Passive investment opportunities in real estate syndication can provide outstanding ways to generate attractive financial returns. In the very best scenarios, you and your fellow passive investors can earn consistent income with few of the headaches that come from other types of investments. Simply put, these passive investment opportunities offer great chances tobuild real wealth.
That being said, getting to these ideal scenarios doesn’t automatically happen. They require some diligence from your end. Because of this, it is worthwhile to explore some of the things that you should consider when analyzing a passive investment opportunity. By doing your homework now, you can avoid mistakes and find the best passive investment opportunity for you.
First Principles in Analyzing Passive Investment Opportunities
To be clear, these are several first principles that you should follow when considering a syndication opportunity. They aren’t the only things that you should consider. Generally speaking, by being measured, reserved, and rational, you will make great decisions.
One of the first things that you can do is research specific asset classes and markets. There are plenty of multifamily asset class types, ranging from new upscale luxury buildings to 40-year-old buildings that were built for low-income residents. Each asset class provides its challenges and opportunities, so you’ll need to evaluate your risk profile before proceeding. The same is true of markets. You may have some more familiarity with a local market, but there may be greater opportunities elsewhere. Make sure that you are soberly thinking about your opportunity set before proceeding.
As with any type of investment, another one of the first things that you should do is research your potential partners. Naturally, much of the attention will veer toward the sponsor or general partner. This is for good reason, as the sponsor is active in the day-to-day operations of the syndicate. But beyond the sponsor’s experience and background, you will also want to evaluate the relevant property management company, commercial real estate broker, and any real estate and securities attorneys. See how they evaluate potential deals and how quickly they can close potential deals.
It takes a team to create and run a real estate syndicate, so you want to have a good understanding of your new partners. Beyond doing simple Internet research, don’t hesitate to make some reference checks. Speak with other limited partners who have worked with any of these individuals or entities. Completing this primary research will give you the confidence that your partners will maximize the value of your investment.
From there, you will need to closely scrutinize your potential returns. After all, much of your interest in real estate syndicates likely comes from the fact that you can earn outsized returns. As a limited partner, you can be compensated in several different ways, including a preferred return, a profit split, or supplemental loan proceeds. Preferred returns and profit splits are more common, but you’ll want to read the fine print for more. For instance, you may discover that your preferred return is 8% before the general partner is paid. Or you may discover an unequal profit split in your favor after that preferred return. Make sure you understand your potential profit before entering the syndicate.
Finally, you will want to examine the opportunity’s underlying fee structure. Sponsors, real estate attorneys, property management companies, and others provide significant value to the overall syndicate. Because of this, they receive compensation for completing their work. This compensation may impact your overall return on the property. For instance, your sponsor may take a profit split on an ongoing basis or upon the sale of your property. Your property manager may take a 10% management fee on the collected income. Whatever the case may be, have a good understanding of how your partners are being compensated. No fee structure, in and of itself, is good or bad. It depends on the value you are getting from your partners and how those fees impact your total returns.
Get Started Today
Whether you are new to passive investment opportunities or have been making investments for some time, it is critical to keep these first principles in mind. They can both help you find attractive investment opportunities and avoid those that are less attractive to your financial goals. Ultimately, the best time to get started is today.
Can I Invest in Multifamily Real Estate Syndications Using Funds From My IRA?
Yes you can, by transferring the funds from your IRA into a self-directed IRA. This article will explain how that works and how doing so will increase your investment options, allowing you to use those funds to invest in a multifamily real estate syndication.
Why would you want to do that? Regardless of the amount of money that you have been able to save, the gold standard is to have those savings tied to investments that are both stable and produce strong returns.
The main advantage of investing in a real estate syndication is the return. If you have money wrapped up in an IRA account that’s earning only 1-2% a year, you may wish to look into setting up a self-directed IRA (sometimes called a checkbook IRA) to allow you to invest in real estate.
Why A Self-Directed IRA?
Only the self-directed IRA can be set up to invest in real estate syndications. The tax code allows for this, and the key is to place your self-directed IRA account with a custodian that will accommodate investments for multifamily syndication. An IRA custodian is the financial institution responsible for record-keeping and IRS reporting requirements.
Multifamily, value-add syndications are a great type of investment for a self-directed IRA, they generate passive returns and then are liquidated for a bottom-line profit. That profit is usually taxed as a capital gain, but if it happens within your IRA, you won’t pay taxes until you actually retire and begin to withdraw income from that IRA.
You have to wait until you reach age 59½ to withdraw your funds, and the withdrawal will be included as ordinary income on your tax return. In the meantime, you have the right to invest in a real estate syndication deal or multiple deals, while maintaining the tax-deferral status of the IRA.
What is a Self-Directed IRA?
An IRA is an individual retirement account that allows the account owner to direct the account trustee to roll over all or part of their IRA and make investments in alternative assets such as real estate. Rolling the funds over from your IRA into a self-directed IRA gives you control of your own financial future. You control the investments instead of the company that handles your IRA.
With a self-directed IRA, you can create a Limited Liability Corporation, (LLC), and that entity invests in and holds your IRA funds. As the LLC General Manager, YOU can now handle the investing.
Tax Implications
Like a traditional IRA account, a self-directed IRA allows owners to defer taxes until retirement age.
When using a self-directed IRA for purchasing real estate, you can’t claim depreciation on property held within it. Also, there may not be a way to take advantage of operating losses as well.
Another thing to consider is income. Most people consider the income that is produced from their IRA as investment income. Occasionally, the IRS may categorize it as business income instead.
If it does, then that income can be subject to something called UBIT, or “Unrelated Business Income Tax” which can be taxed at rates as high as 39.6%.
UDFI, or “unrelated debt-financed income,” is primarily used in the context of IRA investments that generate income derived from debt-financed real estate or other property owned by the IRA. The UDFI is subject to UBIT.
You may be liable to this tax if your IRA participates in buying and selling a significant number of real estate properties in at least half of a year.
The best way to be certain about whether you owe UBIT is to talk with your tax professional.
A Roth Self-Directed IRA
You will eventually have to pay taxes on the tax-deferred income in your IRA when you take cash out. An alternative is to choose a Roth SDIRA. With a Roth SDIRA, there is no up-front tax break, it uses after-tax contributions, but you don’t have to pay tax on withdrawals in retirement. Your earnings will grow tax-free and when you take distributions from the account in retirement, you won’t owe any taxes on them.
Solo 401k
Making the choice between setting up a self-directed IRA or a solo 401(k) is an important decision. You need to consider all of the differences.
To be eligible to benefit for the Solo 401k Plan, investors must meet two eligibility requirements:
The presence of self-employment activity.
The absence of full-time employees.
If there will be debt on real estate investments you are much better off choosing a solo 401(k) over an IRA as solo 401(k)s are exempt from UDFI tax on leveraged real estate.
The Importance of A Good CPA
It is vitally important that you work with a good Certified Public Accountant (CPA) who understands the legal side of real estate investing. Getting the right tax advice is essential in making the best use of your retirement funds.
Setting up Your Self-Directed IRA
A Self-Directed IRA LLC may be funded by a transfer from another IRA account or through a Self-Directed IRA Rollover from an eligible defined contribution plan. Eligible defined contribution plans include qualified 401(k) retirement plans.
With the transfer, you do not receive the IRA assets. The transaction is carried out between the two financial institutions. In order for the IRA transfer to be tax-free and penalty-free, the IRA holder must not receive the IRA funds in a transfer. Rather, the check must be made payable to the new IRA custodian.
You can then instruct the new custodian that you select to request the transfer of IRA assets from your existing IRA custodian in a tax-free and penalty-free IRA transfer.
Once the IRA funds are either transferred to the new custodian, the new custodian will be able to invest the IRA assets into the new IRA LLC “checkbook control” structure.
Once the funds have been transferred to the new IRA LLC, you, as manager of the IRA LLC, would have “checkbook control” over your retirement funds so you can make traditional as well as non-traditional investments tax-free and penalty-free.
It is important to choose the right custodian, consider their experience, fees, and areas of expertise, and check out their rating with the Better Business Bureau.
A Word Of Caution
According to the Securities and Exchange Commission (SEC), you need to guard against criminals attempting to commit fraud against self-directed IRA account holders. Protect Yourself by:
Not taking unsolicited investment offers.
Asking lots of questions – be suspicious if these are not welcomed.
Being wary of those promising unrealistic returns on your investment.
Why Multifamily Syndications?
It’s true that you have many options when it comes to investing. Some high-risk investments yield a high rate of return. Then there are safer investments but the rate of return is low. Multifamily real estate combines low-risk with generous returns.
The most common use of self-directed IRA funds is an investment in syndicated real estate deals. A syndication is a group of investors pooling their funds for investment. The investment is typically larger than one the investor could accomplish on their own. These real estate investments are professionally managed and you are not required to do any of the legwork.
Investment returns & distributions are returned to the self-directed IRA as cash. Accumulated cash distributions can later be invested in another investment.
Pros and Cons
From what we have discussed so far you can see that using a self-directed IRA to invest in residential or commercial real estate which is not allowed through regular IRAs has pros and cons.
Let’s get specific and list them, starting with the positives.
Pros
Tax-free or tax-deferred account growth – With a self-directed IRA, you can invest in real estate as you normally would, but your gains are tax-free or tax-deferred, depending on the type of IRA account you use. There aren’t many other opportunities to invest in real estate in a tax-sheltered way.
Control over your investments – As the owner of the account, you get to decide what to do with your investments. It’s possible to create a limited liability company (LLC) for your SDIRA. Doing this gives you checkbook control.
Investing through an LLC can also provide other liability protections, though you should consult with a tax professional to better understand the LLC laws in your state.
Potential For Higher Returns – A self-directed IRA real estate investment has the potential to earn a higher ROI than investing with traditional securities.
Cons
Fees – The Internal Revenue Service requires that either a qualified trustee or a custodian hold assets on behalf of the IRA owner. This means costs that can eat up into your profits if you’re not careful.
Complex Regulations – Your SDIRA could be disqualified as a tax-advantaged account if you don’t follow all of the IRS regulations carefully.
UDFI – if your IRA owns property that has been financed, some of the income from the property is considered unrelated debt-financing income (UDFI), which is subject to taxes.
Are Self-Directed IRAs For You?
Those investors who choose to use self-directed IRAs do so to seek higher returns and greater diversification.
Self-directed IRAs may not be for everybody but if you want to take advantage of higher yields and less volatility you should seriously consider the possibility.
If you are creative and knowledgeable enough to use self-directed IRAs in the right way it could be a great option for you and your investment future.
While many people tend to dread tax season each year, those who are proactive with multifamily real estate investing (specifically real estate syndications) are likely excited about it. That is because there are tons of multifamily syndication tax benefits and incentives that arise for passive investors that enable them to gain max profits from this dynamic stream.
In short, investing in multifamily syndications offers much more than a lucrative passive income stream; it is also one of the most tax-favoured investing avenues.
Before we dive into these benefits, here’s a quick disclaimer. Since we’re not tax professionals,the information in this article is from our experience and understanding only. You should speak to a qualified CPA for details and advice about your specific situation. This article should not be construed as tax advice.
Below are the leading multifamily syndication tax benefits that every investor should be knowledgeable of so they can be fully prepared to capitalize on their opportunities.
Depreciation
Depreciation is a huge tax deduction and is often overlooked. In tax terms, depreciation is an accounting method that calculates the cost of tangible business assets’ declined value over time and allows the owner to write it off. The most common form is called straight-line depreciation, which is a system that takes the annual deduction cost of items and divides it by its useful life. As for real estate, the IRS states that the useful life of residential properties is 27.5 years, and 39 years for commercial.
For example, if you have a property valued at $1 million. You can divide that by 27.5 years, which comes out to about $36K. That means that you can deduct $36K in depreciation each year for up to 27.5 years. The reason this is such a significant deal is because, hypothetically, let’s say you make about $10K profit in a year on your invested property. In such a case, you do not have to pay taxes on that $10K and you get to keep it completely tax-free. On paper it may look like you lost $26K, but in reality, you earned $10K.
Cost Segregation and Bonus Depreciation
Cost segregation is very similar to depreciation but accelerated. Cost segregation takes into account that some parts of the property depreciate much faster than 27.5 years. For example, flooring such as carpet has a much shorter life span.
You can have an engineer do a cost-segregation study where they evaluate the individual elements of a property and calculate the life span. This can allow you to depreciate many items over a much shorter time frame, for example, 5-15 years.
What’s the benefit of taking the depreciation deduction at a must faster rate?
You see, the hold time for most multifamily real estate syndications is about 5 years. That means that you may only get 5 years of those depreciation benefits listed above (5 out of 27.5 years), meaning you’d miss out on over 22 years of depreciation benefits.
So, if you have something that depreciates in 5 years instead of 27.5 years, and you only hold that property for 5 years, you may end up deducting the full depreciation amount for that part of the property. By being able to take a larger depreciation deduction earlier, you get more of the depreciation benefits and make a higher profit.
When a property is sold, capital gains tax is owed, and in some cases, deprecation recapture.
Another depreciation option, which is a result of new tax bills, is “bonus depreciation”, which gives the option to depreciate the entire value of a property in the first year. This way you can carry forward losses until the property is sold, which can offset capital gains.
1031 Exchange Tax
If you do not want to embark on capital gains just yet, a 1031 exchange would be an ideal alternative. A 1031 exchange is what allows investors to sell one investment property, and in an allocated amount of time, swap it for another. Essentially, instead of having the gains be rolled out to you, you would have the ability to invest them in a new real estate syndication. That all equates to you not needing to owe any capital gains tax to the IRS when the first investment property is sold. Note that not every real estate syndication offers a 1031 exchange outlet, but it is something to be mindful of and ask about during your venture.
Refinance Cash-Outs
It is not uncommon for multifamily real estate investors to invest in a property for about 1-3 years and then refinance the property after the value has increased due to renovations and rent increases. Doing this does not come with any tax obligations because it is not a taxable event when you return part of the investor’s equity.
Other tax benefits
Rental income is not subject to social security tax or Medicare tax, so that is a benefit as well.
Summary – The Tax Code Favors Real Estate Investors
In summary, multifamily real estate syndications can be a great investment that optimizes tax breaks and has been a proven channel to grow and preserve wealth. With the various multifamily syndication tax benefits, combined with typically excellent returns, it is clear how investing in real estate syndications can add up to significant short and long-term gains.
All in all, for any investor looking to convert their hard-earned capital to passive income in one of the most tax-friendly ways, then multifamily real estate syndication is certainly a prime avenue to think about.
Maybe you’ve heard of a 1031 Exchange or simply a 1031. A term that got its name from the IRS Code section 1031, it is an exchange or a swap of one property for another that is a powerful tax strategy allowing for the deferral of capital gains taxes.
Anyone who owns real estate can harness the power of the 1031 exchange. Just by following this process, you can replace your property and buy a replacement investment, while deferring tax payment on what you gain from the sale.
Want to know how you can have more cash flow through this investment? Or want to earn passive income without being pummeled by taxes?
In this article, you will find key points regarding the 1031 Exchange – rules and concepts you should know if you are thinking about any kind of real estate investment, and when using the 1031 Exchange to invest in a real estate syndication.
A Better Return on Investment
This exchange into syndication helps you by offering a better return on investment while giving you an increase in cash flow. Therefore, when you exchange it with a larger and more valuable property via syndication, the benefits increase twofold.
Deferring Taxes
With this exchange, you get the ability to buy like-kind property while deferring capital gains taxes. If you continue re-investing into other properties, doing this exchange until your death, the investment will be handed down to the heirs, and the cost of the property will reset to the current investment value allowing you and your heirs to avoid the capital gains tax.
However, if you sell the property and take the proceeds (without reinvesting), you will have to pay the capital gains.
Timeline to Execute the 1031 Exchange
The IRS has a specific time frame in which the 1031 exchange needs to be executed, and it needs to be followed for the exchange to run smoothly.
You have 45 days to identify the asset that you will be acquiring, starting from the day of the sale of your existing asset. The IRS does not allow you to access the funds or to touch the property once you sell it. It is also a requirement that you engage a qualified accommodator to facilitate the transaction.
Once you have identified your next asset, the IRS gives you a further window of time so that you can close on the asset. This means that you have a total of 180 days from the day you complete the sale of the original asset to the closing of your next asset. The IRS has strict rules and a timeline to follow and if you are unable to follow those rules you will have to pay the capital gains.
The Role of Accommodator
The role of the accommodator (a qualified intermediary) is to facilitate the process of the transaction from the sale of your asset to the closing of your next asset.
The intermediary helps you walk through the entire process and steps required for the syndication and makes sure that you never miss the timeline, which is outlined by the IRS. In doing so they will help you avoid a taxable event.
The accommodator you hire must be an independent entity and should not be related to you.
Once you hire the accommodator, you will have to enter agreements, including an Escrow Account Agreement, Like-Kind Exchange Agreement, and others that will allow the intermediary to act on your behalf through the transaction process.
Identification Rules for Next Property
There are some rules set by the IRS that you can use to identify the replacement properties. You must choose to follow at least one of these options.
These rules are:
The 3-property rule
Investors, most of the time, use the 3-property rule to identify up to three properties that might generate more cash flow. This means you can exchange into one or all the replacement properties.
If you want to identify more than three replacement properties, you will have to use the 200% fair market value rule.
200% fair market value rule
What is that? How does it work?
Let us give you an example.
Suppose you sell your property for $2,000,000, and identify up to 3 replacement properties for exchange.
You can identify a fourth or fifth replacement property as long as the sum total value of all the properties combined does not exceed $4,000,000 or twice your property’s selling price.
95% Exception Rule
The 95% Rule allows for you to identify any number of replacement property options, regardless of valuation, provided that you follow through and actually acquire a property or properties that equate to at least 95% of the identified value within the exchange period.
For example if you sell your property for $2,000,000 and then identify more than three properties worth $10,000,000 to exchange into, that is allowed if you actually end up spending at least $9,500,000 or 95% of the identified value within the exchange period.
Can I 1031 Exchange my Residential or Vacation Home?
Your primary residence or vacation home is not qualified for this type of exchange. However, there is an exemption, which is known as Section 121. This is a complicated structure, and you will need to take qualified advice to make sure that the exchange is properly executed.
1031 Exchange is a technique for investors who want to earn passive income from real estate. You need a clear understanding of the process so as to leverage it correctly. The procedure
can be complicated and that’s why most investors prefer to work with experienced partners.
Our aim is to help you grow your wealth. We are here to help you with the 1031 exchange so that you can enjoy the benefits that apartment syndication provides.
As an investor, there are various ways you could put your money to work. When you’re in the world of private placements, you may have heard of preferred returns. These refer to the order in which profits from a project are distributed to investors. Preferred return indicates a contractual entitlement to distributions of profit. Those who were promised preferred returns are given priority when the distribution of profits happens. This is maintained until a predetermined threshold rate of return has been met.
Preferred returns are usually expressed as a percentage of return on an annual basis. For example, if in an agreement you were promised a preferred return of 8% for a $100,000 investment, then you would receive $8,000 ($100,000 x 0.08) in annual return if available from the net revenue.
As an investor, the rate of preferred return is a vital component in checking the health of a particular investment, as it reveals the intent of your partners in returning your money. When you have preferred returns, you’re given priority over the company’s income before the general shareholders. That means the people running the company should work hard enough to not only meet the promised preferred returns but also generate enough excess income to be profitable.
In short, the operators will be focused on reducing the time spent before you get your return on investment, to increase your overall return. This will ensure that your goals as an investor and the goals of those running the company are in sync, and no one is out to cut the other short.
By the nature of preferred returns, it is indeed more advantageous to the one with the capital. Thus, when you’re offered an investment, it pays to look for this clause. An operator may choose not to offer preferred returns because doing so will delay their split of the profits. While this is acceptable, as an investor, you may see this as a misalignment of interest. Another reason why operators may not offer preferred returns is if they are not as well-capitalized and need the proceeds from the cash flow to fund their syndication operations.
Types of Preferred Returns
Now that we’ve talked about preferred returns, let’s discuss their types.
The first is cumulative versus non-cumulative. When you’re tasked to review a private placement memorandum (PPM), you will want to make sure that you take note of whether it’s a cumulative preferred return. Cumulative preferred return is ideal because it will help protect your overall return and here’s why.
Remember our example earlier? Let’s say, you’re given a preferred return of 8% per annum. In a non-cumulative preferred return, if you do not receive your total preferred return for one year, then you lose the difference. Say, in year 1 you receive back 6% (rather than the 8% that was anticipated). With a non-cumulative return, youforfeit the right of getting the difference after that year has elapsed. Every year the preferred return resets and does not carry forward.
A cumulative preferred return gives you the right to add the difference and roll it over to the next year. For example, if your preferred return was 8% and you only received 6% one year, then your preferred return the following year would increase to 10% (8% + 2%).
In the normal business cycle, cash flows are expected to increase year to year as operations begin to stabilize and become more profitable. Thus, while the promised return in percentage is fixed, the actual value of such will be bigger since the number where it’s computed from also gets bigger as the years pass. This can lead you to get a return on investment sooner.
As a reminder, always read your documents carefully to be aware of whether you are investing in projects with a cumulative preferred return.
Another type of preferred return is the preferred return with catch-up. This setup is considered the second position in the waterfall distribution schedule. Here, once your share of the profit is achieved and is set aside, the operator receives all or most of the profits until the operator “catches up” and reaches the same portion of equity you received. This type of catchup provision allows the operator to receive its entire equity split as originally agreed by both parties.
What Else To Know
Another aspect that you should know about concerning PPMs is the difference between Preferred Returns and Preferred Equity. To differentiate both, let’s go back to the life cycle of the investment. Assuming that funding is already secured, your investment can either be with a preferred return, preferred equity, or both. We discussed how preferred returns work. When it comes to preferred returns, the actual return of your overall capital is not in the picture.
When you have preferred equity, you’re prioritized to get your returns during the hold period and also have a priority treatment to get back your initial capital when the asset is sold.
So it is a good business practice to consider adding an equal amount of preferred equity and preferred returns in your portfolio for risk management purposes. Preferred returns help you with a steadier, consistent cash flow; while as a preferred equity investor, you would receive your specified return and your initial capital back before any of the other investors.
When Do Preferred Returns Go Away?
Preferred returns are often calculated based on how much capital you contributed times the interest promised. However, there are distribution structures where your payouts are deducted from your capital. Thus, every payment you receive means a return from the capital you invested. This will also mean that since your returns are based on your unpaid capital, then it’s safe to assume that you will get smaller payments over time.
Some operators will say that this is a good idea because you are not paying taxes on the cash flow. However, since your preferred returns are based on unreturned capital contributions, your preferred returns will gradually diminish. Some operators prefer this structure because it allows them to achieve profitability quicker.
As an investor, It’s generally better to choose preferred returns that are distributed from profits alone and not deducted from your initial capital so that your payouts will not be diminished. Typically you do not have to worry about the taxes right now anyway, since the depreciation each year should offset all the distributions you receive.
You also do not have to worry about the return in the capital, as preferred returns are not the most efficient way to get it back. Usually, to reduce your unreturned capital contributions or get it back completely, you need to go through a capital event such as a refinance or supplemental loan. Through these events, you would receive a portion of your initial capital back and this amount would reduce your unreturned capital contributions.
To make the above example less confusing, let’s pick up from our last scenario. You invested $100,000 and because of this, you will be getting an 8% preferred return rate (or $8,000 a year). Instead of deducting this amount from the initial capital, treat it as a dividend gain. In year three, when the operations have stabilized and the company is ripe and due for refinancing, that’s the time you can lobby to get a portion of your capital back. Your preferred return would then be based on the remaining unpaid capital. Thus, if during the said refinancing you were able to get around $40,000 back, then you will still be able to enjoy the fruits of the 8% preferred return rate on the $60,000.
With this example, it is important to note that even though your unreturned capital was reduced, this does not reduce your equity position in the overall deal. This amount is only used to calculate your preferred returns. However, some operators will reduce your equity position during a refinance or supplement loan, so be very diligent in reading the PPMs to make sure you know exactly what you are getting yourself into from the start.
Conclusion
Remember that just as with any venture you may get into, always protect your capital first. That’s the basic rule of risk management. Do not look so far ahead, especially to the potential gains, and overlook the red flags and risks that might be lurking in the PPM. Look at preferred returns as a powerful tool for you to protect your capital. It allows you to have preferential treatment in getting back your capital (and more) and eventually helps you grow your portfolio as a passive investor. By carefully choosing preferred returns, you reduce your risk when putting your money in private placements, since you are prioritized to receive the proceeds of all cash flows first.
Maybe you realize you want to invest passively in real estate, but you’re not sure which is better for you – to invest in multifamily (through a syndication) or an REIT.
This article helps you understand the difference between passive investment in multifamily versus passive investment in REIT, and aims to help you make an informed decision.
What is REIT?
A Real Estate Investment Trust, or REIT, is a company that has a wide range of revenue-generating properties. It involves a pool of passive shareholders, who receive subsequent dividends on their investment. A REIT can be any registered corporation or association that invests in real estate intending to generate revenue. It treats an investment as buying stock.
What is Multifamily Property Syndication?
A multifamily property refers to a residential property with more than one unit of accommodation, such as apartment buildings, townhouses, duplex properties, and condos. Syndication offers multiple individuals a wonderful passive investment opportunity that can generate substantial revenue over time.
Comparing REIT with Multifamily Property Investment
Now that you have a basic idea of these two types of passive real estate investment that you can venture into, let’s see which one is better for you. There are several factors on which you can weigh the two types of investments against each other.
Minimum Investment
When it comes to REITs, there is no cap on the minimum or maximum amount that you can invest, which makes it a much more flexible form of passive investment than multifamily properties. But there may be a rule where you can only buy shares in blocks of 10 or 50, and this is predetermined by the company you are buying real estate stocks from. This means that you can start from as low as $1,000.
On the other hand, when you invest in multifamily property, usually there is a minimum investment. For example, some syndications require at least $50,000 as an initial investment. Plus, it may also ask for higher subsequent investments, which is not the case when you invest with REITs. This makes them much more flexible in terms of the minimum investment requirement.
Returns
One factor in which multifamily investments take the lead over REITs is the rate of return. With REITs, for the past five years the average annualized REIT return is under 6%, which is better than having it sit in a savings account, but could be better.
On the other hand, most multifamily property investments can bring you excellent yields of 9% and greater. Some properties have even brought wonderful returns of over 15%.
Liquidity
Liquidity refers to the ease with which an asset can be converted to cash, and while real estate investments don’t normally offer too much liquidity, you can actually experience it when you invest in REITsbecause you can trade them like a standard stock. If you have invested your capital recently but need to withdraw it for an emergency, you can do it quicker than you can with an investment directly in a multifamily property.
In a multifamily property syndication, your investment is locked in with the other investors, at least until the hold period is underway. However, there is a workaround to this problem and you can add it to your partnership or association agreement, which can help you get your capital amount back in a reasonable time.
Taxation
When it comes to taxes, whether you invest in REITs or a multifamily property syndication, there are depreciation benefits. With REITs, there is no way for you to defer the taxes on the profit that comes from the sale of your stocks.
On the other hand, investing in multifamily properties allows you to defer the taxes if you reinvest in another project by taking advantage of the 1031 exchange.
Diversification of Portfolio
No matter what investment you make, your financial advisors may have always advised you to invest in a diversified portfolio or to “never put all your eggs in one basket”. This is a sound strategy that you can also apply to passive real estate investments.
In REITs, your investment is distributed between an entire portfolio of properties, and their individual financial performance combines to bring you a safe and significant return.
On the contrary, with a multifamily syndication, your investment is tied to one multifamily property, and its financial performance constitutes the amount you get as a return on investment. But you can still diversify by investing with multiple syndicators, which is a viable option.
Risks
The risks also need to be assessed when you compare REITs with multifamily syndications. Since REITs are based on the buying and selling of stocks, the value of your investment may fall as the market value of the stocks goes down. This can present a risk.
Multifamily properties are typically a much lower risk, since they give you partial ownership in a physical asset, and the chances of the property value falling drastically are very unlikely.
Ease of Entry
The ease with which you can start investing in REITs or multifamily properties is also a deciding factor for some. As mentioned above, REITs have a smaller minimum investment requirement, and also don’t require any form of accreditation or validation about your financial condition or ability to invest.
However, when it comes to multifamily properties, depending on the route the company that you invest in is taking, they may require you to be accredited. If so, they may ask you to provide an income statement that shows you have an annual income of at least $200,000 to be able to invest in a property.
Ownership
When you invest in a REIT, you own stocks of the real estate portfolio that you invest in, which is somewhat abstract, and you don’t get your name on any property. This also means that you don’t reap the full benefits of the financial performance of that portfolio.
On the other hand, investing in a single multifamily property allows you to attain ownership of the asset. You have partial ownership of a real property that you can physically see. You can see how the investment progresses as the company you’ve invested with implements their plan to improve profitability. Your profits are tied to tangible things – improvements made, rents increased, occupancy rates, etc., which you can track.
Reachability
Reachability refers to the ease of access that you have with the people who manage your investment. With REITs, it can be quite difficult for you to reach out to fund managers or investment consultants. Rather, you will be directed to a manager or representative.
This is an area where investing in multifamily properties excels, because you have direct access to the general partner or sponsor you’ve invested with – the person managing your investment. You don’t have to go through some complicated process to speak to a real human, only to find out they can’t really do anything for you. You can pick up the phone and call the general partner / sponsor or send them an email directly.
Key Takeaway
Both REITs and multifamily syndications allow you to make sound passive investments, and they are generally more attractive than other types of investment. Do a little homework to determine what’s the best fit for you and then invest with a company you trust.
If you’re interested in high returns and great tax benefits, we would love to speak to you about investing passively in one of our upcoming multifamily property syndications. Contact us today to get started!
