartment building, the returns can range from six to 18 per cent, depending on if you're buying a new stable asset or buying a distressed property that needs a lot of maintenance and upgrading,” says Javer. “An established apartment building in Toronto is going to produce a low yield but in a place like Michigan, where opportunities are distressed, we go in, fix them up and garner an average return of 18 per cent.”
Although all investors should consult their tax professionals for professional advice and guidance, here is a breakdown of the tax implications of a real estate syndicate:
The LP agreement provides that income and net taxable capital gains, for purposes of the Tax Act, will be allocated to individual investors in the same proportion as the managers.
Distributions may consist of the following for income tax purposes for which T5013 partnership income statements are issued, usually in the latter half of March for the previous tax year.
a) Distributions that are currently taxable. This portion of distributions for income tax purposes will be treated as regular taxable income (and not treated as dividends or capital gains) to each unit holder.
b) Distributions that are treated as a dividend received from a Canadian or U.S. subsidiary corporation. As such, it will be subject to a preferential tax treatment that all dividends from Canadian corporations receive (subject to the dividend tax credit).
c) Distributions that represent a portion of capital gains allocated to an investor relating to gain on the sale of a property in the year, if any.
“Please note that of the portion reported as capital gains on investors tax return, only 50 per cent of this is included in the calculation of investors' taxable income,” says Thomas Beyer, president of Prestigious Properties Group Corp. “The non-taxable portion of the capital gain is not deducted from the adjusted cost base of LP Units.”
d) distributions that are not currently taxable and will be treated for income tax purposes as a return of capital
“Accordingly, this currently non-taxable portion will reduce the adjusted cost base of the units owned by each LP unit holder,” says Beyer. “If, after deducting the return of capital portion, the adjusted cost base of LP units is a positive amount, no portion of the return of capital will be taxable. If, however, after deducting the return of capital, the adjusted cost base of LP units is a negative amount, you will realize a capital gain equal to the negative amount, and your resultant adjusted cost base of your units will be nil.”
Investors may be keen for a Canada-wide securities commission that administers the same guidelines nationwide, but at present each province continues to be regulated separately. This is important as, to be eligible to invest in a syndicate an investor must meet certain requirements (where it’s deemed that the return is administered through the efforts of a third party).
In Ontario and British Columbia, an investor may require an exemption available under securities law. The most common one used is the “accredited investor” exemption. This means the investor, either alone or with a spouse, must have a net worth of $1 million. Individually, they must have an annual net income exceeding $200,000, or $300,000 with a spouse.
In Alberta, an investor may be exempt if they fit the “eligible investor” requirement, meaning they must have a net worth of $400,000, including a primary residence, or an annual income of $75,000 before taxes. However, it is possible to invest up to $10,000 at any time without having to meet these parameters.
Investors should also have sufficient resources to withstand a loss. “When investing in real estate securities through the exempt market it is important to understand that investors are without many of the investor protection provisions that are mandated when investing in a public company,” says Mark Dickey, senior advisor of Communications at Alberta Securities Commission, Calgary.
For a complete list of eligibility requirements, contact each province’s securities commission.
Alberta www.albertasecurities.com (403) 297-2489
British Columbia www.bcsc.bc.ca (604) 899-6500
Manitoba www.msc.gov.mb.ca (204) 945-2548
New Brunswick www.gnb.ca (506) 658-3060
Newfoundland and Labrador www.gov.nf.ca/gsl/cca/s/ (709) 729-4189
Northwest Territories www.justice.gov.nt.ca (867) 920-3318
Nova Scotia www.gov.ns.ca/nssc/ (902) 424-7768
Nunavut www.gov.nu.ca (867) 975-6190
Ontario www.osc.gov.on.ca (416) 593-8314
Prince Edward Island www.gov.pe.ca (902) 368-4550
Quebec www.lautorite.qc.ca (418) 525-0337
Saskatchewan www.sfsc.gov.sk.ca (306) 787-5867
Yukon www.gov.yk.ca (867) 667-5225
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