The most common profit distribution models for syndication are the preferred return and the waterfall structure. In the preferred return model, investors (LPs) receive a certain percentage of the profits before the sponsor (GP) is eligible to receive its share. This percentage is typically between 5% and 9%. In the waterfall structure, specific percentages of returns are set as hurdles. These hurdles serve as benchmarks that dictate when and how much profit a GP can earn beyond the preferred return. For instance, if an asset produces a return of 15%, and the preferred return is 8%, both the limited partner investors and the sponsor will get the same amount of return, up to that 8%. However, with a hurdle placed at 10% the GP may be entitled to, let’s say, 25% of all profits earned over that 10%.

Sources:

• Profit Distribution in Syndication
• Syndication in Commercial Real Estate

The main advantage of a syndication profit distribution model is that it allows investors to receive a return on their investment. This return is typically based on the value of their investment, and is often referred to as a preferred return. This preferred return is usually between 5% and 9%.

The main disadvantage of a syndication profit distribution model is that it can be difficult to determine the exact amount of return each investor will receive. This is because the return is based on the value of the investment, and can vary depending on the length of the syndication deal and the performance of the asset. Additionally, the sponsor of the syndication deal may be entitled to a larger share of the profits than the limited partner investors, depending on the terms of the agreement.

In addition, the waterfall structure used in many syndication deals can be complex and difficult to understand. This structure involves setting specific percentages of returns as hurdles, which dictate when and how much profit a GP can earn beyond the preferred return. This structure can be difficult to understand, and can lead to confusion among investors.

Tax implications of different profit distribution models vary depending on the structure of the syndication deal. Generally, the profits earned by the sponsor (general partner, or GP) are subject to income tax, while the profits earned by the limited partners (LPs) are subject to capital gains tax. This is because the GP is typically considered to be self-employed, while the LPs are considered to be passive investors.

In addition, the profits earned by the GP may be subject to self-employment tax, which is a combination of Social Security and Medicare taxes. This is because the GP is typically considered to be self-employed, and thus is responsible for paying both the employer and employee portions of these taxes.

It is important to note that the tax implications of a syndication deal can vary depending on the specific terms of the agreement. For instance, if the GP is considered to be an employee of the LP, then the profits earned by the GP may be subject to income tax, but not self-employment tax. Additionally, if the GP is considered to be an independent contractor, then the profits earned by the GP may be subject to both income tax and self-employment tax.

It is also important to note that the profits earned by the LPs may be subject to capital gains tax, which is typically lower than income tax. Additionally, the profits earned by the LPs may be subject to state and local taxes, depending on the jurisdiction in which the syndication deal is located.

Finally, it is important to note that the profits earned by the GP and the LPs may be subject to depreciation recapture tax, which is a tax on the profits earned from the sale of a depreciable asset. This tax is typically imposed when the asset is sold for more than its depreciated value.

Investors in syndication deals can maximize their returns by understanding the terms of the syndication agreement and the profit distribution model. Generally, investors in syndication deals earn profits relative to the value of their investment. There are two main profit conduits through which investors earn income in a syndication — through the monthly income and ultimately through the sale of an asset.

Syndication deals can last anywhere from six months to more than 10 years, so the distribution of profits is a key factor investors must consider before participating. The basic goal of a syndication is that by the time the asset is sold, the partner investors get their money back, plus a certain amount of the profits. More specifically, the non-sponsor investors are supposed to receive something known as a preferred return — which, on average, ranges between 5% and 9% — before the sponsor is eligible to receive its share.

The sponsor in many syndication deals is typically paid in what is known as a waterfall structure. For instance, if an investment achieves a return of 12%, and the preferred return is 8%, both the LP investors and the GP sponsor will get the same amount of return, up to 8%. However, the GP may be entitled to a larger percent of the profits, say, 25%, for all profits above 8%. This is called a hurdle, and in some cases, a deal may have multiple hurdles.

In addition, a sponsor/syndicator will generally receive a disposition fee of around 1% of the sale price when the property is sold. This can add an additional amount to the sponsor’s profit, slightly changing the percentages mentioned above.

Overall, investors should understand the terms of the syndication agreement and the profit distribution model in order to maximize their returns.

The best practices for setting up a syndication profit distribution model involve setting up a waterfall structure. This structure typically involves setting up a preferred return, which averages between 5% and 9%, before the sponsor is eligible to receive its share. The sponsor is usually paid in a waterfall structure, with specific percentages of returns set as hurdles. These hurdles serve as benchmarks that dictate when and how much profit a GP can earn beyond the preferred return. As an example, if an asset produces a return of 15%, and the preferred return is 8%, both the limited partner investors and the sponsor will get the same amount of return, up to that 8%. However, with a hurdle placed at 10% the GP may be entitled to, let’s say, 25% of all profits earned over that 10%. Some deals have multiple layers of hurdles. For instance, in the same deal above, there could be a second hurdle at 15%, and the GP might get 45% of all profits above that 15% return.

It is also important to consider the length of the syndication deal, as this will determine when profits are distributed. Deals can last anywhere from six months to more than 10 years, so the distribution of profits is a key factor investors must consider before participating. Additionally, when a property is sold, the investors get their money back, plus a certain amount of the profits. The sponsor in many syndication deals is typically paid in what is known as a waterfall structure.

Finally, it’s important to realize that in longer deals, returns are typically calculated via Internal Rate of Return (IRR). IRR is a metric used to measure the profitability of an investment, and is calculated by taking into account the amount of time it takes for an investment to reach its expected return.