Using debt to purchase into RE syndication?
Rental Property Investor · Philadelphia, PA · Member since 2020 · 23 posts · 15 votes
Using debt to purchase into RE syndication?
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Brian BurkePro Member
Investor · Santa Rosa, CA · Member since 2012 · 2k+ posts · 7k+ votesInvesting in a syndication with borrowed money can enhance your returns, but it comes with the trade-off of increased risk.
The downside comes in two different forms: If the investment doesn't work out and you incur a loss, you'll add insult to injury by being left behind with debt to pay off. And if the investment returns are less than expected, or there is no cash flow at all, you can be left with partial or complete debt service out-of-pocket.
If you use debt, be sure that if the investments had zero cash flow you could still service the debt without altering your lifestyle. If you are comfortable with the risks and going into it with your eyes wide open, that's one thing. If you are stretching it, that's a whole different story.
As a sponsor, I'd really prefer that investors don't invest in my offerings with borrowed money, and if asked, I'd discourage them from doing so.
28 Replies
- 5yBrian BurkePro MemberInvestor · Santa Rosa, CA · Member since 2012 · 2k+ posts · 7k+ votes
Investing in a syndication with borrowed money can enhance your returns, but it comes with the trade-off of increased risk.
The downside comes in two different forms: If the investment doesn't work out and you incur a loss, you'll add insult to injury by being left behind with debt to pay off. And if the investment returns are less than expected, or there is no cash flow at all, you can be left with partial or complete debt service out-of-pocket.
If you use debt, be sure that if the investments had zero cash flow you could still service the debt without altering your lifestyle. If you are comfortable with the risks and going into it with your eyes wide open, that's one thing. If you are stretching it, that's a whole different story.
As a sponsor, I'd really prefer that investors don't invest in my offerings with borrowed money, and if asked, I'd discourage them from doing so.
- Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes5y
I think it depends a lot on your overall portfolio and how much leverage you can afford. It's really hard for anyone to comment on this in the abstract without knowing a lot about your financial situation that you're probably unlikely to want to share on a message board.
Brian did a great job outlining potential risk. Leverage can magnify your return, but it also increases your risk. I would be very hesitant to accept that capital from an investor, particularly if they were new to syndication investing. If they had invested in a few syndications before using cash that would indicate they are more likely understand the risk.
Hi Elliot,
[This is not Financial advice - I do not give financial advice]
[This is just my personal feelings on this]
All I can say is it "probably" would make me uncomfortable (if I were aware of it).
Even if you met the Federal qualifications to participate in my deal with the debt post closing.
I could see in certain circumstances (and for certain amounts) where I might be less hesitant, but still probably have some discomfort with making the offer to wire.
Everyone is different though.
[This is not Financial advice - I do not give financial advice]
[This is just my personal feelings on this]
Good Luck!
- Investor · Singapore · Member since 2013 · 1k+ posts · 3k+ votes5y
Very risky. You have no control over the syndication and the funds are totally illiquid. Its even riskier than buying stocks on margin. Anything can go wrong with a syndication and you will still be on the hook for the full balance. At least when you own a property if you have positive equity you can always get out of the debt by selling the property. Or worse case let the bank foreclose. In your case the asset is independent from the loan. I invest a lot in syndications but would never do it with borrowed funds.
- 5yAJ ShepardPro MemberReal Estate Syndicator · Portland, OR · Member since 2014 · 453 posts · 312 votes
@Elliot Landes
I’m always of the opinion there is good debt and there is bad debt.
Refinance your house to use money to invest, probably good debt. I think many on this sight would suggest doing that to invest in another rental. We do this all the time to purchase more property, why not utilize it for syndication?
Heloc on houses, probably good debt, but short period of time. If you didn’t plan to refinance in 1-2 years, I would say that this is probably not good debt.
401k loan. Honestly don’t know that much about this, but if you are paying yourself interest to your 401k and then anything above interest goes to you, this seems like a great play. The other option, why isn’t the 401k self directed. Me personally, would rather have my money in real estate than stocks.
Personal loans, doesn’t seem like a good idea, but life is not without risks. It would have to depend on repayment terms and percentage for sure.
My 2 cents. Brian makes great points and his book goes over how to vet sponsors and deals, make sure, no matter what, to invest wisely.
- Investor · Front Royal, VA · Member since 2013 · 586 posts · 418 votes5y
@Elliot Landes i've used a HELOC to invest into a syndication. I probably had a different goal than you so it made obvious sense to me. If I were of trying to create cash flow and build wealth doing that, it wouldn't work. Your net worth likely won't grow rapidly, you can't scale that beyond a certain point, and you lose control of funds that could be called due in a financial crises. I would avoid doing it unless its a short-term play.
- Rental Property Investor · Philadelphia, PA · Member since 2020 · 23 posts · 15 votes5y
@Brian Burke
Thank you for the reply! I actually just downloaded your book yesterday and plan to start reading today.
Interesting to know you (and probably other sponsors) wouldn’t want leveraged money invested.
I could easily cover the debt service if cash flows were dry.
The increased risk is a concern, but part of me thinks this whole thing is so risky already, what’s a little more? Especially if I’ve minimized some risk by thoroughly vetting sponsors, diversifying amongst different sponsors, and get in to differing asset classes.
Not that I’m trying to make an argument for it, but would your response change if you knew I had more money coming your way down the road? And dry debt service won’t be a problem. It’s stable, reliable income from a business venture in addition to my W-2 earnings. My plan is to invest large portions of that money in to RE. But looking for ways to kickstart that process I thought I’d explore leverage to invest now to see benefit sooner and pay back that debt later. Maybe I just need a little patience.
- Rental Property Investor · Philadelphia, PA · Member since 2020 · 23 posts · 15 votes5y
@Bryan Hancock
Thank you for the response. Would speaking with a financial planner help give me a better picture of how much leverage is right for me?
- Rental Property Investor · Philadelphia, PA · Member since 2020 · 23 posts · 15 votes5y
@Taylor L.
Thanks for the reply.
Yes, this is my first deal, so maybe I just need a little patience and wait.
- Rental Property Investor · Philadelphia, PA · Member since 2020 · 23 posts · 15 votes5y
Originally posted by @Account Closed:
"asset is independent from the loan."
I think that just hit the nail on the head for me. I knew had to be some reason why this shouldn't be a good idea, or something I was overlooking, and for me, that's it. Thank you for the reply.
Great responses in this thread from some heavy hitters, but that statement gave me the 'aha' moment I needed to help make a decision. Thank you!
- Rental Property Investor · Philadelphia, PA · Member since 2020 · 23 posts · 15 votes5y
Thanks for the reply. Just curious, what was your goal when it made sense to use leverage for syndication?
I have a pretty specific 5 year target in mind for growing my wealth (Not chasing cash flows to replace my income). I know the destination, now I'm just trying to map my course to get there. Based on all the responses here, leverage through syndication is not a path I'm going to take. I'll try an apply leverage somewhere else.
- Rental Property Investor · Philadelphia, PA · Member since 2020 · 23 posts · 15 votes5yThanks for the reply. I share the opinion on good debt and bad debt. Based on the responses from everyone here, I'm realizing it goes a step beyond that, there agood uses and bad uses of debt. Syndication is probably a bad use of good debt. I'll put my cash in to syndication, and find another use for debt.
401k loan allows you to borrow up to $50k from your funds and then you pay yourself the interest! So there is the conundrum; does my usage of that $50k beat stock market returns? Considering how my 401k has performed (7-9%), that shouldn't be hard. Even if I just match it, at least I'm diversified a bit away from Wall Street. The 401k selection of funds is somewhat limited. It is self-directed to the extent that I get to pick which of those funds I participate in. Using the loan gives me investment options beyond those funds. But I think I'll deploy it elsewhere. - Investor · Singapore · Member since 2013 · 1k+ posts · 3k+ votes5y
One more thing. Most syndications are already leveraged by the sponsor. So you are effectively getting leveraged returns without the debt risk yourself. Thats actually a key benefit of syndication.
- Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes5y
A financial planner may help, but you would need to do the work to find one who understands small business and real estate. Many financial planners are glorified securities salesmen or life insurance pushers. I'd venture to say that most in the industry don't understand real estate or small business well or the needs of people with your goals.
In general risk and reward are inextricably linked. There is no free lunch in this life. An inefficient capital market will provide greater returns, but there is generally a risk component to go with it. Using debt compounds these risks so I'd argue you need to be even more conservative and seasoned to use debt for what you're trying to use it for. Be careful.
- Real Estate Broker · Portland, OR · Member since 2019 · 4k+ posts · 2k+ votes5y
"Direct ownership in rental properties just isn't right for me personally (at this point in life), but I'd love to use leverage to increase my wealth."
If you're looking for a lender, I'd ask first. I think you'd have an issue with recourse for the lender since you can't just sell your interest in a syndication at some price - They're written to "encourage" you to stay in for the life of the deal.
On HELOCs (ie non-tax-sheltered funds) that kinda makes sense since I think most syndications would beat a HELOC (or better yet cash-out re-fi) rate. However, syndication returns are NOT guaranteed unlike loan rates.
On retirement money that is already tax-sheltered, you'd need to look at the rate of return vs other non-sheltered investments in the retirement account.
- 5yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ voteswhat i have seen is very well to folks borrow against their securities at rates that are next to nothing.
and then go into deals.. However like Bryan says if the deal did not work it does not alter their lifestyle.
and I guess it depends on how much we are talking about.. if its just 50k an under probably not a big deal
but doing this with hundreds of thousands .. not so sure for most folks. You got some great responses already, and it sounds like you've already made your decision. So I am only posting as someone who had the same question a few years back. While I did not take out loans to invest in syndications, I did decide not to pay down some other debt in my personal life, because why pay down a 2% or 4% loan when I can make 8%, 10%, 15%, 20% investing in real estate? Well, one of the syndications sold for a pretty weak gain, less than the guaranteed 4% return I would have made by simply paying off that debt. Fortunately, the others have performed quite well, plus I have a good W-2 job so I still would have been able to pay back the loan (even if it was a total loss of capital) and it was worth it overall. So the takeaway is to be aware that there is risk, so it is only a good idea to take a loan that you could still pay back if the deal was a total failure.
- Investor · Member since 2019 · 74 posts · 70 votes5y
I think the key is having a solid W2 so that there are no big lifestyle changes after the deal. Instead of HELOC, do a cash-out refinance then invest in reputable syndication. If you are able to cover the increase in mortgage with W2, then the worst case is covered. Anything above a record-low mortgage rate these days would be a profit. It sounds like a good risk/reward tradeoff to me.
- Rental Property Investor · Philadelphia, PA · Member since 2020 · 23 posts · 15 votes5y
@Bryan Hancock
Those are the reasons I haven’t ever used a financial planner. I only ever talked for 2 or 3 but those discussions all circled around securities or funds that clearly paid them bigger margins than others. And they all seem to think everything outside of the stock market is a bad idea or that somehow the the stock market is inherently better than other investments.
Based on all the feedback here I’m not going to leverage in to syndications. I may deploy leverage elsewhere where it is more directly tied to the asset at hand.
- Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes5y
There are financial advisers who understand your situation just like there are CPAs who actually understand real estate well. The trouble is finding them.
This really isn't rocket surgery though. If you follow the traditional MMM-style advice here is a decent path that a good financial advisor would give you:
//Begin canned advice
WHAT
0. Establish an emergency fund to your satisfaction
1. Contribute to your 401k up to any company match
2. Pay off any debts with interest rates ~5% or more above the current 10-year Treasury note yield.
3. Max Health Savings Account (HSA) if eligible.
4. Max Traditional IRA or Roth (or backdoor Roth) based on income level
5. Max 401k (if
- 401k fees are lower than available in an IRA, or
- you need the 401k deduction to be eligible for (and desire) a tIRA deduction, or
- you earn too much for an IRA deduction and prefer traditional to Roth, then
swap #4 and #5)
6. Fund a mega backdoor Roth if applicable.
7. Pay off any debts with interest rates ~3% or more above the current 10-year Treasury note yield.
8. Invest in a taxable account and/or fund a 529 with any extra.
WHY
0. Give yourself at least enough buffer to avoid worries about bouncing checks
1. Company match rates are likely the highest percent return you can get on your money
2. When the guaranteed return is this high, take it.
3. HSA funds are totally tax free when used for medical expenses, making the HSA better than either traditional or Roth IRAs for that purpose.
At worst, the HSA behaves much the same as a tIRA after age 65.
4. Rule of thumb: traditional if current federal marginal rate is 22% or higher; Roth if 10% or lower, or if MAGI is too high to deduct a traditional IRA; flip a coin otherwise.
For those willing to expend a little more energy than it takes to flip a coin, consider comparing current marginal tax saving rate vs. predicted marginal withdrawal tax rate.
If current > predicted, use traditional. Otherwise use Roth.
See Credits can make Traditional better than Roth for lower incomes and other posts in that thread about some exceptions to the rule.
See Traditional versus Roth - Bogleheads for even more details and exceptions.
The 'Calculations' tab in the Case Study Spreadsheet (CSS) can show marginal rates for savings or withdrawals*.
Remember to include all income-dependent effects in your marginal tax rate.
The CSS does include most federal and state brackets, credits (Child Tax, Education, ACA, Earned Income, etc.), phase-ins, phase-outs, and IRMAA tiers.
It may not include some state tax details, FAFSA Expected Family Contribution, and other items irrelevant to most but important to some.
5. See #4 for choice of traditional or Roth for 401k. In a 401k there are no income-based limits for deductions or contributions.
6. Applicability depends on the rules for the specific 401k. See Mega Backdoor Roth IRA.
7. Again, take the risk-free return if high enough. Note that embedded in "high enough" is the assumption that your alternative is "all stocks" or a "fund of funds"
(e.g., target retirement date) that provides a blend of stock and bond returns. If you wish to consider separate bond funds, compare the yield on a fund
with a duration similar to the time remaining on the loan, and put your money toward the one with the higher after-tax interest/yield.
8. Because taxable earnings will still help your FI journey. If your own retirement is in good shape, and you choose to provide significant help for children's college costs,
a 529 plan may be appropriate. Similar to "put on your own oxygen mask before assisting others," do consider funding your own retirement before funding 529 plans for children's college costs.//End canned advice
The truth is that things get significantly more complicated when you mix your entrepreneurial labor with your capital and you need to account for risk in a different fashion. Are you accounting for the time you risk as well? If so, how?
Underwriting syndications well is a lot harder than it looks and is a skill like assessing the risk, margin of safety, and upside of any other financial endeavor. Those who look at angel investments all day long get good at it provided they have the intellectual horsepower to grow over time. The same can be said of syndications, direct placements, or executing many other financial strategies. The beauty of real estate is that you can leverage well and the assets are relatively illiquid, each of which create ways to exploit pricing mismatches. If you couple that with your labor and impute it at the proper rate net net it may make sense depending on your financial situation.
At the very least make sure you have your bases covered for other risks in your life like an emergency fund, proper insurance, etc. Once you have the core things satisfied (above) you can consider syndications on a tax-advantaged or after-tax basis.
- 5yBrian BurkePro MemberInvestor · Santa Rosa, CA · Member since 2012 · 2k+ posts · 7k+ votes
Originally posted by @Elliot Landes:
@Brian Burke
Thank you for the reply! I actually just downloaded your book yesterday and plan to start reading today.
I hope you enjoy it!
I've been around long enough to know that even the best sponsors have deals that don't go according to plan. Good sponsors want their investors to be happy. If a good sponsor has a deal that isn't going according to plan, the investors can still be happy if they know the sponsor is doing all they can to get the best outcome possible. But an investor who is in with borrowed money won't be happy even if the sponsor is throwing all of their resources behind the deal because every month that investor is writing a check to their lender, and resents it every time they write that check.
Indeed. If you are employing all of those defenses that mitigates your risk regardless of your source of funds. But it doesn't change the fact that if you did all of that with borrowed money, there is still more risk than if you did all of that with non-borrowed money. That might be a risk you can tolerate. Other people reading this thread, perhaps not so much.
My response wouldn't change--it would still be that it increases risk, and my advice is don't do it unless you are aware of the risks and can service the debt (and pay it off if the deal completely fails) without altering your lifestyle. I'm certainly not naïve enough to think that none of my investors are in my deals with borrowed money--I'm sure some are. I'd never ask them to borrow to invest, and if asked I'd discourage them. But people will do this without telling me, and others will ignore my advice. For most of them that'll work out fine, and probably boost their returns. But for some, they're in deeper than they should be.
Elliot, something else to think about is what is your exit strategy for the syndication investment? if you plan to do a 1031 exchange, then you won't be getting the capital back to pay off the loan. While you can roll the proceeds into another syndication, you will still need to pay off the loan at some point. If the loan is variable rate, or if it have a balloon payment, you could put yourself into a tough spot.
If at some point you change companies, then you can transfer your 401K money from the former company into a self directed IRA. You can then invest in syndications without taking a loan on your 401K.
Finally, a loan that represents a small % of the amount you are investing would be interesting to model. Might make more sense for a growth oriented property where the upside from the sale is the main benefit.
- Investor · Los Angeles, CA · Member since 2019 · 38 posts · 22 votes5y
@Elliot Landes I like this idea a lot, as so long as the debt borrowed isn’t a variable rate. Just be careful that you don’t need the cash since you’ll be paying back some principle monthly versus the syndication pays you only interest.
- Multifamily Syndicator · Houston, TX · Member since 2016 · 1k+ posts · 2k+ votes5y
@Elliot Landes Hey Elliot, I totally agree with @Brian Burke on this.
Yes, risks can be mitigated but it can't be eliminated and with borrowed funds, the risks have now been exacerbated solely based on the source of funds.
As I read through your question: I picked on a few things, and mainly I sense that as a high earner, you might be able to fund your first investment in syndication if you have a fiscal plan that can help you save like $50k over a period of time and that would be your seed money in your first syndication.
Honestly, there is no rush to invest in a syndication, like right now.
You can go back to the drawing board, make a plan and then save and before you know it you are in on a deal.
Just wanted to give you another approach.
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