July 20, 2022
Contrary to popular belief there are many ways to get involved in real estate without directly owning and managing properties yourself. For many busy professionals seeking financial freedom, real estate is known as one of the fastest and safest ways to increase personal net worth and build generational wealth. It is no wonder why more than 90% of self-made millionaires made their fortunes through real estate.
Today, there are many options available to savvy professionals through investing in private equity real estate deals or through public equity mediums such as Real Estate Investment Trust (REITs). In this article I will discuss the major benefits and risks of each option and how Cash Flow Portal’s Marketplace allows greater transparency for syndications.
REITs, similar to mutual funds or exchange-traded funds, is a single investment into a diversified basket of real estate properties. The U.S. Congress passed the REIT’s Act of 1960 which allowed ordinary Americans to invest in large-scale, income-producing real estate without directly acquiring commercial properties. It essentially leveled the playing field to compete with wealthier Americans and institutional investors who had access to these exclusive opportunities.
REITs proliferated in the latter half of the 20th century to the current day, where it has gained global adoption in 37 countries (i.e. Australia, Canada, U.K, Ghana, etc). It is important to note that there are public and private REITs. The distinction is that public REITs trade on public stock exchanges while some private REITs offered through crowdfunding sites are only available to accredited investors. Consequently, not any portfolio can be considered a REIT; there are strict government requirements that must satisfy such criteria.
Some benefits of REITs is that it offers investors the best of both worlds – own a diversified real estate portfolio and trade and buy like a public stock. As with public markets, REITs are readily traded on the major stock exchanges which means that financial information is public and audited. The barrier to entry is lower compared to private real estate offerings which may impose investor qualifications such as accreditation status and high net worth.
To purchase REITs, investors do not need a lot of capital and can easily participate in the real estate sector. You can buy REITs with as little as $25. Another benefit of REITs is that they are highly liquid like stocks. By contrast, buying and selling property directly requires operational logistics, time commitment, and higher expenses.
REITs are subject to the highs and woes of the stock market. Market volatility directly impacts the stock price of REITs versus the underlying, intrinsic property value. This means that real estate diversification through public REITs provides less protection than directly owning and managing properties.
One of the biggest downsides of owning REITs is the dividend requirement mandates companies to funnel 90% of profits back to investors immediately. This greatly restricts public REIT’s potential for higher appreciation; instead of using profits to acquire more properties, it dispenses dividends to shareholders. In order for REITs to scale, they must acquire more debt financing or sell more shares.
Other considerations include dividends payments that REITs investors receive constitutes ordinary income which is taxed at the individual income level. This means that for high-income individuals, capital gains are taxed at the same rate (which does not offset taxes). Furthermore, REITs may have high management and transaction fees leading to lower payouts for shareholders. Do your due diligence and read the fine print to understand all fees associated.
Private equity funds, not to be confused with real estate syndications are similar, both pool money and resources from private investors to acquire a large-scale asset. For this article, we will solely focus on syndications that are asset specific.
Syndications are a legal transaction between the sponsors (“General Partners”) and the passive investors (“Limited Partners”) to acquire an asset. The sponsorship team is responsible for identifying the property, underwriting, managing, and executing the business plan while the limited partners invest capital and receive quarterly distributions. Investors get all the benefits of property ownership but are not involved with the day-to-day operations.
Syndications have become a hot topic recently but in order to subscribe, investors must have access to deals. This presents a more exclusive club where deals are only offered to those in the know. Syndication deals are regulated by the SEC which offers 506b deals to sophisticated and accredited investors but prohibits solicitation. Conversely, only accredited investors are able to invest in 506c deals and allow for advertising on social media.
There are many benefits to investing in real estate syndications – superior returns, less market volatility, and more tax advantages compared to REITs. Real estate syndications offer cash flow that investors can count on each quarter, even if the real estate market is down. This offers stable passive income compared to REITs where the cash flow is lower.
There is more transparency for investors to vet the sponsorship team before investing to ensure that their goals are aligned. This gives investors more confidence to know who they are investing their money with as the success of the deal is ultimately defined by the execution and capability of the general partners.
One of the benefits of investing in syndications is the tax deductions that may offset income from other passive investments (e.g. rental income). Tax losses are passed through to investors through K-1 filings which means that you can essentially compound your money for years without **legally** paying taxes (please consult your CPA). Unlike REITs, capital gains from the sale of a syndicated property are taxed at a lower rate than ordinary income.
A significant con to syndications is the high barrier to entry, minimum investments are generally around $50K. The average American would consider this a hefty price tag to pay to subscribe to a deal. Furthermore, even if investors have liquid cash sitting in their bank account, it does not necessarily mean they are accredited. This is why many consider syndications to be a members-only club.
Due to the nature of a private equity deal, information on the sponsorship team and property is not made widely available – investors can only trust the team’s track record and reputation. Given the trust factor, investors must do their due diligence before investing in the deal.
Another major downside is that investing in syndication is illiquid for the entire hold of the asset which is typically 3-5 years. Unlike REITs where the minimum is much lower and can be quickly sold with a push of a button, initial invested capital for syndications will be returned once the asset is sold. This means that you should not invest if this is the last $50K in your bank account.
Marketplace offers access and transparency to syndication deals
Syndication deals may not be as widely visible as other investment opportunities. Unless investors regularly attend conferences and network with others in the industry, access to lucrative deals may be a challenge. This is why we introduced Cash Flow Portal’s Marketplace which allows investors to connect with sponsors. With the sponsor’s biography page, investors can vet previous deals, and track records and instantly connect to learn more about future offerings.
If you are interested in learning more about the Marketplace and connecting with sponsors, check us out at https://www.cashflowportal.com/marketplace.