How Real Estate Syndicators Protect Assets & Avoid Taxes

Once upon a time, only the richest and most connected investors could participate in real estate syndications

Today, real estate crowdfunding platforms, lower investment minimums and a wealth of project information available online all mean that real estate syndications are within reach for many investors.

But here’s the bad news: Whether they’re interested in syndication investments or directly investing in a piece of real estate on their own, many investors are at risk of a lawsuit taking all these assets from them. 

How safe are you?

Anyone looking to sue you can hire lawyers to go after an individual asset, track it back to you, then go after everything else you own.

The Delaware Statutory Trust is a great way for syndication investors (and certain other investors) to hold assets anonymously, compartmentalize every single one of them and avoid franchise taxes where they apply. 

Let’s take a closer look.

 

 

What is Real Estate Syndication?

First, let’s define some concepts. Real estate syndication (also known as property syndication) is a partnership between members who pool their resources to purchase and manage properties. 

Before the 2012 Jumpstart Our Business Startups (“JOBS”) Act, you really had to know someone who invested in private real estate deals to get in on the action. Even if you did, true syndications were secretive collaborations between the ultra-rich. The deals typically involved many millions of dollars invested in commercial real estate properties—meaning syndications were out of reach for the everyday investor.

The JOBS Act meant new securities no longer had to be registered with the Securities Exchange Commission (SEC), opening the gateway to public solicitation without registration—just so long as all investors are accredited.

So, how does real estate syndication work?

There are usually two roles in real estate syndication: the syndicator and the investor. You’ll hear different titles used. The syndicator is often called the sponsor, managing member or general partner. Investors can be called limited partners or simply members

So who does what? In a nutshell: Syndicators find and manage properties, while investors provide the money to buy, renovate, or operate those properties. 

Sponsors have a lot of responsibility to the investors. The syndication’s fiduciary stewardship falls on them, as do reporting and accounting. The sponsor should be able to recommend the best time to sell the property or have a predetermined exit strategy in place for the syndicate.

How Do Real Estate Syndicators Get Paid?

What does the syndicator get? The syndicator typically earns an acquisition fee (basically a commission) for bringing in the deal. Sometimes the sponsor will secure the property with a contract and put in some of the money, but they’re usually the ones providing the “sweat equity.”

The passive investors/mentors usually don’t want to deal with the day-to-day headaches of owning property. Aside from financing the deal, they typically don’t have many responsibilities. They typically receive a monthly or quarterly return on the investment. In addition to the monthly or quarterly return, the syndicate may pay other investors an annual “preferred return” as high as 10 percent.

A preferred return, sometimes called an investment hurdle or first money out but usually simply called the “pref,” is a way to protect the capital of limited partners in a real estate deal. Those capital investors want to get paid first. 

Let’s look at an example. 

  • A sponsor/syndicator secures a commercial property for $1 million. 
  • Four investors each put in $250,000 and will be paid a preferred return of 5 percent.
  • Each of the five people (the sponsor and the four investors) owns 20 percent of the syndicate.
  • The sponsor gets a 1 percent acquisition fee ($10,000)

Assuming the building’s annual net operating income is $80,000, who makes what?

Each investor will get a $12,500 preferred return each, or $50,000 total. The remaining $30,000 is split five ways ($6,000 for the sponsor and each of the investors).

Investors/limited partners end up with a 7.4 percent annual return, while the sponsor makes $16,000. The sponsor can make more if he/she manages the property without paying for third-party property management.

When the members (the sponsor and the investors) want to sell, they’ll also realize whatever appreciation the property sees. In the example above, assume that in five years, the syndicate sells property for $1.5 million. The $500,000 appreciation (remember, we bought the building for $1 million) gets split five ways.

Of course, every real estate syndication is different. Sometimes the sponsor gets a smaller cut of the appreciation. Or, if the sponsor spends tons on maintenance and repairs over the lifetime of the deal, they may get a larger share. At the start of the deal, everyone would have agreed on the split based on how much work needs to be done acquiring and managing the investment.

How Does The Delaware Statutory Trust Fit In?

Real estate syndication can be a win-win for real estate investors. But if they are located in California or if the syndicate has property in California, the costs of doing business can be huge. Knowing how to avoid the California franchise tax using a Delaware Statutory Trust is a key part of the puzzle.

The DST is not included among the business structures required to pay the annual $800 franchise tax mandated by the California Franchise Tax Board. DSTs are considered estate planning tools—not a traditional company. 

Are limited liability companies (LLCs) enough to protect syndicators from lawsuits? No! The kind of asset protection syndicators need is impossible to accomplish with the LLC. We love the LLC, but  if you try to lump all of the assets inside of one LLC, you end up with a huge pool that litigious sharks can easily attack. 

With the DST you can create anonymity with the ownership of every single asset the syndicate opens. Those sharks won’t be able to discover the extent of your assets; if there’s ever a lawsuit against one asset, they can’t go after any of the other assets.

Your syndicate can form a Delaware Statutory Trust in Delaware and use it anywhere in the United States—including California (whether you live there or not). It’s one single trust with one bank account, one EIN number, one set of accounting books. It’s treated as a pass-through entity for tax purposes, meaning you can claim income on your personal income tax returns instead of a separate business tax return.

In a syndicate, each individual investor possesses his or her own share of the DST property. Any potential income, tax benefits and appreciation are part of this share.

 

Protecting Syndication Assets With Delaware Statutory Trusts

Did you know 80 percent of real estate investors will be sued in their lifetime? Don’t let a frivolous lawsuit destroy your future. 

If you’re a syndication investor with properties inside of California, the DST can give you affordable anonymity and asset protection so people won’t even know that you’re a good target to come after in the first place. 

The DST can also diversify equity to reduce your risk exposure in the event of a lawsuit by giving you both anonymity and lawsuit protection. A series structure makes it infinitely scalable at no additional costs, no matter how many assets you acquire. Incorporating new real estate investments into the structure is quick and easy. 

As we’ve seen, syndication gives investors an opportunity to invest in high-value properties.  When a Delaware Statutory Trust is leveraged, real estate syndicates often eliminate the liability for the individual investors altogether. When a DST acquires assets, investors can purchase beneficial shares, meaning they become beneficiaries of the DST and direct partial owners of the real estate asset. The trust takes on all property liability.

Syndicators can compartmentalize every single asset underneath its own entity structure by creating an infinite number of child trusts for free. This gives the real estate syndicate infinite scalability every single asset compartmentalized—one asset per child trust.

 

Discuss the legal safety of your real estate investment portfolio?

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