What is a syndication?
A syndication is simply a pooling of resources to accomplish something that you couldn’t by yourself. I attended a real estate investing conference a couple years ago. Gene Trowbridge, a well-known attorney in the world of private securities offerings, presented a nice example of a syndication. He said its like when you fly in a commercial airplane. You contribute a couple hundred bucks or so. Another 150 people also contribute funds, and the passengers team with the airplane manufacturer (the asset) and the airline company (the general partner, management team) to fly from point A to point B. Numerous other examples exist in everyday life, but how does a syndication apply to real estate investing??
A real estate syndication allows an individual to invest in a large asset for a reasonably small amount ($50,000) while leveraging the experience and expertise of the general partner/operator and not demanding much of the investor’s time. As a result, this is called a “passive” investment. Syndications acquire large assets that are heavily depreciated so the taxes on cash flow are deferred. Lastly, the passive investor is not subjected to personal liability or credit risk that is typical of real estate investments. This blog provides more information in what Green Bison considers as five key reasons to invest in real estate syndications.
1) Ability to Invest without a drain on your time
One of the most appealing characteristics of investing in real estate syndications is that you have the ability to be a passive investor. Therefore, the investment is not a drain on your most precious asset – YOUR TIME. The investor is completely removed from the asset management and the property management. The investor does not have to deal with the day-to-day decisions and receiving phone calls from the tenants.
When you participate in syndicated investments, an investment sponsor or manager (also called a general partner) will handle all operational aspects of the investment. Usually, investors will pay the manager based on the investment performance with some share of the cash flow and appreciation, with a certain percentage going to the investors (limited partners) and the remainder going to the general partners. This split can range from 80/20 (LP/GP) to 50/50 (LP/GP).
The sponsor team is responsible for activities such as performing due diligence, locating a profitable property (or properties, if the investment is a fund), hiring and managing the property manager, executing the business plan, sending out quarterly financial reports, facilitating cash flow distributions, and handling investor relations.
In exchange for the sponsor fee, the investor is able to be completely passive. Think of it as an extremely high return on your time. However, one must perform thorough research on the sponsor team (general partner) as part of his/her due diligence prior to investing. The jockey (sponsor) is more important than the horse (asset).
2) Diversification
Real estate can be an important part of an investment portfolio. However, because even inexpensive properties can range from $50,000-$100,000, many investors consider investing in real estate syndications in order to get better diversification within the real estate asset class.
When you invest in real estate syndications, you are able to pool your money with other investors in order to purchase multiple properties. This strategy allows you to experience the benefits of diversification within real estate, and with a lot less cash than if you were investing by yourself. When you invest like this, you are diversifying your investment and limiting your exposure to the vacancy, maintenance, and miscellaneous expenses of a single property.
You will receive no income if you only own one property and that property becomes vacant. However, if you own 10% of 10 properties and one property becomes vacant, you are still 90% occupied and will receive 90% of your expected rent. Because you will be receiving monthly cash flow from the occupied properties, it will be much easier to make your mortgage payments and pay for unexpected expenses.
3) Tax Friendly
Syndications are direct investments in real estate held by single purpose entities (typically LLCs). As a result, you take advantage of the critical characteristic of real estate in terms of being tax friendly: depreciation. Depreciation is essentially a tax shield. It is a non-cash expense that is allowed by the IRS to reduce the taxable income. In fact, large commercial properties are typically depreciated on an accelerated schedule.
Consider a syndication where the sponsor is purchasing an existing, occupied apartment building, and this asset is producing cash flow. Because of accelerated depreciation, interest payment write offs, expense write offs, and so on, your annual tax exposure will usually be zero or even negative (i.e., a loss), even if you receive thousands of dollars in distributions from the property’s cash flow. When the property is sold, the investors will pay taxes on the gains they receive from distributions, but the tax rate will be lower. Long term capital gains are at a lower tax rate than short term capital gains. The end effect is that the taxes during the hold period of these investments are deferred while cash flow is coming in. This allows investors to accelerate their returns without taxation being an annual drag on the after-tax returns on investment.
4) No Personal Liability and No Credit Risk
When you invest in a real estate syndication as a passive investor (limited partner), you get an additional layer of protection between you and any liability resulting from the general partners. This additional layer of protection is not possible if you were investing in your own commercial real estate projects. In real estate syndications, your liability is limited to your investment and this is stated in the contractual documents you review and sign during the funding stage prior to acquisition.
Let’s say you invest $50,000 in a real estate syndication that is purchasing a $20 million apartment community. A bank is providing a $14 million loan at a favorable 4.0% rate that will be signed by the general partner (GP). The GP’s credit will be on the line. Because of this access to inexpensive debt financing, the returns on your invested cash will be much higher than if the property were purchased with all cash. You are able to take advantage of the GP’s experience to acquire a large loan that you probably wouldn’t be approved for, but you still have no personal liability on the loan.
5) Access to Large Investment Opportunities
The purchase prices for commercial real estate have a tremendous range, from a few million to several hundred million dollars. 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 massive personal investment.
When syndicators create investment opportunities like this, they have typical investors with $50,000 to $100,000 to invest in mind. In fact, the offering documents (private placement memorandum (PPM) or operating agreement) can have a minimum investment as low as $25,000. This allows typical investors to invest in opportunities that they would never otherwise be able to invest in. In fact, many commercial real estate properties you see today were purchased using some form of a syndicated structure.
