Real Estate Syndication vs. REITs
What’s the difference between a real estate syndication and a REIT (real estate investment trust)?
Real estate syndications are private equity investments that are not traded on public stock exchanges and are not necessarily available to the general public. Many are only open to accredited investors with a net worth of over $1 million or high incomes.
There’s no secondary market for selling your shares in real estate syndications. That means no liquidity: once you buy in, your money remains locked in the deal until the GP either sells the property or refinances it to return capital to you and the other investors.
In other words, real estate syndications should be approached as long-term investments. Once on the ride, you stay on until it comes to a full stop.
Real estate syndications also come with much higher minimum investments than public REITs. Most syndications require a minimum investment between $25,000 and $100,000 — hardly chump change. In contrast, you can buy shares in publicly traded REITs for the price of a single share, often $10–$100.
Suppose those all sound like downsides (and they are), real estate syndications have several huge upsides. To begin with, REITs have too much correlation with the broader stock market. When the stock market falls, so do REITs in most cases, even if real estate markets remain strong.
Real estate syndications often pay dramatically higher returns. Being available to the public, public REITs earn returns based on whatever Joe Six Pack is willing to accept. If you’re only willing to invest at a yield of 10%, but he’s willing to invest for a 7% yield, he’ll outbid you on the stock.
However, real estate syndications are private investments that are not easily accessible to every Jimmy and Joe. That exclusivity is precisely what drives up the returns.
See the other pros of real estate syndications outlined above. Personally, I avoid REITs and invest my own money in real estate syndications.
Real Estate Syndications vs. Crowdfunding
While real estate crowdfunding investments are more common with real estate syndications than public REITs, they’re still available. Some only allow accredited investors to participate, others allow anyone to invest, but they’re all publicly advertised.
Most real estate crowdfunding platforms allow investors to sell early, even if they charge a penalty for it. You can pull your money out early if you want to take a hit. That option doesn’t exist at all for most real estate syndications.
Like real estate crowdfunding investments, some syndications allow equity investments, while others offer debt investments. Some offer both. Debt investments pay more consistently and have high cash flow, while equity investments offer more upside potential when the property sells.
If you’re new to passive real estate investing, start with real estate crowdfunding. You can find public reviews of crowdfunding platforms more easily than private real estate syndicators, making them easier to vet. Plus, you can usually invest at any time rather than waiting for individual property deals to come along.
Tax Benefits of Real Estate Syndications
Syndications come with significant tax advantages, even for passive investors.
The syndication legal entity doesn’t pay any taxes itself—all profits and losses pass through to individual investors, preventing double taxation.
It also means that all investors, including limited partners, can take advantage of all property tax deductions. From loan interest to closing costs, repairs to property management fees, and beyond, these deductions reduce the taxable income from syndications.
Most notably of all, those deductions include paper losses from depreciation. Even as investors collect distributions and cash flow, they typically show paper losses on their tax returns in the first few years due to accelerated depreciation. You can use those paper losses to offset passive income from other sources, but unlike how rental income is taxed, you can’t use losses from syndications to offset up to $25,000 in active income.
You can carry the paper losses forward if you don’t have other passive income streams to offset this year. They’ll come in handy when the property sells and you get a fat paycheck (and tax bill).
You can also use 1031 exchanges with real estate syndications, but it’s tricky. Suppose you want to convert 1031 Exchange funds from another real estate sale into a syndication. In that case, you have to convince the sponsor to structure your investment as “Tenants in Common” rather than a typical LP investment. Most sponsors are only willing to do that for high rollers investing $500,000 or $1 million in their deal.
Alternatively, entire real estate syndications can 1031 Exchange when they sell a property. But it requires all (or at least most) LPs to be on board, so it’s usually designed this way from the start.
Step-by-Step Real Estate Syndication Investment Process
Real estate syndication might sound complex, but the actual process follows a straightforward path. Here’s exactly how to go from interested investor to fractional property owner:
- You’ll receive an investment summary outlining the deal specifics, projected returns, and business plan. Review this thoroughly—it’s your blueprint for understanding the opportunity.
- Once you’re interested, you’ll submit an “indication of interest” form. This isn’t binding, but it tells the sponsor you’re seriously considering investing and reserves your spot while you complete due diligence.
- Next comes the formal investment phase. You’ll receive subscription documents, including the Private Placement Memorandum (PPM), which outlines all legal terms and risks. You’ll also get operating agreements and formal investment documents.
- After reviewing and signing these documents, you’ll receive wire instructions to transfer your investment funds to the deal’s escrow account. Once the sponsor confirms receipt, you’re officially a limited partner in the syndication.
The process typically takes 1-2 weeks from receiving the investment summary to funding. Most sponsors handle everything electronically now, meaning it’ll be much more streamlined and paperless.
Understanding Fee Structures
Real estate syndication fees can seem mysterious, but they’re actually quite standardized across the industry.
The acquisition fee compensates the sponsor for finding and securing the deal. It typically runs 1-3% of the purchase price. Think of it as a finder’s fee for sourcing a profitable opportunity.
Asset management fees cover the ongoing work of overseeing the property and executing the business plan. These usually range from 1-2% annually of invested capital. This pays for the sponsor’s time and expertise in managing your investment.
When the property sells, expect a disposition fee of 1-2% of the sale price. This covers the work involved in preparing and executing the exit strategy.
Some sponsors also charge construction management fees if major renovations are planned, typically 5-10% of the construction budget. This compensates them for overseeing contractors and managing the improvement process.
These fees are factored into the projected returns you see in the investment summary. While they impact your bottom line, they align the sponsor’s interests with yours—they only really profit when they execute the business plan successfully.
FAQs About Real Estate Syndications
Still, have questions about these group real estate investments? These answers might help.
What are the three phases of real estate syndication?
General partners for real estate syndications refer to three phases of a deal: the origination, operation, and liquidation phases. The origination phase involves finding a good deal, raising money to buy it, and closing on the property. As the name suggests, the operation phase involves managing the property, improving it, and raising revenues. The liquidation phase involves selling the property for a profit.
How do real estate syndicates make money?
Real estate syndication deals make money by adding value to a property and raising the rents. Not only does that improve the cash flow while the sponsor owns the property, but it also increases the property’s value, as commercial real estate is priced based on net operating income and cap rates. The sponsor adds value by increasing rents and revenues, adding profits upon sale.
What are the different types of real estate syndications?
Real estate syndications fall into many buckets. To begin with, they could be a single property, a fixed portfolio of a few properties, or an open-ended fund that hasn’t yet bought all the properties. Syndications could include different types of commercial properties, including multifamily apartment buildings, self-storage facilities, mobile home parks, retail or restaurant properties, industrial properties, office buildings, outdoor recreation such as campgrounds and RV parks, natural resources such as oil and gas, or agricultural properties such as farms or vineyards.
How do investors decide which real estate syndications to get involved in?
I mean… how do investors decide which stocks to buy? You invest based on your goals, risk tolerance, and investment hypothesis.
Look for deals in stable or growing markets with investor-friendly local laws. Look for a fair profit split between the GP and LPs. Most of all, look for GPs with a strong and long track record of success.
I personally invest for diversification: I want to do deals in many cities and states with different sponsors and different property types. I don’t know what tomorrow will bring, but I know that with eggs in enough different baskets, the law of averages will help protect my returns.
How do you determine the potential returns of a syndication?
The sponsor provides you with projected returns, but you are responsible for verifying how realistic and conservative they are. Broadly speaking, returns depend on two main factors: how well the sponsor can raise revenues and the exit cap rate.
Sponsors don’t have much control over the exit cap rate, so look for a “sensitivity analysis” showing how the deal would perform at different exit cap rates. The market might move, with buyers paying less for the same income levels.
Sponsors have more control over raising revenues. What’s their plan for improving the property to command higher rents? What’s their plan to improve property management and occupancy rates? Make sure you feel comfortable with their projections.
Final Thoughts
Real estate investors can make money in countless ways, from long-term rentals to short-term, flipping houses to wholesaling real estate, mobile home parks to self-storage to office buildings. That says nothing about passive real estate investing options like REITs, private notes, and real estate crowdfunding.
However, few real estate assets blend the high return on investment, positive cash flow, tax breaks, and hands-off nature of real estate syndication deals.
As you consider expanding your investment portfolio to include real estate syndications, keep your long-term investment goals and financial needs in mind. You may not get your money back for five years or longer — a deal breaker for many investors, regardless of the returns.♦
How do you see syndications fitting into your real estate portfolio? What questions do you have about them?
