Pros and cons of syndication investing

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Pros and cons of syndication investing

Scott Nguyen
Member since 2018 · 16 posts · 4 votes

Investing in a syndication sounds like a good idea, put in some money with to own a much more expensive property, and then get returns on it. What are some pros and cons of investing in a syndication?

Do any investors have any stories (success or failure) with this type of investment?

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Dan HandfordPro Member
Investor · Lexington, SC · Member since 2018 · 779 posts · 501 votes
7y

@Andrew Angerer I am not sure what you were listening to but most syndications have 60-90% passive investors. The tax advantages are still pass through to the passive investors. 

@Scott Nguyen I have invested in several of these types of deals and the returns/tax losses are great. 

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  • Andrew Angerer
    Rental Property Investor · Dayton, OH · Member since 2018 · 234 posts · 183 votes
    7y

    I just listened to a podcast about this, it usually is a good idea, however, under the new tax law there is a new caveat. Apparently if you form a corporation for the syndication, and more than half of the members are limited (give money only) then everyone involved loses out on  tax advantages. It sounds like those with experience are trying to make these limited partners more involved so they could be considered active members and avoid the new taxes. 

    This is a small bit of everything that has to do with syndication so be sure to do more research if you are interested. 

    2Reply
  • Dan HandfordPro Member
    Investor · Lexington, SC · Member since 2018 · 779 posts · 501 votes
    7y

    @Andrew Angerer I am not sure what you were listening to but most syndications have 60-90% passive investors. The tax advantages are still pass through to the passive investors. 

    @Scott Nguyen I have invested in several of these types of deals and the returns/tax losses are great. 

    6Reply
  • Michael Bishop
    United States · Member since 2015 · 401 posts · 394 votes
    7y

    @Andrew Angerer I'd be interested to see what you're seeing. Because like Dan every deal I've been involved in has pass through taxation (showing losses) and haven't heard any mention of this new rule you're referring to.

    @Scott Nguyen I would say that any possible negatives of an investment in a syndication would be related to the Sponsor. Are they inexperienced and don't know how to operate this type of deal? Are they overly aggressive in their underwriting? Are they week in the area of investor relations activities? Are they not genuine people and only have their best interest in mind?

    If you get with a good Sponsor, there aren't many negatives. Unless you find a lack of control in your investment a negative, in which case this niche isn't for you. Of course you run the possibility of the market going south, but no asset class is immune to that. With strong underwriting and a good Sponsor who knows their stuff, some deals can even provide a small return while you hold through the downturn and recover on the upswing.

    6Reply
  • Andrew Angerer
    Rental Property Investor · Dayton, OH · Member since 2018 · 234 posts · 183 votes
    7y

    I will have to review my notes, but I am quoting bigger pockets podcast episode 269. It sounds like under the new tax law, you may be considered a tax shelter if you have too many people that are limited. I will re-listen tomorrow to make sure. 

    Sorry about any confusion.

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  • Andrew Angerer
    Rental Property Investor · Dayton, OH · Member since 2018 · 234 posts · 183 votes
    7y

    I went through the Bigger Pockets show 269 transcript. These are the notes I'm referring too. Keep in mind I originally referenced a very specific tax law, I know that there still are many other tax advantages...

    interest limitation? I think I wrote it in a note here. What was that?

    Brandon Hall: Yeah, so a lot of this was breezed over, even by me initially. But after we did a second dive, we realize it’s probably going to apply to a lot more people than we originally thought. So business interest limitations—what it is, is it’s a 30% limit on pretty much your operating income, at least for the next four years, I think. It goes through 2022. So what it is, it’s a 30% limitation on what they call EBIDAT. So Earnings Before Interest Depreciation Amortization Taxes. Maybe that was it. Yeah. So if I have like $10,000 net operating income before I take into account interest taxes, depreciation, and amortization, I am now limited to a $3,000 interest deduction. So 30% of my debt operating income. You’re excluded from this if you have revenue and you have revenue of less than 25 million. So that’s like almost everybody, I’m assuming, that’s listening to this. It’s definitely me.

    But there’s an exclusion to the exclusion—that’s probably not the right way to say it. There’s an exception to the exclusion that basically says if you’re running a tax shelter, then that $25 million dollar allowance does not apply to you. And the interest limitation at that point does apply to you. In the past, the tax shelter has been a bad thing. It’s an entity that’s set up purely for tax avoidance or tax evasion. There’s no real economic benefit. But in this new code section, a tax shelter simply means an entity in which more than 35% of the ownership is held by limited partners.

    So if I’m a syndicator, I have probably given away 60-70% of my entity to my limited partners, my investors. All of a sudden, that subjects me to this business interest limitation. And all of a sudden, I’m scrambling to try to figure out how to not be subject to the business interest limitation. But this also applies to people that—like, let’s say I’ve set up an entity and my dad comes in and he’s a private equity and he’s a money guy or whatever, but he takes a 50% stake of my entity. It’s just me and him.

    We’re not doing anything big. We’re buying little $50,000 homes. If he’s not actively involved in the business, he’s limited in that case. He’s a limited partner in that case. And all of a sudden, I’m that entity, that small entity is now subject to the business interest limitation. So it is going to apply to multiple people, not just the bigger fish.

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  • Sunny Shakhawala
    Parsippany, NJ · Member since 2016 · 64 posts · 49 votes
    7y

    @Andrew Angerer

    The new law you're referring to is the cap on interest expense deduction. You can't write off more than 30% of your NOI in Interest Expense. Nothing to do with ownership.

    So let's say you have 100K in NOI at the end of the year.

    But your loan has 40K in interest expense.

    You would only be able to deduct 30K as a write off. 

    The remaining 10K wouldn't qualify for write off.

    Why did they do this? To prevent over leveraging. 

    I am involved in a lot of syndication deals. And many of them have greater than 30% of NOI as interest expense.

    So while they may not be taking full advantage, there's still an advantage to be had.

    @Scott Nguyen

    @Scott Nguyen If you can find a good sponsor, Syndications are a great way to go. I think, if underwritten conservatively, larger assets (200 unit apartment buildings) are less risky than smaller assets (SFR).

    4Reply
  • Ivan BarrattBusiness Member
    Investor · Indianapolis, IN · Member since 2015 · 764 posts · 953 votes
    7y

    @Scott Nguyen my advice is figure out the pro's and con's for yourself. A fool and money are soon parted! :)

    I mean that with your best interest in mind!

    Get educated before doing anything. One strong method is review a hundred offerings before investing in one.  Do that and you'll know what a good deal looks like and more importantly; when a critical element is missing!

    All the best young hustler!! :)

    5Reply
  • Alina Trigub
    Rental Property Investor · Glen Rock, NJ · Member since 2015 · 3k+ posts · 2k+ votes
    7y

    @Scott Nguyen

    The list of pros and cons from LP (limited partner) perspective of investing in syndications can probably go on forever but I'll give you the main points:

    Pros:

    1) minimal involvement 

    2) limited liability 

    3) pass-through tax benefits 

    4) equity ownership 

    5) utilizing leverage 

    Cons:

    1) Lack of decision-making power

    2) Limited liquidity

    Bottom line, I agree with @Sunny Shakhawala: if you find a good sponsor, then your investment is in good hands.

    6Reply
  • Theo Hicks
    Rental Property Investor · Tampa, FL · Member since 2015 · 1k+ posts · 969 votes
    7y

    To build on @Alina Trigub's list

    Pros

    • Completely passive
    • More consistent returns (as you are usually offered a preferred return)
    • Stake in an asset you wouldn't be able to purchase otherwise

    Cons

    • No control of the business plan
    • Less upside potential
    • May need to be accredited
    • Higher barrier of entry (from a educational standpoint)
    • Less liquidity
    5Reply
  • EZ Hassan
    Member since 2018 · 12 posts · 0 votes
    7y
    0Reply
  • Scott Nguyen
    OP
    Member since 2018 · 16 posts · 4 votes
    7y

    @Michael Bishop Thank you for your advice! Do you have a checklist or a set of questions you ask the sponsor before you make a decision? What do you consider a "good" deal?

    @Sunny Shakhawala Thank you for your answer! Just to follow up, why is are larger assets less risky than smaller assets? And what do you mean by underwritten conservatively?

    @Alina Trigub@Theo Hicks@Ivan Barratt @Andrew AngererThank you! I really appreciate your help!

    1Reply
  • Mary M.
    Rental Property Investor · Portland OR · Member since 2018 · 2k+ posts · 3k+ votes
    7y

    I am curious - what type of return are these syndications throwing off?  Also, what specific tax advantages - are they different than normal RE tax advantages?

    0Reply
  • Michael Bishop
    United States · Member since 2015 · 401 posts · 394 votes
    7y

    @Mary M. check out the below blog talking about tax advantages of syndications:

    Power Tax Advantages of Commercial Multi-Family Syndication

    In terms of returns, that depends on the deal, market, Sponsor, etc. It's not uncommon to see an 8% preferred return, 8-10% CoC, 15%+ IRR and 1.6x+ equity multiple. Keep in mind these numbers are typically the lower end of projections, and projections (with a good Sponsor) are conservative and often exceeded.

    @Scott Nguyen no problem! I'm happy to discuss in further detail if you care to PM me.

    2Reply
  • Alina Trigub
    Rental Property Investor · Glen Rock, NJ · Member since 2015 · 3k+ posts · 2k+ votes
    7y
    EZ,
    You have to be accredited when an investment follows Rule 506(c) which allows for accredited investors only!
    Note, while Rule 506(b) allows for sophisticated investors to invest in a particular deal, these investors must have pre-existing relationships with a deal sponsor prior to investing with them!

    Originally posted by @EZ Hassan:
    0Reply
  • Joel OwensBusiness Member
    Moderator
    Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
    7y

    Sponsor makes all the difference. Is this someone looking to make a quick buck or an expert in the industry that values integrity and in it for the long haul?

    Podcast Guest on Show #47
    NNN Invest53 Reviews
    WebsiteView Page
    1Reply
  • Frank Wong
    Real Estate Broker · Bay Area · Member since 2018 · 1k+ posts · 3k+ votes
    7y

    Pro

    - A true passive investment vehicle. Literally, receive a check every month or quarter depending on the syndicator.

    - You don't have to do any manual labor, deal with PM, contractors, tenants, etc 

    Con

    - You have no control 

    - There is a high risk.  The deal can go south and you can lose everything. It all depends on the experience of the syndicator.  

    I think it's a great way to get into space where you would not be able to get into otherwise.  I would not put all your eggs into a syndication. 

    2Reply
  • Alina Trigub
    Rental Property Investor · Glen Rock, NJ · Member since 2015 · 3k+ posts · 2k+ votes
    7y

    @Mary M.

    The returns vary from investment to investment for syndications, even with the same deal sponsor. It's best to look at each investment individually. 

    As for the tax advantages, the main difference between what you refer as "normal RE tax advantages" (which I assume you mean as someone who's actively investing in real estate) and syndication (passive real estate investor) is: 

    passive investment generates passive income/loss for LPs (limited partners). Keep in mind, this income/loss in syndication is not the same as the distributions passive investor receives during the year. This is due to the fact that normally in the first few years syndications generate passive (aka "paper") losses due to Depreciation, and at times Cost Segregation studies utilized to create additional Accelerated Depreciation.  As I mentioned earlier, these passive losses can only be netted against passive income, which will most likely be produced in the later years. 

    The idea is passive investor (aka limited or equity partner) in a syndication performs no work other than reviewing the offering and deciding whether to invest, and then gets rewarded with the benefits not available to people that don't invest in the real estate directly rather do it through REITs or don't do it at all.  However there are special rules qualifying people to be eligible to invest in syndications as accredited investors and sometimes as sophisticated investors. 

    Feel free to PM with additional questions.

    Best!

    2Reply
  • Mike Dymski
    Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes
    7y

    Pros & Cons:  I have both a direct owned portfolio and a passive syndication portfolio and the biggest difference is control.  It's both a pro and a con for obvious reasons.

    Returns:  If you can add value or buy below retail, you will get higher returns investing on your own because that value created is 100% yours.  If not, passively investing in syndications (done properly) can generate similar (or better) returns as a stabilized direct owned active portfolio.

    3Reply
  • Theo Hicks
    Rental Property Investor · Tampa, FL · Member since 2015 · 1k+ posts · 969 votes
    7y

    @EZ Hassan you must be accredited to invest in 506c syndications. 506b can have up to 35 non-accredited, sophisticated investors, but I know some syndicators who do 506b who only take on accredited. 

    Passively investing in a few syndications can help you become a syndicator yourself one day.

    0Reply
  • EZ Hassan
    Member since 2018 · 12 posts · 0 votes
    7y

    Is there any fixed rules on how to become a sphisticated investor?

    0Reply
  • Account Closed
    Multifamily Syndicator · Conifer, CO · Member since 2018 · 80 posts · 84 votes
    7y

    https://www.biggerpockets.com/users/EzH1

    Disclaimer: I'm NOT, I repeat NOT, an SEC attorney.  

    I am part of a syndication team & we do use 506B and allow Sophisticated Investors to participate.

    What we do is... tell ALL investors that Our Policy requires us to have a substantive preexisting relationship before we collaborate on an investment.  Additionally, we MUST understand their ability to make this type of investment decision. 

    The SEC has stated that a “relationship” may be established by using an investor qualification questionnaire.

    Once I receive the investor qualification questionnaire I personally Contact, and Connect with, the potential investor so we can learn more about their goals and I get a further understanding of their ability to make this type of investment decision.

    Once the PPM is live we do NOT allow new investors into that offering even if they are qualified as sophisticated or accredited.

    We have turned investors away.

    Further, as part of our subscription process we have them complete another investor qualification questionnaire and we review each subscriber's questionnaire upon every new investment. 

    Based on the questionnaire and conversations, as we get to know them in a substantive way, we make an executive decision on whether or not they are sophisticated and whether or now we're going to allow them in as an equity limited partner.

    We do work with people (podcasts, groups, blogs, conversations, answering questions, articles, etc...) to help them become sophisticated so that one day the may participate.

    I hope this was helpful-

    Don't hesitate to reach out.

    Dino

    0Reply
  • EZ Hassan
    Member since 2018 · 12 posts · 0 votes
    7y

    Perfect. Thank you for answering my question in detail

    0Reply
  • Ben Leybovich
    Rental Property Investor · Phoenix/Lima, Arizona/OH · Member since 2012 · 4k+ posts · 4k+ votes
    7y

    I really like @Mike Dymski's response here. The main distinction is access to worthwhile deal flow. Worthwhile is defined as value-add. On your own, without the right connections, you will struggle in this capacity. Putting money with someone who gets better deals might be the safer option in this cycle. Yes, you loose control. But, what good is control if all you can get your eyes on are the deals everyone who knows better has already passed on...

    2Reply
  • EZ Hassan
    Member since 2018 · 12 posts · 0 votes
    7y

    Would another con be the fees charged?.. also how is the risk correlated with the size/state of the syndicator..meaning a very large investment company with a lot of employees versus a smaller operation

    0Reply
  • Scott Morongell
    Investor · Charlotte, NC · Member since 2017 · 791 posts · 479 votes
    7y

    @Scott Nguyen this thread is already filled with solid answers of pro's and con's. Ivan is right, educate before jumping into a syndication. Would love to hear what choice you have made moving forward.

    0Reply
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