Syndications are best suited for investors seeking freedom of time, plus leverage of a sponsor's experience, which can result in many benefits, including:
- Access to deals: A good sponsor will have a proven way to find deals that the general public never knows about.
- Lower required investment: Rather than having to fund the purchase of a whole property, most syndications allow investors to invest a smaller portion of the capital required.
- Low time commitment: The sponsor handles all the day-to-day work.
- Lower risk: Investors can leverage the sponsor's experience to avoid costly mistakes.
- Economy of Scale: Sponsors tend to buy larger properties. Larger properties create economies of scale that can result in higher yields and more stable cash flow.
- Returns: It's not uncommon for investors to make a better return being passive than they would have if they took the plunge themselves.
- Direct access: Unlike traditional investments, passive real estate investment offers direct communication with the people responsible for the performance of your investment and the properties themselves.
- Tax benefits: Investors can receive significant tax advantages that come with ownership of real estate, such as depreciation. (keep in mind, some asset classes are more tax efficient than others, such as my personal favorite, mobile home parks)
- Retirement-account friendly: Passive investments can be a great fit for retirement accounts because they are hands off and don't violate rules related to prohibited transactions and self-dealing.
- Fund Diversification: Similar to the way a mutual fund works, a real estate fund diversifies the investment across a group of properties instead of a single property. This can result in reduced risk and blended performance across all the properties in the fund, and can also create the opportunity for compounding returns by reinvesting cash flow distributions back into the fund.
With all that said, passive investors are exposed to both deal risk and sponsor risk. Deal risk can be mitigated by choosing a sponsor who has a track record of good deals, and can be further mitigated by investing in a fund with a sponsor with a good track record.
Sponsor risk can be mitigated by doing a good job of vetting and (IMHO) is the most important step in evaluating any passive investment. As you connect with sponsors that resonate with you, take the time to develop a relationship with them. Trusting the sponsor will be paramount to you sleeping at night, and I can't stress that enough. It does no good to place capital with a sponsor who has an attractive deal to find out later they can't be trusted.
Making sense of the deal and understanding track record is important, of course, but I believe you should develop TRUST before you invest. Developing that trust with someone you don't know may seem like a challenge, but if you approach it correctly, you should be able to achieve a pretty solid foundation before you engage.
One way to approach this is to look for investments with professional administration. In that environment, most of a passive investor’s concerns related to honesty, transparency, accuracy, and timeliness are managed by the administrator who is a neutral party. It’s like having a referee that is overseeing the investment to ensure that the sponsor continues to do what they promised.
If that is not available, another approach is to talk to investors who have had an experience with the sponsor already. If the sponsor is willing to connect you, there is nothing that replaces a conversation with someone who has already built that trust with the sponsor over time.
Also, be careful not to get blinded by just the projected returns. Your overall experience in a passive investment involves much more than the returns, so when you find a sponsor you like, do yourself a favor and get clear on what your experience will be like AFTER you have invested.
Find out how existing investors' overall experience has been. How accessible is the sponsor? If you have a concern, will you be able to reach them? Do they return calls? Are they transparent, even when they run into a problem? Does the sponsor have a communication plan? How often will you receive reporting? How are they delivered? What will the reports cover? How often will you see financials? When will you receive tax documents? How often will you receive distributions? In the sponsor's history, have all those things been delivered on time?
If the investment has professional administration, you will have access to the answers to those questions, but also much deeper vetting of the sponsor that will include personal background checks covering things like bankruptcy, judgements, litigation, criminal history, and other red flags related to a sponsor that you would want to avoid, plus other items that investors rarely consider like ensuring that the properties are actually titled correctly, property taxes are paid, and insurance is current.
The purpose of investing passively is to leverage a sponsor's time, expertise, and ability to source great deals, but your overall experience will be driven by the answers to all the questions above, so make sure to cover that in your vetting process. Otherwise, any return you could make simply may not be worth the risk, or will cause you years of sleepless nights.
All the best,
Jack
