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SHOW NOTES FOR EPISODE 658: THE PROS & CONS OF REAL ESTATE SYNDICATION INVESTING
With the ups and downs of the stock market, coupled with a highly volatile economy, real estate investing has emerged as the leading investment choice for many investors. In today’s podcast, Bill examines the pros and cons of one of the more passive forms of real estate investing – syndication investing.
Introduction
Many people are attracted to real estate investing because it’s considered a passive form of investing. You can have a full-time job and invest in real estate on the side. However, unlike most other passive income investment options, real estate investments often requires that you actively participate in the business to generate income. Unless you hire a property manager (and even with that, there’s certainly no guarantee you won’t still be working your but off…), you’d need to find a GOOD property manager who will manage the tenants well, promptly take care of any maintenance, and pay all the bills, etc. to make it truly passive.
There are many other ways to passively invest in real estate without buying a rental property. One that mimics direct ownership without any of the management responsibilities is participating in real estate syndications. You can become a limited partner in a single real estate asset without lifting a finger to collect the passive income.
What are Real Estate Syndications?
A real estate syndication is when a group of investors pools their money to purchase a property that would be too large for a single investor to buy, like an apartment complex, office building, or warehouse. The sponsor of the deal, known as the general partner (GP), will identify an attractive property they desire to purchase and offer other investors, known as limited partners (LPs), the ability to participate in the deal. The sponsor, usually an established real estate company, will manage the property or hire a property manager on behalf of limited partners. Many sponsors will offer the opportunity to invest in a real estate syndication deal via an online marketplace like CrowdStreet or RealtyMogul or directly through their website.
Syndications allow investors like you to partner with others who do all of the work. The 2012 JOBS Act opened up the market and allowed even more passive investors to partner in proven real estate investment strategies through crowdfunding. But lets just look at investing in syndications as a Limited Partner or LP.
As I have transitioned from being an active hands-on active real estate investor to a passive investor through syndications (see podcast episode #632) I have seen the pluses and the minuses of both. I have been both a passive investor in syndications and an active syndicator (GP General Partner), bringing passive investors into our multifamily investment deals. At the time of writing, I have invested or partnered in over $40 million in investment real estate.
If you are considering passive investing through syndications, here are some of the top pros and cons I’ve identified for passive investors in syndications.
#1 Pro: 100% Passive Real Estate
Passive syndication investors, or Limited Partners, do not actively participate in the management and operation of their investment properties.
When you invest in a syndication as a Limited Partner, you do not have to deal with tenants, toilets, termites and trash.
You review reports from the General Partners, join in on occasional conference calls, and if all goes well, enjoy your passive cash flow and piece of the profit when the project is sold!
Time is your most scarce asset. By investing passively with experienced operators you can reduce your time commitment to your real estate portfolio, while investing in assets that produce great returns.
Many high earning professionals undervalue their time in their minds, and believe spending a few weeks a year finding, fixing, and managing their rentals is no big deal. That’s not passive income, that’s another job.
What passive investors need to do:
As a passive investor in syndications, it is important to carefully vet the General Partners managing the investment. Make sure they have a track record of success, manage money responsibly, and do not have criminal backgrounds. Get comfortable with the risks involved and make sure you understand the potential returns. If you’re not comfortable, just move on!
#2 Pro: You can invest with world-class investing experts
You can invest passively alongside sponsors who have bought hundreds of millions of dollars in investment property. The importance of a track record in real estate cannot be underestimated.
You, as a passive investor, can invest your capital alongside those with incredible track records. Try doing that with single family rentals – it’s much more difficult! You’re all on your own in that case.
Rookie mistakes are around every corner in DIY real estate investing. Rookie mistakes in real estate can be costly, so it’s important to know what to avoid. Experienced syndication sponsors are not rookies by definition, and while they are human and can make mistakes, they will have learned many tough lessons in past deals.
Rookie Real Estate Investing Mistakes Often Include:
- Not having a plan: When you don’t have a plan, you end up making decisions based on emotion instead of logic, which can lead to poor choices! Business plans are critical in real estate.
- Underestimating repair costs: Repairs and capital expenditures can be a huge part of one’s budget when buying underperforming investment real estate. Rookies don’t know which landmines and pitfalls await them inside the walls of their buildings! Nuances such as issues with buildings built in the 1970s, plumbing and electrical nightmares, and rodent infestations can end up costing rookies dearly.
- Buying in a bad location: Location, location, location! This is one of the most important aspects of any real estate investment. Not understanding the neighborhood you’re buying in could lead to occupancy and cash flow problems down the road.
- Insufficient Operating Reserves: Even the best-performing properties can have down months. A well-funded operating reserve can help you get through these tough times without having to sell your investment property prematurely.
- Trying to Self-Manage: Property management can be a full-time job in and of itself. Trying to manage your own property can be a recipe for disaster if you don’t know what you’re doing! There are many Federal, State, and Local laws Leave the property management to the professionals.
- Pro: You do not go into debt: Most syndicated properties are bought with debt. However, in most cases the sponsors are on the hook for the debt, rather than the investors. Passive investors can get the benefit of leverage, without the downside of being personally on the line for the debt.
Remember: all deals are different and always read offering documents thoroughly! Those documents will clarify who is responsible for the debt.
Another way to get involved:
Passive investors can sometimes elect to take a bigger role as balance sheet partners. Balance sheet partners help the sponsor qualify for loans by providing their net worth and liquidity to help meet the requirements of the loan.
Commercial real estate loans are based on the performance of the property, rather than the solely on the qualifications of the owners. However, the owners do still need to meet basic qualifications for net worth and liquid assets.
Passive investors can become balance sheet partners for an extra slice of the deal, which typically comes in the form of some General Partnership shares.
Note: Being a balance sheet partner comes with additional risk! As always, do your due diligence.
#3 Pro: Multiple asset classes!
It’s amazing how many asset class options are out there for passive syndication investors. Multifamily apartments, self-storage, mobile home parks, triple net leases, commercial, industrial/warehouses, large single family portfolios or developments, hotels, and on and on!
There are experienced sponsors across the board who accept investments from accredited investors just like you. If you want to break into a new asset class as a passive investor, there is probably an option out there for you.
It’s also smart to diversify with various real estate asset classes – especially in inflationary and recessionary markets.
Look before you leap
It is important to study a new asset class before investing in it. This will help you to understand the risks and rewards that are involved in any particular business plan. There are numerous resources available for nearly any asset class, so be sure to do your research before diving in.
#4 Pro: There are many ways to fund your syndication investment
You can fund a passive syndication investment in many ways. Cash, retirement accounts such as self directed IRAs, QRPs/Solo 401(k)s, Life Insurance plans, you name it. Most syndicators will accept funds from any of these sources with no issue.
The key is to communicate and be ready to invest when the opportunity comes. Great opportunities do not last for long, so passive investors need to be ready to strike when the iron is hot.
There are even ways to invest in syndications through a 1031 Exchange but, keep in mind, not all sponsors allow 1031 Exchanges.
Every situation is different
The way you choose to fund your syndication investment can make a big impact on how taxes are handled. Be sure to understand potential tax implications of your investment and seek advice from a CPA or other qualified tax professional familiar with real estate syndication investment experience.
#5 Pro: You can invest basically anywhere
Sponsors are syndicating properties all across the country and even other countries. I have owned property in multiple states that I’ve never lived in.
Passive investors can invest remotely through syndication without the hassle of traveling to the properties themselves.
Remotely investing in out-of-state real estate is tried and true through syndication! If you live in an expensive market, consider digging into syndication
Make sure the sponsor knows their market
Syndication sponsors oftentimes do not live in the markets where they invest. That is not a problem, but it is very important to make sure the sponsor has a strong understanding of the markets where they buy property. They should not be learning the market on your dime!
Now, let’s look at some of the drawbacks…
#6 Con: You Must be an Accredited Investor
One caveat is that most real estate syndications are only open to accredited investors. To qualify, an investor needs a net worth of over $1 million (excluding the value of their primary home) or an income above $200,000 annually ($300,000 if married). While many investors likely don’t currently meet those qualifications, they could eventually qualify if their net worth grows to exceed $1 million. It’s also possible that the SEC could make changes to the definition. Meanwhile, there are occasionally opportunities open to non-accredited investors.
You can invest in syndications without being an Accredited Investor but there are not a lot of opportunities out there. You can, however, invest in syndication type deals through real estate crowdfunding sites like RealtyMogul, Fundrise or YieldStreet.
#7 Con: The Cost of Investing
Another detracting factor is that most real estate syndications have a high minimum investment, usually between $25,000, $50,000 and $100,000 minimum investments. That’s a much higher minimum than many other real estate investments, such as a real estate investment trust (REIT). However, it’s lower than the typical initial investment required to purchase a rental property.
#8 Con: Syndications are not liquid investments
When you’re invested in a syndication, you should be in it for the long haul. Many syndications’ business plans can go 3, 5, 7, maybe 10 years!
Furthermore, when investors buy in a syndication they are buying what the SEC calls “restricted securities.” Restricted securities are, as their name implies, restricted in how and when they can be sold. This is a complex topic.
These deals will typically need to keep investor capital for most of the hold period, so you as an investor should expect your capital to be in the deal at least as long as the sponsor projects.
Illiquid investments are, by definition, difficult to sell. This can be a problem if you need to access your money quickly to cover unexpected expenses.
#9 Con: Control – You’re not in the driver’s seat
Hey – maybe you don’t want to get out of the day-to-day operation of your investments. As a passive syndication investor, you’d be completely out of the day-to-day operation, but that also means you’re not the one in the driver’s seat, making the operational decisions.
Once you’re invested in a deal the Sponsor takes over, and passive investors sit back and let the Sponsor run the deal. Not everyone is comfortable with that.
What if you’re not comfortable giving up control?
Not Comfortable Giving Control to a Particular Sponsor:
Perhaps a sponsor you’re considering does not inspire confidence in you. Maybe you feel they’re too inexperienced to handle your money. Maybe a particular deal you’re looking at just doesn’t feel right.
Listen to your gut and keep looking, if you think syndication investing may be for you but you just haven’t found the right sponsor yet.
Not Comfortable Giving up Control at All:
Maybe syndication investing isn’t for you at all, no matter what sponsor or operator is in the driver’s seat, or no matter what the deal looks like. There is nothing wrong with that, as there are numerous other real estate investing strategies that may fit your goals. Just be ready to do the work!
By investing on your own and not with a sponsor you are setting yourself up to retain more control and have more day-to-day responsibility in your deals.
In Conclusion
Syndication investing can be a great way to diversify your investment portfolio. You can participate directly in a variety of real estate investments without having to do the work on your own. There are many ways to participate in and benefit from syndication investing, but investors must be sure to do their research, do their due diligence, and not invest before they understand the risks.
Syndication investing is not for everyone. Not all investors are comfortable investing in illiquid investments or giving up control in the operation of their real estate investments.
However, if you’re in the market for an opportunity that will take care of operational details while you focus on other business goals, syndications may be worth exploring further.
References:
https://www.fool.com/investing/2022/08/21/forget-buying-a-rental-property-consider-this-pass/
https://www.passivewealthstrategy.com/8-pros-cons-syndication-investing/
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