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SHOW NOTES FOR EPISODE 301: HOW TO BE A PASSIVE INVESTOR IN REAL ESTATE SYNDICATIONS
If you want to invest in lucrative, high-yielding real estate deals without having to deal with “toilets, tenants and trash,” passive investing in real estate syndications may be for you. In today’s episode, real estate investor, author and syndicator James Kandasamy shares details and insider tips on what it looks like to be a passive investor, how to become one, and what tax advantages and benefits can be achieved.
What You Will Learn
- How to invest in a real estate syndication
- Key ways to determine a “good” investment
- How he acquired 1,000 units in 3 years
- What the difference is between a 506 (b) and a 506 (c) syndication investment
- How to know if you are an “Accredited Investor” or a “Syndicated Investor” and why it’s important
- What specific steps you need to take to become a passive investor
- How passive real estate investing can change your tax bracket so you are paying less taxes
- What are the two main passive investor compensation plans
- Secret tax tip that can give you unlimited depreciation credits
- Advantages to having “voting rights” as a passive investor
About Our Guest
James Kandasamy
James Kandasamy is return guest to the Old Dawg’s REI Network (see episode 217), a real estate investor, author, sponsor and syndicator who has been in multifamily acquisitions and asset management since 2015. He has special expertise in finding value-add multifamily opportunities. He has identified, underwrote and overseen the acquisition process of over 1,400 multifamily units worth over $100 million and also ran the execution of each business plan in the portfolio, averaging 20% IRR. James has a Bachelor of Science in Electrical Engineering from Science University of Malaysia and an MBA from the University of South Adelaide in Australia. James has also just written his first book entitled Passive Investing in Commercial Real Estate: Insider Secrets to Financial Independence.
More About James
- Have closed about a thousand units in the last 9 months
- He recently, closed around 370 units in San Antonio and Austin (he lives in Austin and this is the first deal that made sense since he has been investing)
- Because he has a good track record, he has been able to close a lot of good deals on and off-market
- Really good deals are still hard to find
- He is very selective on what deals he chooses
- However, he has slowed down a bit and now wants to concentrate on operation efficiencies
- James has also just written his first book entitled Passive Investing in Commercial Real Estate
- He also is launching his own podcast called Achieve Wealth Through Value-Add Investing
The Challenge of Finding Good Apartment Deals Today
- James said is very hard to find good deals today
- He is buying “on-market” deals because he has the advantage of being a local player – sometimes, they are even better than off-market
- A lot of brokers will say a deal is “off-market” just to get potential buyers but it is not really a good deal – they are marketing it to ALL the local players
- To get a “true off-market” deal you’ll need to:
- Go directly to the seller or
- If the broker knows you have a deal nearby to distill, or
- You get a deal that has fallen out of contract and they need someone to come pick it up in a panic situation
- If you look for deals less than $20 million, most institutional guys won’t go there. They also won’t touch huge value-add deals – they want more “core” or “yield” deals
- When he started out he was looking for more “mom and pop” type deals but what he got started, the brokers would bring them other bigger deals
- Because he is local and has a track record, most deals come to him come to him from brokers – he doesn’t have to chase after the deals now
- As a local player, he knows the sub-market well and this helps
- He doesn’t have to use his old direct-to-seller “ninja tactics” now that he has a good experience record in San Antonio
Moving Into New Markets
- He is now exploring new markets
- Unfortunately, brokers don’t know him and he would only get the deals no one else wants
- He’s still focusing on Texas but when he goes to Dallas, Houston or Austin, he is treated like a newbie
- In the new markets, he may have to go back to his old direct-to-seller “ninja tactics” – that’s the only way to get a good deal in a new market
- Otherwise, you get into the bidding process and you have to be the highest paying guy
- The guys who sold to James when he first started tended to be people with no experience with multifamily, who didn’t like it
Staffing Up for Expansion
- As his portfolio rapidly grew, he realized it was too much for just him and his wife
- Although he currently has 24-30+ onsite property management staff (property managers, maintenance, maintenance leads, etc.) at the apartments, they needed corporate level help for all the properties combined
- His first hire was a Regional Manager because he is vertically integrated with property management and construction
- At one point, he hired an Asset Manager to do underwriting and construction planning but it didn’t work out because he didn’t have enough to keep him busy. He still works with him but on an hourly basis to do analysis, etc.
- He has three school age kids so he and his wife have to mange them too
Passive Investing
- He used to do a lot of webinars for his passive investors to better educate them
- He also writes a lot in his blog
- So it was natural to move into a book
- He wrote the book because he wants more passive investors to be better educated
- Most investors are passive, no sponsors
- There really aren’t any books for this group
- It took him 1.5 years to write the book because he was still doing deals and managing his growing portfolio
Passive Investing Topics in His Book
- How and Where to Get Started (Chapter 2)
- Considering Deals (Chapter 3)
- Deal Sponsors (Chapter 4)
- Capital Source (IRA, 401K, QRP, cash, etc.) (Chapter 7)
- The Process (Chapter 5)
- Other areas address include:
- Communication with the sponsor
- The various players in a syndication: GPs, LPs, equity raisers, property managers, sponsors and operators
- Other bonuses
- Free Passive Investor Checklist
- Comes with free audio book
Getting Started in Passive Investing
- You may be invited to participate in a webinar where the project opportunity is presented
- Once you are interested, you email the sponsor with the following information:
- Your name
- Address and state
- How much you want to invest
- Your source of funds and when it will be available
- Whether you are an Accredited or Sophisticated Investor
- How do you know if you are an accredited investor:
- If syndication is a 506 (b), you just have to say you are accredited (self-accreditation)
- If it is a 506 (c), you can go to websites like verifyinvestor.com to get a letter verifying you are an accredited investor or go to your CPA to get a letter verifying accreditation or go to a broker/dealer
- 506 (b) – Investors need to have a previous relationship with the sponsor to participate in the deal, will allow 35 sophisticated investors and unlimited accredited investors
- 506 (c) – only accredited investors and reasonable verification that they are accredited. Can advertise and don’t have to have previous relationship
- James does mainly 506 (b) on all his syndications
- Once an investor is accepted into the deal you, they need to send the funds to the sponsor and the funds are deposited into the LLC account established from the PPM for the deal, not into the sponsor’s account. The funds can be wired, done thru ACH or a check mailed
- Sponsor needs to confirm you are in the deal
- Right before closing, the investor will get a signed subscription agreement
- He generally tries to raise 20-30% more than the exact amount they need because some investors may change their mind right before the deal is ready to close
- James specific steps:
- He creates a password-protected PDF file of instructions for those investors who verbally commit
- After an investor, reads the PPM and wants to invest, they contact James and he texts them the password to open the PDF file, which has details on sending their investment funds (bank information, instructions on how to fill out the PPM)
- Once they wire the money, investors text him immediately that the funds were sent, he verifies the funds went into the account, and texts the investors back the confirmation
- James tracks the funds on an Excel spreadsheet when and as the funds come in
- Usually a 2-3 week process to compile the funds, do IRA paperwork, replace investors that drop out, etc.
- Every couple weeks sends updates to every investor saying where they are at in the closing process, inspection, appraisal, etc, to give them the latest news on the status of the deal
- Just before closing, for example, he tells the investors, “we are closing tomorrow, this is the rate we got from the bank, etc,” and then they close
- Then, he tells the investors when the next communication will happen
- The key is to “over communicate” with investors, that they are well-informed and and don’t have the need to ask questions
- Investors are trusting by giving the sponsors $50,000 to $100,000 of their hard-earned funds and deserve good communication
- If he receives more than he requested, he usually keeps those funds but he tries to only take exactly what he asks
- Once the closing documents are signed, the work begins
- Sponsor states when the first reports will come in
- Once reports come in, investors can review reports and ask questions as they need
- James sends full reports monthly – summary and financials together
- Others may do monthly reports with just summaries, others do quarterly reports with financials
Investor Compensation
- Two types of quarterly investor compensation
- “Preferred-return-based” or “fee-based” (more of a cash flowing deal with light value-add. This compensation structure may give out investor payouts right away)
- “Equity split” or “profits split base” (James prefers “profits split base” because he does lots of heavier value-add. In first 6-8 months, no payments are typically sent because they are still turning around the property)
- There are pros and cons for both payment structures, just different motivation levels for the sponsors
On-Going Investor Communications
- Continues monthly reports
- He doesn’t usually do webinars unless something major is happening like re-financing or to sell
- Some people do webinars every 3 or 6 months, James doesn’t because his monthly reports are very detailed
- Most people just want to know that their investments are doing well and just want to receive steady cash flow
Exit Strategies
- Keeps investors aware and updated on where they are at in terms of the exit strategies (3-5 years)
- Some sponsors may re-finance, cash-out and buy-out the sponsors, James likes to continue with his investors after re-fi and throughout the life of the deal
- He may hold on to a property long term but hasn’t had the opportunity yet (has only been doing this for 4 years)
- Every year, James assesses each property’s performance to see if it is ready for sale or re-fi or whatever
- James is a long-term player. He likes to do cash-out re-fis to reduce everyone’s risk and continue holding on to the property
- He sees real estate as a long term play
- If you look at the tax structures, all the incentives offered, etc.
- You could probably flip most properties in 2-3 years and get out but he likes to hold on to the properties for long term because of the cash flow and depreciation for more than 5 years
- If an investor wants to get out early, they can always sell their shares:
- To the sponsors
- Another investor in the LLC
- Can open up to outsiders to sell shares
- When the property is ready to sell or re-fi
- James allows his passive investors to vote and he will have a vote with his investors, together with the GPs
- Two-thirds vote is required
- If for example, at year 4, most investors vote to sell, they sell and then
- Return original capital back to investors
- Minus expenses from profits
- Some sponsors also have fees that must be paid
- After expenses and fees, split profits and distribute to investors
- If they have another deal pr a fund, some investors may want to just reinvest
- James just returns the funds plus profits and lets his investors do whatever they want
- Investors who sell will have to do a depreciation recapture at 25%
- If there is a capital gain, investors will have to pay 20% also
- LP investors can’t do a 1031 exchange unless it’s a TIC (tenants inn common) structure or JV (joint venture) model and then they have to go into another TIC investment
- Tax Advantages for Passive Investors
- If, for example, you are in a 37-39% tax bracket
- You are converting all of your active income money to real estate
- You cash flow is tax sheltered with depreciation and because your depreciation is higher than your cash flow, you show negative income
- On paper, for IRS, you are losing money
- In actuality, you are making money
- On sale, you are recapturing 25% on depreciation and you’re recapturing at 20% for capital gain and thus, you are converting all your original income from a 37-39% tax bracket into 20-25% tax bracket – reducing your overall tax liability to the IRS
- There are other tricks investors can do as well
- If a passive investor can move into more of an “active investor” status
- Investor may buy, for example, some investment properties or a 10-unit property. That qualities you as an active investor and now you go for full depreciation
- If, for example, a husband and wife are filing jointly and the wife doesn’t work but the wife, if she manages the property or properties, she can be categorized as a full-time investor or “real estate professional” and you can get unlimited depreciation
- If you are investing with a self-directed IRA
- You are taxed on the “leverage” part of it
- For example, if you or your sponsor leverages 80% of the investment, 80% of your profit gain will be taxed
- It’s better to go with a QRP (Qualified Retirement Plan). A QRP meets the requirements of Internal Revenue Code Section 401(a) and is therefore eligible to receive certain tax benefits. Such a retirement plan is established by an employer for the benefit of the company’s employees. Qualified retirement plans give employers a tax break for the contributions they make for their employees. Qualified plans that allow employees to defer a portion of their salaries into the plan also reduce employees’ present income-tax liability by reducing taxable income.
- You could invest through a solo 401K (check book IRA)
- You don’t pay any tax liability to IRS
- There is a way in various states where you can get a 401K while you are still working a W2 job
- If you are married and not retired, there is a way you can get a 401-K
- Also, check out Old Dawg podcast episode #131 – Investing Power of the Self-Directed 401K where 401-K and solo 401-K strategies are discussed in detail
- If a passive investor can move into more of an “active investor” status
- If, for example, you are in a 37-39% tax bracket
How to Order His New Book
- To order Passive Investing in Commercial Real Estate: Insider Secrets to Achieving Financial Independence, click here
- To get a Free Audio Version of the book, go here
How to Reach James
- AchieveInvestmentGroup.com – Blog and free info
- YouTube Channel
- Watch for his New Podcast (coming Soon): Achieve Wealth Through Value Add Investing
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