Syndication -- the elegant term for group participation in the ownership or development of an idea, product or tangible asset -- has facilitated enormous advances in science, technology, information delivery and the products that we take for granted in our everyday routine. Syndication also has a long and active history in Southern California investment property. The ability of an individual with a sound investment strategy is greatly enhanced by forming a group of investors to supply capital and relationships to produce investment clout, amplify returns and reduce risk.

Chuck Wise

An individual with a desire to own San Diego investment property is often discouraged by the equity requirement in the current market. When capitalization rates (yield on total investment) were higher it was possible to purchase a property with 20 percent cash down payment. Now lenders are requiring a cash down payment of 40 percent or more.

By forming or joining a group investment, the individual can participate in larger, more cost efficient deals. This is also true with long-term investors taking advantage of a 1031 exchange. Group ownership formed as tenancy in common allows several owners to exchange into an interest in a larger property, with no change in the individual vesting, and enjoy the benefits of professional management and economy of scale.

While most people are already familiar with group ownership as joint tenants with a spouse or members of a homeowners association, not everyone is comfortable, or familiar, with the process and the inherent rewards and pitfalls of joining a group investment.

Investor motivation. Some of the attractive features of a group investment to an investor would be: reduced risk, professional management, tax savings, increased cash flow, clout with lenders/vendors, limited liability, ease of identifying and closing a 1031 replacement property, diversification and access to state-of-the-art information services.

Investor obstacles. The source of most investor dissatisfaction stems from the fact that real estate investment rewards those with patience and punishes those lacking the will and the means to stay the course. Some of the most common problems are change in sponsor/general partner circumstances, cash calls for unexpected capital requirements, disagreements among partners, unrealistic investment strategy and IRS rules and regulations.

Some of the inherent problems in all group investments are loss of individual control, lack of liquidity, higher cost of formation and administration, more stringent lender requirements and need for legal/tax counsel.

Forms of Group Ownership. In addition to determining the type of entity to use for a group investment (general partnership, LLC, Limited Partnership, Tenancy in Common), an investment plan and a style of funding are also important. Some group investments are formed to purchase a pre-identified asset (apartment building, office building, etc) and cash is raised to complete the purchase and rehab of that specific property.

Some group investments are formed to start with a specific property, and make room in the initial capitalization to acquire other like properties in the area that meet the same criterion. The experienced sponsor may form a "blind pool" in which the cash is raised first and the properties identified and acquired after the minimum funding is reached.

The form and style of the group ownership entity will be determined by the needs of the investor, as well as the experience, track record and continued probability of success of the sponsor.

The Securities Act of 1933. While the Securities Commission regulates the "investment of money in a common entity with the expectation of profit derived solely from the efforts of a third party promoter," the Private Offering Exemption (Reg. D) allows for investment groups to raise limited capital from a small number of qualified investors as a "small offering exemption."

Under the provisions of Reg. D, a sponsor can raise as much as $5 million in any 12-month period from up to 35 investors who have a pre-existing relationship with the sponsor. Other provisions apply, especially in California, and care should be taken to seek competent tax and legal counsel.

Qualifications of a sponsor. The sponsor of a group investment should be experienced and knowledgeable in the target investment specialty and the market area demographic. The sponsor is the key to unlocking hidden value through proactive management, visionary guidance and realistic leadership in changing markets. Sponsors may have gained their knowledge as developers, real estate agents, property managers or individual investors. Certification through CCIM, CPM, SIOR or the REALTOR Institute, indicates a knowledge of best practices, experience, specialized training and ethical standards that an accredited sponsor may bring to the group.

Compensation to the sponsor. Sponsors are typically compensated for their contributions to the selection, acquisition, operation and ultimate disposition of the asset in a combination of four methods. The operating legal document for the group must spell out the compensation to the sponsor for formation of the group, including fees, commissions and costs of organization; promotional or subordinated equity in addition to the sponsors cash investment may be created upon formation of the group; operating fees, leasing commissions or management fees may be earned during the holding period; and disposition fees or brokerage commissions are often paid to the sponsor at sale.

Many agreements will gear the compensation to the sponsor to the success of the investment. In a rapidly appreciating market, sponsors will reap huge rewards, but in a down market compensation needs to be adequate to provide incentive through troubled waters. Remember, real estate investment returns tend to be cyclical and an investment group will be well served to plan ahead for all contingencies.

Wise, CCIM, is president of CCIM San Diego, president of Wise Investment Properties Inc. and senior vice president of IPC Commercial in Carlsbad.