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We all know the great benefits of investing in real estate: cash flow, tax write-offs, access to leverage, and a hedge against inflation. But what happens when you have a property go vacant? What happens if you want to invest in something that is too large for your portfolio? For many years, Real Estate Syndications have been providing a straightforward answer to all these potential problems and more.
Diversification is the main reason investing in real estate is important for everyone planning for his or her financial future. However, because even inexpensive properties can range from $50,000-$80,000, many investors consider investing in real estate syndications in order to get better diversification within the real estate asset class.
When you invest in real estate syndications, you are able to pool your money with other investors in order to purchase multiple properties. This strategy allows you to experience the benefits of diversification within real estate, without shelling out several hundred thousand dollars.
For example, instead of buying one property for $60,000, you invest that $60,000 into a group fund where ten investors each invest $60,000. Instead of owning 100% of one property, you will own 10% of the fund’s profits from cash flow and appreciation.
When you invest like this, you are diversifying your investment and limiting your exposure to the vacancy, maintenance, and miscellaneous expenses of a single property.
Obviously, if you own one property and that property goes vacant, you will receive no income for that month. However, if you own 10% of 10 properties and one property goes vacant, you are still 90% occupied and will receive 90% of your expected rent. Because you will be receiving monthly cash flow, it will be much easier to make your mortgage payments and pay for unexpected expenses.
2) Access To Large Investment Opportunities
Some of the best real estate investment opportunities in the world are in commercial properties. However, the purchase prices for this asset class can range from $5,000,000- $500,000,000! Because real estate syndications give you the ability to pool your funds with other investors, you are able to get exposure to this asset class, without a seven-figure investment.
When syndicators create investment opportunities like this, they have typical investors with $40,000-$100,000 to invest in mind. Therefore, they create the PPM or operating agreement, there will be a minimum investment that can be as low as $10,000. This opens up the doors for typical investors to invest in opportunities that they would never otherwise be able to invest in. In fact, the vast majority of commercial real estate you see today was purchased using some form of a syndicated structure.
Once you start using this pooled investment model, you can get exposure to shopping centers, mobile home parks, self-storage deals, and many other amazing cash-flow-focused opportunities.
3) Ability to Invest completely passively
Possibly the most beneficial reason to consider investing in real estate syndications is that you have the ability to be a passive investor. In most investments like these, the investor is completely removed from the asset, the management, or the operational perspective of the investment.
When you invest in syndicated investments, there is a fund sponsor or manager who will handle all aspects of the fund’s performance. Usually, investors will pay the manager via the performance of the fund with a split of the cash flow and appreciation. (Anywhere from 80/20 to 50/50 split for the investor is common.)
Remember, this doesn’t mean the sponsor is managing the properties himself; it means he is responsible for activities such as doing due diligence, locating a profitable property (or properties), hiring and managing the property manager, sending out quarterly reports, handling investor relations, and so on.
In exchange for the sponsor fee, you are able to be completely passive as an investor. Once you fund the opportunity, the only thing you should have to do is cash your monthly or quarterly checks.
Now, don’t get me wrong, there is a lot of homework to be done when investing like this. When you decide to add another layer between you and the asset by hiring a sponsor, you are further complicating the investment and, therefore, increasing your risk of being defrauded. Because of this, all of the work for investing in a structure like this needs to be done prior to investing. Running background checks, visiting the asset itself, and building a personal relationship with the fund manager all should be completed before making your final decision.
4) Tax Deferred Status
When you invest in pooled investments that utilize Limited Partnerships and LLCs, a whole new world of tax-deferred status is open to you. This structure allows you to compound 100% of the fund’s proceeds for years, as long as you do not distribute the gains outside of the fund.
For instance, let’s say you are investing in a syndication where the sponsor is purchasing a fully occupied apartment building and holding it for cash flow. Because of depreciation, interest payment write offs, expense write offs, and so on, your annual tax exposure for this opportunity will usually be zero or even NEGATIVE, even if you receive thousands of dollars in distributions from the property’s cash flow.
Of course, when the property is sold, the investors will pay taxes on the gains they receive from distributions, but giving your money the chance to compound without paying taxes can completely change your portfolio’s trajectory.
5) Enjoy High Returns Without Exposing Yourself to Personal Liability and Credit Risk
We all know that using an entity such as an LLC is advisable when investing in real estate. However, when you invest in a real estate syndication with a sponsor, you add another layer of protection between you and any liability resulting from the fund’s managers or debt obligations.
In real estate syndications, there are typically two sides of the operating agreement: the “A Side,” which lists the managing members who are responsible for the decisions behind the fund, and the “B Side,” which lists the investors who bring only capital to the table. Under no circumstance will “B Side” investors be responsible for making management decisions of the fund, and, therefore, under no circumstance would a judge find the “B Side” investors liable for decisions made during the fund’s performance. This way you are completely removed from any lawsuits that may arise due to fund-related activities.
Even though single-member LLCs provide significant asset protection, if you are going to receive a large loan from a bank, the bank will usually require a personal guarantee from a natural person.
Let’s say you invest $50,000 in a real estate syndication that is purchasing a $9,000,000 student housing building. A bank is providing a $6,300,000 loan at a favorable 5.5% rate, which will be signed by the managing operator and, therefore, his credit will be on the line. Because of this access to inexpensive leverage, the returns will be notably higher than buying the property in all cash.
First of all, the reason the bank is willing to loan the operator more than six million dollars is because of his experience in the field, track record, and credit worthiness. If you do not have a similar track record, it is unlikely that you would be accepted for a similar loan size. This way, you are able to take advantage of the operator’s experience to acquire a large loan that you probably wouldn’t be approved for, but you still have no liability on the loan.
Adding another layer of protection between you and the asset allows you to leverage another’s expertise with your capital, distance yourself from the liability of the fund, and receive sizeable gains as a passive investor. This concept encompasses the whole ideology behind real estate syndication investments.