October 31, 2022
The decision to invest in a real estate syndication as a passive investor is usually based on promises of juicy returns. Although these investments are tempting, it is vital that you evaluate the entire setup critically before you decide to invest your money. This article will discuss the pros and cons of real estate syndication to help you make an informed decision.
Illiquidity means that you don’t have access to your money. When you invest in a real estate syndication, you are investing with a group of people. All of them are putting their money together to buy an asset (an apartment building). Therefore, it’s not like investing in a stock market or a mutual fund, where you can pull your money out at any time. In a real estate syndication, your money is illiquid for the length of the investment, which is often around five years. You have to be ready to have your money locked for 3-5 years.
In real estate syndications, a minimum investment amount is usually $50K, which is a lot of money for most people. The syndication is not for you if you don’t have $50K that you won’t need for the next five years.
When it comes to investing in real estate, most people think about rental properties, where you buy a property, rent it out and get a rental check every month. Investing in a real estate syndication is an entirely different process. It’s not as intuitive and will require some time and commitment from your side to learn all the ins and outs.
As a passive investor, suppose you prefer to make strategic decisions yourself and have your finger on the pulse of everything in your investment. In that case, you won’t be able to do that in a real estate syndication. You will have to put all of your trust in the deal sponsor team, who will be running the show day-to-day. Therefore, you should invest with a deal sponsor that has a solid reputation and track record so that you can trust them to make the decisions affecting your investment.
Any investment is subject to market volatility. A real estate syndication is no exception. Nobody can guarantee you a return on investment, and you should be ready to lose your returns if the market experiences a considerable downturn.
There are many articles out there talking about various benefits of real estate syndication. We want to highlight a few advantages that we consider the most significant:
Cash flow is a way of mitigating risk. That’s why most investors love it. When investing in a real estate syndication, getting a preferred return of 6-8% is quite common. This preferred return acts as a safety net for your capital because the sponsor won’t be compensated if you don’t receive it. As a result, sponsors work hard to meet the target. Moreover, if the sponsor doesn’t meet the preferred return during the hold time, they will have to pay it out of sales proceeds before receiving their compensation.
Syndication allows you to take advantage of all the benefits of investing in larger properties. Let’s say, if you buy a duplex and one of the tenants moves out, you lose 50% of your revenue. This is not the case with syndications. It offers more stability and predictability than investing in single-family homes or duplexes. Even if a few tenants move out, others will continue covering the operating costs. Therefore, the asset will generate profit in 90% of cases.
While for some people who like to have complete control over their investments and take essential decisions, passive investing is not so appealing, for the majority of us, it is one of the most significant advantages of real estate syndication. It is a proper passive investment, and, unlike a partnership or a joint venture, the only thing you are risking is your capital. Therefore, there are no added legal risks. If you are a high-income individual, you want to invest passively without incurring additional risks.
What is equity? Equity is the value of the asset minus the amount of debt owed. In real estate syndication, we can create equity by forced appreciation, market appreciation, and amortization. By making improvements to the property, syndicators force valuation, and market appreciation is usually achieved naturally through market drivers.
When you invest in real estate syndication, you can take advantage of cost segregation and bonus depreciation. Read this article to find out more about bonus depreciation for non-real estate professionals. Real estate syndication allows you to minimize the tax you own on your investment and take advantage of numerous tax benefits that make your money work even harder. A multifamily property can show a paper loss even when generating positive cash flow, boosting the tax efficiency of your investment.
With real estate syndication, you have many possibilities to diversify your portfolio by investing in various asset classes. For example, you can consider multifamily properties, self-storage, mobile home parks, hotels, triple net commercial, etc. As a passive investor, if you want to break into a new asset class – you will always find an option out there with a syndicator.
Real estate syndication offers many ways to fund the investment, including self-directed IRAs, cash, QRPs/ Solo 401(k)s, etc. Most syndicators accept investments from these sources. There are also options to invest through a 1031 Exchange, which is a bit complicated. We will cover this topic in one of our future articles.
Organic growth and diversification are the only sustainable ways to increase your investment returns. Syndications allow you to partner with other investors and buy larger properties that you would not be able to buy on your own. Syndication gives you the advantage of working with experts in real estate who take care of the day-to-day management of the property, freeing you up to focus on growing your business or simply living the life you want.
However, when looking into investing in syndications, think carefully about the pros and cons. Before you decide to put your money in a deal, familiarize yourself with how syndication works, evaluate the deal sponsor, and study the fees structure. Real estate syndication is a lucrative business that welcomes people who spend time investigating and analyzing the market to understand the risks and benefits.