Top 10 Reasons To Invest In Real Estate Syndications
Updated: Sep 30, 2019
In my opinion, real estate is the best way to grow wealth. If you want to invest in what the rich do, get involved in real estate — but I'm not talking about just any real estate.
Real estate has been a staple in many successful investment portfolios for decades, and for good reason. It is a limited commodity that has a proven track record of lucrative returns, the offer of diversification, and resilience to economic recessions. One may hold a number of real estate assets from land to single family homes, and even small multifamily homes. One type of asset structure that is often overlooked, is real estate syndication, specifically for large multifamily apartments, self-storage facilities and manufactured home parks. The reason behind this may be one of many; limited access, high cost of entry, or the lack of “know how” to name a few.
The biggest reason investors participate in real estate syndication is access to deal flow. Not every investor has the time to search and underwrite hundreds of properties to find a gem to acquire. By getting involved with trusted real estate syndication partners, investors gain access to this deal flow and the ability to invest in high quality real estate without the hassles of property management.
What is Real Estate Syndication?
Simply put, real estate syndication is an effective way for a syndicator/sponsor and a group of investors to pool their financial and intellectual resources together to invest in properties and projects much bigger than they could afford or manage on their own. Over 90% of large multifamily purchases are made through a real estate syndicate.
The parties at the forefront of a multifamily syndication investing deal include the sponsor (also referred to as the general partner, operator, or syndicator), the limited partners (or passive investors) and the property management team. There are plenty of other team members involved that make the deal work behind closed doors, including, but not limited to, a commercial broker, a team of attorneys, CPAs, and lenders.
Role of a Syndicator
The sponsor/syndicator is the person who initiates the real estate syndication; they are responsible for identifying the market, underwriting the property, securing financing, overseeing the business plan/renovations and the daily activity of the property management company, ensuring strong investor relations, and managing the asset it general.
Role of an Investor
The limited partner, or investor, is the individual (or group of individuals) that provides the equity to fund the deal. The role of investors in real estate syndication is very simple: they invest their money in a real estate project that is run and managed by the syndicator, and they earn a percentage of the project’s profits based on a predetermined and agreed upon rate that is split between all investors and the syndicator.
Now that we've covered what syndication is and the parties involved, below are my top 10 reasons to invest in real estate syndication. I believe it is a great passive wealth building vehicle for qualified investors to reap the major benefits of investing in real estate.
What role does diversification play in your overall investment portfolio, and how much is dedicated to high cash flowing real estate investments? One of the biggest reasons investors diversify their real estate investment portfolio is to mitigate risk exposure. The phrase “don’t put all your eggs in one basket” applies directly to this concept, as spreading your investment across a broad spectrum is how investors balance risk and reward in their investment portfolio. What I love best about multifamily syndication investing is that it's relatively easy to build a framework around diversification by niche, geography and sponsor.
Niche Diversification - Many investors consider investing in real estate syndications in order to get better diversification within real estate asset classes. Typically each sponsor has a specialty in a specific type of asset class that they have a competitive advantage in. One should be cognizant of diversification in your real estate portfolio, so spreading investments amongst apartments, self-storage and manufactured home parks is a great way to achieve this. Understand asset cycles and trends. Some areas like office may not do so well in a down economy where more stable assets like apartments, self-storage and manufactured home parks may hold up nicely.
Geographic Diversification - Another form of diversification within real estate syndication is geographically. Actively investing out of state can work, but passive investing through syndication deals is ideal for out of state investors looking for better value in top markets. Some of the best deals are out of state in growing markets. It can be very difficult trying to be an active out of state investor due to competition, relationships, market knowledge, etc but if you align yourself with a reputable, successful operator in that local market you can gain access to some great deals you otherwise wouldn't have had access to.
Sponsor Diversification - Vet sponsors carefully and don’t stay married to one sponsor forever. Ensure they are growing their depth with key management for continuity and that they are staying true to their philosophy and model which should be conservative and tested. When you invest with multiple sponsors you gain a perspective that allows you to sniff out the good deals from the bad deals since you'll see so much more deal flow.
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 $50,000 - $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 $25,000. This opens up the doors for typical investors to invest in opportunities that they would never otherwise be able to invest in.
Once you start using this pooled investment model, you can get exposure to apartment communities, self-storage deals, mobile home parks and many other amazing cash-flowing 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. Read our post What is Real Estate Syndication? to learn more.
When you invest in a real estate syndicate, the syndicator/sponsor will handle all aspects of the deal 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. Investors will pay the syndicator via the performance of the deal with a split of the cash flow and appreciation. (Anywhere from 80/20 to 50/50 split for the investor is common but I typically see a 70/30 split.)
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 need to do is sit back, relax, and collect payments in the form of quarterly or monthly cash flow distributions and lump sum payouts at refinancing and disposition.
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. Under the new law, investors in pass-through entities like commercial real estate will greatly benefit from an additional 20% deduction.
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. Note: Savvy syndicators will utilize 1031 exchanges to roll your investments into the next deal, thus pushing taxes off even further!!
5) Forced Appreciation
Unlike single family homes, a multifamily apartment syndication is a business that is valued primarily by its Net Operating Income (NOI), not by property comps. Through physical and operational improvements, you can increase the value of the property by increasing NOI. Most value-add syndicators look for opportunities to capture appreciation through capital improvements or through streamlining known operational inefficiencies with current owners.
One of the first things you will want to look at when considering an investment with an apartment syndicator is the general partners plan to reposition, or force appreciation on, the asset. There are three ways to force appreciation; increase income, decrease expenses, or a combination of both. Regardless of which approach is used, the result will be the same – an increase in NOI.
Let’s look at how an increase in NOI will affect the value of the asset. Imagine we buy a 100-unit apartment complex for $5M that has a NOI at time of purchase of $250K, thus a CAP of 5% (NOI/Asset Value). Now say we invest $350K on improvements that garnish an average premium of $75/unit. This increases the NOI from $250K to $340K and thus brings the FMV (fair market value) from $5M to $6.8M (NOI/CAP = 340,000/.05). Investing $350K for a $1.8M FMV increase, a $1.45M return, is a very lucrative move. As you can imagine, a decrease in expenses will affect the numbers in the same way by increasing the NOI.
6) Risk Reduction
By investing with other investors through a syndicator with a proven track record, investment risk is dispersed among all the investors. A real estate syndicate allows you to adjust your investment to a more comfortable risk level.
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.
7) Economies of Scale
This one is simple - the more units under management, the higher your ability will be to lower expenses (think cost per unit), thus driving up NOI. This is particularly true when using a property management company or undertaking renovations. Property managers will lower their cost of onsite management the more units that you have, even better if they’re in a more condensed area (as opposed to 100 SFHs spread throughout town). When thinking of renovations, contractors price per unit will be lower the higher the number of units, and providers of renovation materials – flooring, appliances, doors, siding, paint, etc. – often offer deals or discounts for ordering in bulk.
8) Consistent Returns And Less Volatility Than Stock Market
The long-term performance of commercial multifamily real estate makes it a compelling asset class for many investors. If I could sum up that performance in two words, it would be consistent performance.
Consistency is really important. After all, anyone can have a great game, but true greatness comes from consistently high performance over a long period of time. With that said, what is the long-term performance of the three largest asset classes?
Source: NCREIF, Bloomberg, Barclays, Lehman, RCG
As you can see, since the great depression, commercial real estate has had far more up years than down years in comparison to both stocks and bonds. In fact, commercial real estate has three to four times fewer down years than the other two.
If you look back even further at the historical performance of the S&P 500 you get a clear picture of the inconsistency of the stock market.
Source: Macrotrends.net, S&P 500 as of July 05, 2017
In the last 90-years from 1927-2016 the composite index or S&P 500 has had 28 down years. That is one down year every 3.2 years on average. Now there are reasons to invest in the stock market, but it seems that far too many investors throw money at the market like they’re swinging for the fences.
Since commercial multifamily real estate has 3x to 4x fewer down years than the stock market, it too has performed better. That is 3x – 4x more stability that has created more income, more equity, and more wealth for apartment investors.
It is that consistency of performance that has more Americans saying that real estate is the best long-term investment and the statistics show it.
9) Principal Paydown
Isn't it great to have other people pay down your debt? Imagine several hundred people doing that. That's what happens in large multifamily apartment and self storage deals. Rental income pays down the debt and builds equity in the property. Through the life cycle of the syndication, rental income from the property pays all debt service. Upon sale of the property principal reductions will be returned to investors.
10) Great Inflation Hedge
As inflation levels began to ramp up and the purchasing power of each unit of currency begins to take a hit, investors may be wondering how they can avoid this monetary backlash and avoid losing value on their investments to inflation. One way to do so is through investing in hard assets such as apartment buildings. Investing and building wealth through apartment buildings is a great way to hedge against inflation because rents, which is the source of an apartment investor’s gross income in the investment, rise along with inflation. Real estate in general is always a great investment, but the benefits of doing so are greatly augmented during times of rising inflation. Because of the limited amount of land, in certain markets, and rising population growth, demand in the real estate apartment sector is high. This limited supply and high demand means that increased property values offset any deterioration in wealth caused by a rise in inflation.
Hope you enjoyed reading my Top 10 reasons for investing in real estate syndications. As an asset structure and investment opportunity often overlooked, I truly enjoy getting the chance to talk with investors about the many benefits real estate syndication investment opportunities offer.
For those looking to build long-term wealth while creating a nice passive income stream along the way please consider taking a look at these types of deals. I realize this may not be a fit for everyone and there are many other wealth building strategies out there, but for those who have started investing through this type of vehicle, the biggest regret I hear is, "I wish I started earlier." (That includes me too!)