March 1, 2022
Disclaimer: I do not provide personal investment advice and I am not a qualified licensed investment advisor.
In 2020, approximately 144M Americans owned REIT stocks directly or indirectly. At the same time, roughly 120K investors participated in real estate syndications. It means that you are still early for the party and can start building generational wealth with RE syndications today. This article will discuss five reasons why real estate syndications are better than REITs for investors, especially when it comes to long-term investments.
You might be asking, why such a big difference in the number of investors between REITs and syndications? One of the reasons is that REITs have been there for more than 40 years, while syndications have become more accessible since the JOBS act in 2012. Another reason is that till recently, investing in REITs has been relatively simple using modern technology, unlike with syndications that required a lot of manual work before the emergence of real estate investor portals.
Now that real estate syndications have become more accessible to investors thanks to the emergence of technology and more syndicators coming on the scene, many investors are confused about what benefits this investment can offer them. So let’s dive in.
Many REIT investors don’t know that they are not purchasing any real estate assets when they invest in REITs. Instead, they own shares in the company that owns real estate assets. We will discuss the downsides of this in the risks section.
On the contrary, when you invest in a real estate syndication, you and other investors become limited partners in an LLC. Therefore, you own a % of an LLC that the specific rental property belongs to. It means that you purchase directly into the real estate asset by contributing funds through the LLC.
Most people who passively invest in real estate are non-real estate professionals. The primary misconception is that they need the RE professional status to benefit from bonus depreciation and other tax cuts and deferrals. It’s far from being the truth. That’s why in our previous posts, we’ve written about bonus depreciation and tax benefits for non-real estate professionals. To save you some time, here is a quick summary of how much you can save in taxes with a cost segregation study and bonus depreciation.
These depreciation benefits alone are a primary reason for many investors to choose real estate syndications over REITs.
RE syndications distribute their income before depreciation, and tax benefits can often surpass the cash flow and significantly reduce your tax burden. As a result, you will be showing a paper loss while your cash flow is positive and using these losses to offset your passive income (can be passive income from other RE assets). What’s more, you can carry those losses over indefinitely.
Unlike real estate syndications, with REITs, you are investing in a company, not in real estate. Also, REITs distribute income as dividends that are not tax-deductible. And because they allocate these dividends from net income instead of earnings, the payout is lower, and REITs already factor in depreciation benefits before distributing your dividends. So you can’t use depreciation to offset your income. As a result, you don’t get any tax breaks and deductions with REITs.
When you invest in REITs, you don’t have the freedom to pick assets that REIT buys. Portfolio managers take all the decisions in REIT, and it often happens in a very opaque manner. Usually, REIT firms own and manage a portfolio of various properties in one or several markets. For example, shopping malls, multifamily properties, healthcare facilities, offices, etc.
When you invest in a real estate syndication, you have direct contact and relationships with your GP. Moreover, deal sponsors usually organize thorough webinars and inspections of the property, whether virtual or in-person, for example, like in this multifamily capital raise case study.
Investing in a syndication means that you invest in one property in one market and can obtain all details about both, such as the property’s location, the surroundings, the business plan, and financials. As a result, you can evaluate this investment and perform a risk assessment. You can’t do this with REITs, which brings us to the fifth reason why real estate syndications are better than REITs.
Diversification can be considered a benefit. However, it also means that there is no specialization. Some of the markets where REITs invest can experience natural disasters, changes in economic factors affecting real estate, and, as a result, your dividents. Moreover, REITs are traded on stock exchanges, and, like other stocks, price movements in financial markets affect REITs too. It means that you can receive less money than what you paid initially if you sell your shares on the public stock exchange. Unlike with real estate syndications, with REITs, you don’t have any equity to depend on if the market value of REIT holdings sinks.
With real estate syndications, you get direct equity in a property asset. As a result, you have a cushion to fall back on to protect you from the total loss of value.
One of the benefits that real estate syndications offer to long-term investors is long lock-in periods. As a result, limited partners cannot leave the syndication and liquidate their investments during this period. It means that syndications are very stable investments because their business model mitigates risks of irresponsible investors joining. All the partners in a syndication have a shared vision for their investment.
REITs are highly liquid investments (with some exceptions). It means that investors usually tend to buy when they see a good performance and sell when the performance goes down. It affects the potential returns that investors could be getting on their investments.