Apartment Syndication vs. Turnkey Single-Family Rentals

12 Replies

I know this has been asked in the past. I've read through those posts and am looking to update the discussion based on current market conditions and get some advice based on our specific circumstances listed below.

We are looking to diversify our stock-heavy portfolio into more passive, cash-flowing real estate and are analyzing our options. Our current real estate holdings consist of a few large-scale class B value-add apartment syndications in markets around growing major metro areas (with a very experienced sponsor), as well as a couple class C turnkey single-family rentals in the Midwest. We're looking at buying more of one or both of these asset classes and want some help comparing the two.

Some more background: we are accredited investors who are busy professionals and don't have time (right now) to learn how to find, and manage our own rental units without the help of a third party like a syndicator or turnkey provider. All else being equal, we prefer a more passive approach, but we realize some "work" is necessary for any investment, at least upfront. Rental properties in our local market are overinflated and the numbers do not make sense as long-term rentals from a cashflow perspective, which is why we are looking at investing out of our local area. We budget well and are ok with the irregular cashflow from the apartment syndications.

Here are some of the pros and cons of each option that we've identified so far. We'd love to hear others' thoughts on the risk/reward profile of each and anything we haven't yet considered:

Value-Add Apartment Syndications
PROS

  • Higher return potential (most pro-formas I've read aim for 13-18% IRR over the life of the investment) due to value-add component
  • Specific market and asset risk is short-term (most funds aim to sell properties in 3-7 years, after value-add is complete)
  • Can fairly easily spread risk across multiple assets and markets using a syndication fund
  • Investment opportunities (at least at the moment) seem to be readily available from many different syndicators
  • Portfolio risk from individual unit vacancy is minimal (although nationwide eviction moratoriums and neighborhood/regional factors can still present a risk)
  • No impact to personal credit. Leverage is baked into the investment at the GP level
  • No decisions to make once investment is made (until the assets are sold and you need to find another investment)

CONS

  • No control over investment
  • Illiquid
  • Some syndications have high initial investment requirements
  • Short-term nature of investment requires identifying new investments as assets are sold
  • Risk/return is more reliant on competence of syndicator - more due diligence needed upfront to vet them

QUESTIONS

  • What unique risks are there with the value-add apartment syndication model that go along with the higher returns? How to mitigate those risks?
  • What is the long-term outlook on value-add apartment investing? Are current IRR numbers sustainable over the long run? Is the "value-add" component creating a more speculative component that could be riskier if the market shifts?

Turnkey Single-Family Rentals
PROS

  • Medium return potential (seems to max out at 7-10% CoC currently, using leverage)
  • Full control over investment
    Long-term investment - most of the "work" is front-loaded. With good property management in place, it can be fairly hands-off after that
  • More liquid than syndication investments - at least as long as there is a market for the property. Caveat is that turnkeys sell for the high-end of market value, so disposal in the first few years will likely lose money

CONS

  • Specific market and asset risk is long-term (per property - mitigate by diversifying across different markets and property types)
  • Spreading risk across multiple assets and markets requires multiple investments and quite a bit of due diligence
  • Turnkey properties (along with most other single-family homes) are becoming harder to acquire and thus more expensive, compressing returns and making it harder to find properties to buy with solid cashflow
  • Portfolio risk from individual units is high (until sufficient number of doors achieved to mitigate this risk)
  • Using leverage requires qualifying with personal credit - may become harder/more expensive with recently-announced changes at Fannie May
  • Requires some effort (to "manage the property manager") and decisions required at some point for capital expenditures

QUESTIONS

  • What unique risks are there with the turnkey single-family rental model? How to mitigate those risks?
  • What is the long-term outlook on class B/C turnkey rental investing? Will CoC numbers continue to compress or will they level out/rise over the long run?

Overall, we are leaning more towards adding more value-add apartment syndication investments, mainly due to the higher return potential, more plentiful opportunities and lower barriers to entry at present, as long as we feel comfortable selecting a competent syndicator. We'd like to know if there are factors we are not yet considering in the above analysis and if there other options we should be looking at for real estate exposure in a mostly "hands-off" fashion. Is there a higher risk of loss of capital in one of these two options? Are there any different tax benefits to holding one or the other?

@Mark Koster , great write up.  I’m in a similar situation and also invest in both.  I don’t really have much to add at the moment, but am interested to hear others’ thoughts and will be following this thread.  Perhaps I’ll be able to jump in later with more meaningful feedback.  I guess the only thing that comes to mind at the moment is the benefits of the long-term, fixed interest rate debt on the turnkey rentals that can be locked in at today’s low rates.  As others have said, “the deal is in the debt.”  I think this needs to be included in the overall return profile of the turnkey route.  Yes, syndications also generally use leverage, but as you mentioned, the exit is fairly short term.  These 30-year loans on turnkey rentals will probably look REALLY good going forward based on where things are today and where they could be heading (inflation, rising rates, etc.).  

@Mark Koster , great job on your very detailed list of pros and cons! To answer one of your questions, one of the largest risks of turnkey investment is that the property cannot be rented at the level in the marketing proforma's, or that the costs run well in excess of those predicted. Do your diligence and make sure your analysis assumes realistic vacancy and maintenance allowances and any ancillary costs that may be necessary with a property (is the owner responsible for any of the utilities, lawn care and snow removal, etc). I do think your estimate of return potential of 7-10% CoC is low; there are many markets where double digit returns are achieved with high quality units and tenants. Best of luck to you as you expand your existing portfolio!

@Mark Koster This is a great summary. I'm invested in both of these passively and am actively looking for deals on the GP side of syndications. One thing I see as another con or at least something to consider is entity structure, specifically for single family homes. You are more protected by default for syndications as compared to single family homes because the apartments are already in an LLC. There is some startup cost and hands on work to set something up on the single family home side.

For me, right now, I like the economies of scale of multifamily value add syndications.  It is easier to deploy more capital in a single deal and ramp up investing.  In the future though, I see myself continuing with both.

Investing in a syndication is closer in substance and spirit to investing in a small public REIT than investing directly in SFR's. The former is a truly passive investment; the latter typically is not (despite what a turnkey seller might tell you). If you are not interested or have not time to learn the average price of copper pipe, pine 2 by 6's or sewer lateral replacement in your market, you probably should stick to syndications.

I'm an investor and support myself and my family from my investment income. And I invest in both direct real estate (via residential rentals) and syndication/crowdfunding passive investments. In my opinion, both have their pros and cons and neither is 100% superior to the other. And I feel the ideal portfolio can benefit from the diversification of both. But I also feel directly owned properties that are turnkeys are kind of a hybrid with unique risks (that I myself am not comfortable with).

1) Directly owned properties are great because they give you maximum control and the ability to tweak them exactly how you want. So for example I'm very conservative and don't want any debt on them because I feel this hardens them in case of a severe recession. That's unusual and it would be very difficult to find a passive investment like that.

Also direct control means you know exactly what's going on. And, for those people who have more time than money, they can put in sweat equity into directly owned real estate. This will increase the return above what can be obtained on a passive investment.

The flipside of having the power to control everything is that can be alot of work (and a full-time job if you are putting in sweat equity). Not everyone wants that or is willing to put up with that. It also requires gaining a level of sophistication and knowledge that not everyone has the time, inclination or ability to do. And someone jumping into this as a complete newbie can expect that they have a decent chance of making some expensive newbie mistakes.

2) On the other hand, one of the main advantages of passive investments (via syndication/crowdfunding) is that you can hire a manager who has years more experience than you can ever hope to obtain yourself. And once you finish the due diligence, your work is done: it's completely passive. Also, rather than taking a large amount of money and investing into one single directly owned property, you can split it up into much smaller chunks across many different passive investments. This can allow a person to get much better diversification protection across geographies, asset types, strategies, investment subclasses etc. Versus putting all the eggs into one basket.

The downside is that someone has to be comfortable with turning over control to someone else. That means learning how to vet a manager. Not everyone can do that and not everyone feels comfortable turning over control. So it's not a fit for everyone. Also there is a management fee to pay for all of the above. So someone who is looking purely to maximize potential return (and has unlimited time) is unlikely to find this a good fit.

3) Turnkey operators are kind of in-between. However I would not consider them to be truly passive because they do not put any skin into the game like a good passive investment does (via a sizable coinvestment). This coinvestment is what mitigates the risk of the other party taking risks that could be a detriment to the investor. Turnkey operators don't work like that and they are more like a broker collecting a fee for their work (regardless of the long-term performance). So they are financially misaligned on long-term performance (and I think this is why there are so many people who have had bad turnkey experiences)

And, as someone who has done lots of rehabs directly myself, I have seen hundreds of ways that turnkey operator could take shortcuts (to the detriment of the investor but beneficial to their bottom line) which investor could never detect (or not until years later when it's too late). So personally I don't trust reviews from investors saying there turnkey operator is great (because really they have no way of knowing). And personally I cannot pull the trigger on a turnkey operator. However there are other investors who feel very differently and love turnkey operators.

Hope this helps.

You guys might like our Hybrid model. It's a single family strategy like turnkey, where we find lease/option buyers, vet them with our lender partners up front, then if they qualify we let them pick out a home and match them up with a single investor. It's good for busy professionals because the maintenance and repairs are the responsibility of the tenant so everyday property management and expenses are not on the shoulders of the investor. There is money paid by the tenant up front in the form of a non-refundable option fee that brings net cash in down and is nice insurance. The cash flow and back end profit in 1 to 3 years is better than syndications and regular SFR rentals.

BENEFITS OF INVESTING PASSIVELY

1. Minimizing PITA: No more managing tenants, vacancies, maintenance and the managing the manager (who is a $12-20 dollar employee who's compensation structure us not aligned with your goals) By passing the control of the day to day operations to true experts who are literally partners (direct alignment of compensation and motivations), you can assure the investment is being optimized while you spend your time on what you want which is 1) making more money at your day job, 2) spending time with your family or 3) finding that one off deal that you want to do one your own while pairing with a Limited Partner strategy.

2. Asset Diversification: Many commercial real estate investments have high acquisition prices (think $10M+) where most people don't have access to. You want to get away from these other Mom and Pop invests like these 1-40 units. When I was a syndication newbie and thought I could do everything by myself and did not trust anyone. I then realized in a few months that 1-40 unit deals had horrible pricing because all the amateurs were involved and the ones that looked good from a per unit price prospective were under 80% occupied and had ISSUES. Investing passively in a group can allow you to invest in multiple asset classes (apartment/mobile home/assisted living), in multiple locations and with varying business plan duration.

3. Avoid Credit and Liability Risk: Investing passively allows one to avoid being exposed to credit or liability risk. No W2 documented income no problem! You do not need to personally guarantee multi-million dollar loans and and be the fall guy. Plus now you can get into all the travel hacking credit cards and tradelines you want

4. Cash Flow: The goal of a LP syndication investor is to create a "ladder" of investment that create accumulated cashflow and cashout at different times. It's like your grandpa's CD ladder strategy but with 10-30x returns.

5. Taxes: All the deprecation benefits of single family home being your DIY direct investing but even better! Bigger deals are able to pay for a cost segregation to squeeze out even more depreciation. 


@Mark Koster You've certainly done your due diligence - nice job! I can help you on the apartment syndication-specific questions - 

QUESTIONS

  • What unique risks are there with the value-add apartment syndication model that go along with the higher returns? How to mitigate those risks? 

  • (***Biggest risk is always the operator - their leadership skills to execute the business plan and their  underwriting to hedge and mitigate risks. I have a webinar recording my mentor did a few months ago that will help you know what to look for - it's called "Tricks Syndicators Play to Make the Numbers Look Good".  I'll PM it to you)
  • What is the long-term outlook on value-add apartment investing? Are current IRR numbers sustainable over the long run? Is the "value-add" component creating a more speculative component that could be riskier if the market shifts? 

  • (***also depends on the underwriting, the market, and assumptions made by the operator in the pro forma - sent you PM with details)

@Mark Koster Your analysis is sound. To further mitigate risk on passive syndication consider investing in value-add with existing stabilized cash flow. This will typically be in secondary and tertiary markets, but its hard to go wrong when you cash flow from day one plus have the value-add execution to force appreciation.  

@Mark Koster To every investor, the pros/cons will be valued different. Having done both small and large properties, I can say experience and time are big factors to choosing a per unit investment such as SFH or buying in bulk so to speak with apartments. To follow-up on the excellent points by @Lane Kawaoka ,

Experience : Often the smaller properties are being managed by teams with small portfolios or experience. This simply means the systems/processes are not as fully developed as an apartment property management team. Not always the case, however the risk profile goes up with smaller sized properties due to the unpredictability of these smaller teams over X amount of years.

Time : As you mentioned, performing due diligence per SFH investment takes time. Each property will require repeating the same form of due diligence. In apartment syndication, this can be a one time event and allow for 5-7 years of cashflow without repeating that time effort. For some, this is preferable. A set it and forget it approach versus trying to place capital in 5-10 some SFH and maintaining those investments.

Diversification : A big one to repeat. Syndication groups can offer fund offerings whereby capital is placed directly into multiple large apartment complexes in multiple states, thus truly giving much higher diversification. All with the same tax benefits and economies of scale. We did this in our fund thus achieving investments in Texas and Ohio through one fund.

Everything comes down to what the investor is trying to achieve. What aligns with the lifestyle and goals? And what group do they feel good about? :) Relationship is far more important then it would appear at surface level.

Hi @Mark Koster . Great post and analysis. You won’t go wrong following the advice from @Ian Ippolito above. He has a wonderful site called The Real Estate Crowdfunding Review where you can see reviews of syndicators and more.  
I would also recommend you get the excellent book by @Brian Burke called The Hands-Off Investor that will help you in evaluating syndicators. Brian’s also got one of the best multifamily syndication companies out there. 
  Lastly, I would recommend looking outside just apartments for syndications. There are other fragmented asset classes where mom and pop sellers can provide more risk protection and upside potential. I like mobile home parks and self-storage.  
     Good Luck!  

I don't like turn-key investing. You are buying a rental property that someone else stripped all of the equity out and then you're relying on them to lease it and manage it for you. There is no value add upside. They are typically in lower end areas and often in low to no growth cities. 

Now, with that said. I am biased, as I am a multifamily value add syndicator and also invest passively in syndications. I do, however, own a portfolio of 1-4 family rentals. I purchased those for a deep discount, renovated and refi'd. If you want to go the SF route, that, in my opinion, is the way to go.