Real estate is a popular type of investment for people who like putting their money into a tangible asset. Maybe you’re thinking about it, but are worried it seems like too much work. But that’s not necessarily the case — you have options. There are several paths within real estate investing, each with their own risks and rewards. Syndication investing is a great way to earn extra income without the more hands-on role that active real estate investing requires. Don’t worry, we’ll walk you through it.
These real estate syndication top tips will have you feeling more confident as you start your journey.
1. Understand the Main Benefits of Syndication Investing
There are two main benefits to syndications: 1. having the ability to pool your money with others to find deals you wouldn’t otherwise be able to afford on your own, and 2. having the ability to be involved in larger deals, which can provide greater profits.
A third (and bonus) benefit is you receive distributions and profits with passive or limited participation in the management. That means you don’t need to know how to run an apartment complex or commercial building or healthcare facility. You’ll just enjoy the distributions as they begin coming in.
2. Understand What It Entails
The first step to any successful endeavor is a fundamental understanding of what you’re getting into. If you have a solid career, with minimal free time, and see the benefits of investing in real-estate but want to leave property investing to a professional, syndications are a great route to take. You receive most of the the rewards of investing in real property without the challenges and they don’t require a lot of upfront experience. You share and participate in the cash distributions, market returns, equity ownership, and depreciation.
There are drawbacks though. You are giving up a share of the profits to syndication management. You have less control over your investment once it is made, and it may not yield the same tax benefits as active investors. There are also fees and much longer investing time periods.
So what makes real estate so popular to invest in? Well, there’s a low correlation between the stock market and real estate, so both categories won’t necessarily be affected in the same way at the same time. Typically, you receive distributions monthly, sometimes quarterly, along with your principal and earnings.
One of the important aspects of any real-estate project is the passive losses or depreciation which can help offset other passive income. Investing in a syndication is a great option for people looking to diversify their current real estate portfolios or help offset other passive income, without much upfront time or ongoing efforts. It’s also a great way to get started and learn how real estate investing works.
3. Know the Basics of a Syndication
A real estate syndication is the process by which you’ll be able to invest passively in real-estate. A syndication involves the following participants: sponsor, underwriter, general partners, and limited partners. Each one of these parties have a specific role to play but we’ll focus on the general and limited partners. The latter is where we’ll focus most of our attention as this is the way most investors invest in real-estate syndications. As a limited partner, your assets will be pooled with several other limited partners and general partners to purchase the property.
There are a few items you will be provided before you sign up to invest, which include executive summary and offering documents. These documents provide an overview of the project and potential returns.
Once you agree to invest you will receive more detailed documents, which provide the most important information and may be worth having a real estate attorney review for you. These will include a Private Placement Memorandum, Subscription Agreement, and Operating Agreement to secure your financial safety and best interests.
Further, syndication will cater to two different types of passive investors: accredited or sophisticated. Accredited investors need to have a net worth of over $1M excluding their home, or make $200-300K annually with their spouse. Sophisticated investors have less strict net worth requirements, but need to understand the risks of investing, while having enough net worth to sustain a complete loss of their investment.
4. Connect Directly With Syndicators for Best Results
A popular way to find a property or start investing is to through an online crowdfunding platform that typically will provide a number of deals to invest in. Crowdfunding also has a lower threshold to invest and often does not require an accredited investor verification.
However, due to the additional management layer, there are additional fees you should make yourself familiar with. It might be worth the additional fee for the lower entre point and online platform.
The best path to syndication investing is to connect directly with a syndicator, avoiding extra expenses and working with a source that you can hold accountable. Real estate podcasts, seminars, and events are great ways to find them — but the best way is to seek referrals from friends, family, previous investors, or your financial advisor.
No matter how you connect, always do your due diligence by researching your sponsor. Conduct a background check, review the offer with your financial team, and contact those within the management of the syndication to learn more about the team. Since there is minimal time spent on the back-end after investing, spend your time upfront conducting a thorough research on the syndication.
5. How to Read an Offering Memorandum
The Offering Memorandum (OM) is the executive summary of the deal. There are key factors to watch for before signing.
Most syndications will approach a project to either stabilize or streamline the current management, or add value to the property. With the latter, typically you are stabilizing the property and adding value.
Stabilizing projects tend to have higher distributions from the get go. While value-add projects tend to have lower distributions upfront and ongoing, in lue of larger capital returns once the property is sold or refinanced.
The OM will list “projected” returns, which can be broken into a couple of categories.
The split, or the breakdown between general or limited partners or if there is a preferred return
Cash on cash return, which shows the annual cash flow based on the amount invested
Average annual return, or the average cash flow return, during the hold time, or before the property is sold.
Internal rate of return which is based on the net present value and a series of cash flows, as well as an “equity multiplier” over the time invested (15-20% target).
You’ll also want to take note of the fees the sponsor is charging you. There will usually be a 1-3% acquisition fee, 2-5% asset management fee, and a possible 1-2% of the sale price included in the OM.
Lastly, you’ll be able to see the projected hold time of the property so you can plan accordingly. Typically, it will be between a 2 and 10-year hold period, but these are common time frames, not the rule.
6. Know the Tax Benefits
When it comes to taxes, depreciation is what serves you most. Property values depreciate over time, and everything from carpets to appliances can be written off yearly as a “paper” loss, that can be used as a tax deduction. Syndicators will typically use a cost segregation study to accelerate depreciation. While the IRS requires you to pay depreciation back when the property’s sold, the recapture is capped at 25% — lower than it would’ve been taxed at regular income tax rates.
Very commonly, in your first year investing with a syndication, you receive positive annual distributions but also have an overall tax loss on your K-1. Yes, you receive a K-1 from your syndication explaining the breakdown of tax and tax loss. And if you have a positive cash flowing real-estate portfolio, you can use syndication losses to help offset your passive active income.
Note: In the eyes of the IRS, syndication passive income/losses are different from passive investment portfolio (stocks and bonds) income/losses.
7. Consider the Market
Before signing the OM, make sure to look at the market. Where is the suggested property or properties located? Find out the population rates in that area. If the population is increasing, you’re more likely to see a significant appreciation in value. If the population is staying stable, you’re likely to see higher cash flow. More thriving markets match with higher prices, while slower markets have lower prices. This creates a dichotomy: you’ll probably be looking at either getting cash flow now or appreciation later. Decide which option will serve your financial goals best!
As you consider pursuing passive syndication real estate investing, the most important factor is to start off with a fundamental understanding of the process. By being informed about the logistics, benefits, and risks of investing, you’ll be more confident in your decision — and more likely make a great return. If you’re interested in learning more about your specific options, schedule a GoodFit meeting to discuss your goals today. #KWA