It was a beautiful sunny spring afternoon about three or so years ago. I had a meeting set up at Starbucks with a potential investor, Stu. Why Starbucks? You probably guessed it—it offers a comfortable and semi-private setting for people to have a conversation and enjoy a Grande cup of expensive (yet mediocre) coffee. Consequently, Stu and I both opted for bottled water.
From a cursory look, Stu was a regular guy who blended in, which obfuscated just how much cash he has been sitting on for quite some time.
We exchanged the usual pleasantries and went through the normal banter about appreciating warmer weather so early in the spring. I inquired about Stu’s family. He described his family: his wife of 30-plus years and his two kids, both of whom were grown and lived on their own. So then I pressed on to ask Stu about his investment goals. He paused for a second, and then in his own quiet way inquired about my background.
As I shared my story, our conversation flowed as if we were old friends. I weaved in a few more questions about Stu’s and his wife’s professional journeys. He casually responded that in the past they both had worked at banks, but they retired early to enjoy life. I was simultaneously impressed and surprised since I don’t meet many retirees who prefer to diversify into new types of investments.
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Why the wealthy choose syndications
I decided to ask Stu directly: “If you are already enjoying your retirement, then you don’t really need more money to build your wealth, do you?” Stu basically agreed, and elaborated that his and his wife’s main goal was to continue building their wealth in order to help others re-create what they were able to retain and produce for their family.
Next, I asked about how they were able to build their wealth? He smiled and admitted that most of his family’s wealth had originally been built by his parents—mainly his father who had discovered real estate syndications long before home computers existed, and back when real estate syndications were called “private placements.”
At this point, Stu said that he didn’t quite understand how so many well-off people (like his family) have been able to take advantage of real estate syndications, while many other investors are missing the boat. “Certainly,” Stu mused, “there are risks associated with this type of investment just as there would be with any other, but the benefits far outweigh the risks.” So, Stu and I discussed the aspects that people should consider before investing in real estate syndications. They are conveniently identified and discussed below.
A true passive investment
Your job is to research and understand what syndication is, and then how to evaluate an offering; at that point, your work is pretty much done. So if an investor has a primary business or practice, or is a professional with a successful career, or is simply enjoying their life and doesn’t want to spend time dealing with tenants or toilets, then investing in syndications is the way to go!
Preserving your capital
While it depends on each specific investor’s strategy, many look to find ways to keep risks low and minimize losses. It is not uncommon for syndications to earn on average 8-10% of cash-on-cash return over an approximate five-to-ten-year period.
While the stock market targets around 7% annual return, it has many drawbacks. Most notably, the stock market doesn’t offer nearly as many tax benefits, and it is absolutely unpredictable.
Relying on calculated risk
When it comes to real estate investing, diligent underwriting is critical. Experienced syndication operators ensure that the risks associated with a particular investment are accounted for in their underwriting.
Leveraging tax advantages
There is absolutely no doubt that real estate is one of the most intelligent ways to reduce your tax burden. This can be accomplished in a number of ways: depreciation, cost segregation, 1031 exchanges, Opportunity Zones, and tax-loss harvesting (just to name a few). And all of the aforementioned tax strategies may be utilized when investing in a variety of real estate syndications.
In general, real estate offers great tax benefits. It all comes down to hiring an expert CPA who is not only knowledgeable regarding tax compliance, but is also real estate savvy and can offer tax strategies to help you plan ahead.
Generating residual income
You review the offerings, make a decision as to which individual asset or real estate fund to invest in, subscribe, and wire the funds. That’s it; your work is done. Really? Yes, really! From this point on, you sit back and allow the operator to do their job, while you collect your monthly or quarterly dividends directly in your bank account.
Risks to consider
No investment is without risk. Here are some things to consider before diving into syndications.
No management decisions
When you invest passively in a syndication, you are essentially giving up your right to participate in the decision-making process for this investment. This comes with a bonus though: you’re investing as a limited partner, and hence your liabilities are limited to your original investment.
It’s not your typical liquid investment
If you buy a stock or a mutual fund (or anything on the stock exchange, for that matter), you technically can sell it any time you want. This sort of liquidity is not possible in real estate syndications. The way real estate syndications are structured, an investor basically invests and forgets about it until the deal has a capital event or the property is sold.
There is some flexibility, however, when it comes to investing in closed-ended funds. Closed-ended funds usually have a so-called “lockdown period”—which may be a year or two—after which you’re free to take your investment out.
If you plan to invest in a value-add type of project or even new construction, be prepared for the long haul. It may take a while for a project to go through its full cycle. A common underwriting period is usually five to seven years. So as long as you invest money on which you will not be relying within that time period, you are good to go.
Grow your wealth through passive investments
As one of my most favorite investors of all time, Warren Buffett, once said, “If you don’t find ways to make money while you’re asleep, you are going to work till the day you die.” So, the greater the number of these passive investments that are ongoing simultaneously, the better off you are. Not only are they generating passive income, but they are also helping you save on taxes.
Before leaving Starbucks and going our separate ways, I asked Stu if this was enough material for him to start spreading the word—so that more people could start taking advantage of the same strategy that well-off folks like him had for years. Stu looked at his notes, nodded, and thanked me.
After all these years, I still think back to that conversation with Stu about the incredible investing strategy that: one, generates passive income for you while you sleep; two, allows you to save on taxes; and three, in some cases, also makes a positive impact on communities. I hope you can take something from this and apply it to your own investing plans.