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There’s going to come a point in your commercial real estate journey when you find a property that you simply can’t afford.
It may be an office building located in the heart of town, a prime spot for a restaurant or retail store, or a rental property that’s all but guaranteed to produce a healthy return.
As a real estate investor, there’s nothing worse than the feeling of being unable to afford something. But fortunately, there’s a strategy that can potentially help you land a dream property even when you’re short on cash and can’t afford the purchase price on your own.
It’s called real estate syndication, and it’s one of the most powerful strategies that you can use when hunting properties.
This post provides a rundown of what real estate syndications are, why they’re useful, and how to get started.
First up: What are real estate syndications?
Real estate syndication is the process of joining forces with other real estate investors to purchase properties.
This real estate syndicate strategy can be used for a variety of commercial real estate properties — like multi-family homes, apartment complexes or apartment buildings, office buildings, industrial centers, infrastructure, and retail spaces, to name just a few examples.
There are a few ways of using real estate syndications.
Direct ownership involves becoming a part-owner of a property, by splitting funds with a group of investors or at least one general partner. This strategy is called a real estate limited partnership (RELP). Most of the time, a RELP is set up as a limited liability company (LLC).
Suffice it to say that this is not an avenue a passive investor will want to pursue. Through direct ownership, you assume ownership of the property along with limited partners and share profits, costs, and management responsibilities with the group of investors.
Direct ownership can be very lucrative. However, it’s also highly resource-intensive, requiring significant capital expenditure, time, and management.
Real estate investors have to come up with down payment and closing costs, property management expenses, utilities, and marketing fees, to name just a few examples.
What’s more, direct ownership can be risky, especially when it involves large sums of money. There is the risk that the investment may not pan out as intended or that the other investors may be difficult to work with.
Beyond that, the investment property could simply lose value via depreciation, resulting in a capital loss. These are risks that you need to account for before entering into any type of real estate deal.
The other real estate syndication option is to invest indirectly by joining forces with a large pool of investors. This can be accomplished by purchasing real estate investment trusts (REITs) or by using a strategy called crowdfunding.
Investing through REITs
REITs are companies that own and sometimes operate real estate projects. REITs can get bought and sold directly throughout the trading day just like stocks using brokerage firms like Schwab and TD Ameritrade.
REITs are typically low-risk investments because the money gets spread out over a large pool of properties instead of getting concentrated into one area. So, if something happens to one of the properties in a REIT’s portfolio, the overall investment probably won’t be impacted all that much.
There are many types of REITs across different industries like healthcare, telecommunications, residential properties, and office buildings, among other things.
Investing through crowdfunding
In this case, companies raise money for real estate projects by pulling funds from large groups of investors. Firms pool money and use the capital to buy exclusive, high-end properties that would be otherwise too expensive or difficult to obtain.
Crowdfunding companies may also sell REITs, providing additional investing opportunities.
This strategy can help if you need to secure financing for real estate but don’t want to ask friends, family members, or private lenders for money. In other words, it’s a low-barrier entry into real estate.
The main downside to real estate crowdfunding is that companies can charge heavy fees and you won’t have direct control over operational decisions.
Direct vs. indirect syndication: Which is the better option?
As a real estate investor, you have the option to engage in both direct and indirect real estate syndication at the same time. This strategy can help diversify your investments, reducing risk while maximizing revenue. Of course, you can also choose to exclusively invest in one option.
As an investor, you have a unique financial situation and needs and so only you can decide which investment opportunity is best.
With all this in mind, here are some things to keep in mind when deciding whether to go the direct or indirect route.
It’s a good idea to look at your overall financial situation and determine your real estate risk tolerance.
Just as the name suggests, real estate risk tolerance is all about figuring out how much risk you can put into a real estate investment. This all depends on your cash flow, your financial stability, your overall debt, and your age.
Figuring out your risk tolerance can be tricky. For example, young investors typically have a much higher risk tolerance than older investors simply because they have more time to absorb a bad investment.
At the same time, going too hard into a real estate investment and biting off more than you can chew can potentially send you into debt and create a financial mess. So, in some cases, older real estate investors with deeper pockets on more diverse portfolios may have a higher risk tolerance with commercial real estate syndication.
It’s also a good idea to take a look at your overall financial situation, including liquidity, investments, and credit.
Direct investing is for people who have enough cash to fund a direct project, assets they can use as leverage, or excellent credit for leveraging debt. In fact, debt can be a real estate investor’s best friend.
For investors who are starting out or lack substantial assets, the indirect option is typically the safer route because it comes with far less of a barrier to entry.
Real estate knowledge
Direct real estate investing is for experienced investors. Succeeding in real direct real estate, even via syndication, involves having expert knowledge of properties and markets.
Investors often get into trouble when they blindly trust business partners and other individuals without understanding what they are getting involved with. For example, someone may approach you about investing in a property because they know you have money or want to invest. But if you don’t thoroughly understand real estate, this can be a risky play.
Of course, indirect real estate can be risky, too. But it’s a different type of risk than buying direct. If you’re familiar with the stock market, it’s a bit like buying an index fund — or collection of securities — as opposed to going heavily on one particular company.
Succeeding in direct real estate requires having an expert team of professionals in your corner. It’s critical to have a solid group of real estate experts, financial advisors, contractors, and property inspectors that you can rely on to make sound financial decisions. Very generally, the best RELPs are power groups comprised of high-performing, motivated, and experienced professionals.
It also helps to have deep connections with the local community, so that you can get a deeper sense of changing short-term and long-term market conditions. Information is critical in real estate, and the more you know about a property and the local area, the better off you’ll be.
Of course, building a strong network takes time. It requires forming trusted business connections and expanding your personal network. If you’re just getting started in real estate, investing indirectly could be the better option.
The Pros and Cons of Real Estate Syndication
- Potential portfolio diversification
- Rental income
- Less expensive than buying property alone
- Access real estate expertise
- Passive real estate
- Less control than being an individual investor
- Requires dealing with other investors
- Syndication deals require sharing profits
- Management fees and acquisition fees
Frequently Asked Questions
Below are answers to some of the most frequently asked questions about real estate syndication.
What are accredited investors?
The U.S. Securities and Exchange Commission (SEC) classifies an accredited investor as an investor who is financially competent and capable of trading securities that aren’t regulated.
As a general rule, accredited investors must make at least $200,000 per year in income and/or own at least $1 million in assets.
Once you become an accredited investor, you can purchase unregistered securities — which are high risk and off-limits to non-accredited investors.
Are there tax benefits for syndicators?
Tax benefits largely revolve around how a syndicate is set up.
For example, if the syndicate is set up as an LLC and you receive a pro-rata share of profits, then you will receive shares based on the entity’s tax strategy. If you are a debt holder, then you won’t share profits and won’t gain any tax advantages.
Suffice it to say that taxes can be tricky when working with a syndicate. That being the case, it’s a good idea to have a savvy tax advisor on board to walk you through the process and help you save money.
The Bottom Line
Any way you look at it, opportunities abound with real estate syndication.
If you play your cards right, syndication can be a great investment strategy leading to passive income and exclusive investment opportunities that you might not otherwise be able to secure on your own.
At the same time, it’s important to do your due diligence before getting involved with any real estate opportunity. Real estate investing is risky and joining a syndicate or investing indirectly through crowdsourcing can present unique challenges.
If you’re new to real estate investing, you’re probably best off launching your career as an investor by gobbling up a couple of REITs. That way, you can learn the basics of real estate investing and begin assembling a portfolio that generates returns via capital gains and dividends.
Once you’ve got a few successful trades under your belt, it might be time to move to the next stage in your career as a real estate investor and get involved in real estate syndication and other kinds of deals.
Who knows? You might become a real estate magnate before you know it. Good luck!