8 Reasons to Invest in Real Estate Syndications
In a previous post we discussed the Top 5 Investment Vehicles for Busy Real Estate Investors. But in this post we will drill down into a popular investment vehicle called syndication.
Syndications are partnerships that allow investors to pool their capital together and invest in larger properties than they could purchase and manage individually.
There is a sponsor (also called a syndicator, operator, or general partner) who is responsible for managing the investment from beginning to end. This includes finding, purchasing, managing, and selling properties on behalf the partnership.
Then there are limited partners, or investors, who provide the capital to purchase the property. Limited partners are passive and do not participate in the management of the investment.
So if you're a busy professional or business owner, why should you consider investing in a syndication?
It's a Passive Investment
One of the primary benefits of investing in a syndication is it is a completely passive investment for limited partners.
And as a limited partner, you will receive the benefits of direct real estate ownership without the headaches of dealing with the day-to-day management of the property.
The most work you'll have to do is identify which sponsor and which investment opportunity to invest in.
Sponsors usually have a previous track record of success, and know how to react to various issues that may arise during the course of an investment.
Plus, they work closely with professional property management to manage the day-to-day operations of the property.
That means your investment will be in safe hands. And you won't have to take time away from your career or business to go handle issues with the property (i.e. fixing toilets or finding new tenants).
Also, sponsors will provide you with updates on the status of your investment on a monthly, or quarterly basis. That way you'll always have an idea on how your investment is doing.
Investing in a syndication gives you the opportunity to diversify your portfolio into an asset class that is not directly tied to the public markets, and can remain largely unaffected during a financial crises or recession.
Tenants still need a place to live and will be paying off your mortgage on your behalf, increasing the equity in the property, and producing cash flow. And with some real estate asset classes, the value of a property increases during tough times as the demand for affordable housing increases.
With that said, syndications tend to be less volatile than stocks, bonds, and mutual funds, and provide a more stable return.
Also, because your investing in large properties with multiple units, you'll have multiple tenants paying rent. And should a few tenants move out, the other tenants are still covering the operating costs of the property.
Multiple Profit Centers
In the single family world, property values are based on comparable properties recently sold in the area. If a similar property down the block sold for $100,000 2 months ago and another last month for $105,000, then yours will be valued at a similar amount.
But not in the commercial (and large multifamily) world. Here properties are valued by their Net Operating Income (NOI). NOI can be increased by increasing rents (and other income) and reducing expenses. This is often controllable, and thus called "forced" appreciation.
Sponsorship teams will identify and purchase undervalued properties that are mismanaged, outdated, or in disrepair. Then bring in new property management and renovate properties to current market conditions, sometimes even changing property classes. (i.e. C to B).
Once the property is up to market condition rents can be increased. And costs can be controlled by the new and more competent management.
A sponsorship team buys a 100 unit building with NOI of $100,000 for $1,000,000, indicating a 10% cap rate (NOI/Purchase Price). If rents can be raised by just $10 it will produce an additional $12,000 of NOI, bringing the total NOI $112,000. Divide the $112,000 NOI by the 10% cap rate to find the building is now worth $1,120,000 million. $120,000 of equity was created by simply raising rents by $10 per month.
Principle Pay Down
Another benefit of investing in real estate is principal pay down. Much like a house, the principal of the mortgage is paid down every month and the amount of equity in the property increases.
This effect is magnified with larger properties as multiple tenants are paying down the mortgage, producing another source of profit for investors.
An obvious reason for investing in real estate is cash flow. Depending on the strategy of the sponsorship team, cash flow can be paid to investors on a periodic basis.
It is also important to note that larger properties have multiple tenants paying rent, if a few tenants move out, in most cases the other tenants will still cover the operating costs of the property and not put a huge dent in the cash flow the way a tenant moving out of a single family rental would.
Tax Advantaged Income
Unlike other investments such as stocks and bonds, income from real estate is considered tax advantaged income.
This is because of a non-cash expense called depreciation. Depreciation combined other operating expenses can easily cause a property to show a loss for tax purposes, even though it is producing positive cash flow.
Since syndications are set up as partnerships, these losses are passed down to you as a limited partner. These losses can offset other passive income, and depending on your income level these losses can potentially offset your ordinary income. If not, they are carried forward into future and can offset future passive income.
Economies of Scale
Sponsors like to purchase large properties including:
- Mobile Home Parks
Because they deal larger properties, property management fees are lower on a per unit basis. And the cost per unit for onsite management is also reduced for properties with larger number of units.
Plus the all of units are located in the the same area (i.e. an apartment complex) so there is no need to travel across town to visit each unit, which reduces travel cost and time.
Renovation expenses are also lower as the number of units increases. This is because contractors will reduce their price per unit when working on a larger number of units, and material vendors can give discounts when buying in bulk.
The Bottom Line
If you're a busy professional or business owner, investing in syndication will allow you to participate in the benefits of direct real estate ownership. But without the hassles of day-to-day management.
Your investment will be managed by a professional management team with a previous track record of success. And with larger properties, you will benefit from economies of scale, and risk will be spread across multiple units.
You will also be able to diversify your portfolio outside of the volatile financial markets, while maintaining a passive role, allowing you to focus on your career or business.