Real Estate Syndication 101: Your Path to Passive Investing
Real estate is the most popular long-term investment vehicle in the United States, with 29% of Americans indicating it’s their top choice. Think about it: real estate investing. When you hear “real estate investing,” what do you picture in your mind?
Many people think about buying a home and renting it out on a long-term lease. Others think about exploring the short-term rental market and leasing homes on Airbnb, Vrbo or other platforms. And still others imagine buying a home that needs renovations, fixing it up, and flipping it for a profit.
Those are all viable real estate investment options. But it’s important to understand that they are active investments. That is, investors must play an active role in acquiring the property, managing it, and selling it (hopefully at a profit).
But not all real estate investments are active. Real estate syndication is a way to invest passively. You contribute capital for the investment, and experts take care of everything else.
While real estate syndication can be one of the most attractive real estate opportunities, it often takes time for investors to discover syndication and its many benefits. If you’re unfamiliar or just starting to explore real estate syndication, here’s an explainer on everything you need to know.
How Does Real Estate Syndication Work?
As mentioned above, investors often start their real estate investing journeys by purchasing single-family homes. Why? Because that’s what they can afford. Most investors are unable or unwilling to finance a multifamily apartment building completely on their own.
That’s where real estate syndication comes in.
Through syndication, investors can pool their money with others to purchase a larger property — and to benefit from the size and scale of that investment.
Investing in single-family homes versus real estate syndication is a lot like flying private planes versus flying commercial.
On a commercial flight, you get onto the plane with dozens or even hundreds of other passengers. You fly together on a world-class jet to visit a common destination. You can depend on the pilots being highly trained and deeply experienced, and you can also rest assured that the plane has been checked and approved for safety. You get all of that for an airfare of a few hundred dollars.
A private plane can take you to the same destination, but there would be a series of tradeoffs. Yes, you would be the sole decision maker on your voyage: deciding the time, crew, etc. But you would certainly pay more than you would to fly commercial. Additionally, the flight might be a little bumpier and more uncomfortable. And smaller planes are more likely to experience in-flight issues that potentially affect safety.
It can be said that the same is true of real estate.
Through syndication, you’re able to be a passive participant in an investment that mitigates risk. Real estate syndications provide cash flow on a monthly or quarterly basis, plus a potential lump sum when the property is sold.
Self-managing single-family homes is a great way to get into real estate investing. Many people do it. But self-managing single-family rentals requires a lot of time and energy. There’s more risk involved. And it’s more difficult to achieve the outsized returns that investors are typically looking for in real estate.
How are Syndications Structured?
The unique structure of real estate syndications is what makes them passive. In each syndication, there are two parties involved:
Syndicators (also known as general partners, operators, or deal sponsors) manage the deal from start to finish. They search for and evaluate investment opportunities. After an investment is made, syndicators handle all of the day-to-day management duties and strategize an exit plan to create lucrative returns for investors.
Investors (also known as limited partners or LPs for short) pool their money to make the investment. After they contribute capital, these investors are fully passive participants. They make no deal-related decisions other than the initial decision to invest, and they are not held liable for anything related to property management.
The two parties — syndicators and investors — form a limited liability company or partnership prior to making an investment.
How Can You Participate in a Real Estate Syndication?
Real estate syndications do require investors to meet certain qualifications. Specifically, you must be an accredited investor to participate. There are two ways to qualify as an accredited investor:
Income: To qualify via income, you must have made $200,000 in each of the last two years, and you expect to make $200,000 again in the current year. This threshold moves up to $300,000 combined with a spouse if the investor is married.
Net worth: To qualify via net worth, you must have $1 million or more in assets. This total net worth does not include equity in your primary residence.
You only need to qualify either by income or net worth to be an accredited investor. You do not need to qualify through both.
When considering whether or not you are accredited, look beyond just your income from your day job. Consider also your side hustle income, rental income, plus other money you make over the course of a year.
Before participating in a real estate syndication, you will need to either self-declare or obtain a letter confirming your accreditation. When self-declaring, you simply check a box that you meet either the income or net worth thresholds. Sometimes a letter is required from a lawyer or CPA, certifying your accreditation status. Most syndications work with a third-party service that makes it easy on the investor. All the investor needs to provide to a third-party service is documentation of either net worth or income.
How Do Real Estate Syndications Produce Income for Investors?
Real estate syndications are often purchasing an asset that is some form of business. Whether it’s a multifamily apartment building, storage facilities, or a medical office building, these assets are income producing. That income takes two forms:
Cash flow: As tenants pay rent at multifamily, storage or commercial properties, the profits are divided and paid out to individual investors as monthly or quarterly cash flow.
Sale: Syndications typically have plans for each investment, including how long the syndication is planning to hold the property (sometimes four, five or six years). When the syndication sells the property, the profits are also divided among the investors. While monthly and quarterly cash flow is nice, the proceeds from a sale typically deliver the strongest returns for investors.
How soon can investors expect cash flow? Properties can typically start delivering cash flow in 90 days. Also, while hold periods are often planned as four, five or six years, they can be as short as one year, depending on a variety of factors like market conditions, occupancy, bank interest rates, etc.
The Benefits of Real Estate Syndication
Real estate syndication is among the most popular approaches to investing because of the many benefits it delivers.
Real estate syndication is fully passive. As mentioned above, investors or limited partners only provide capital. They have no management duties.
Real estate syndication allows access to larger deals. The scale available through investing in a multi-million-dollar multifamily property allows for the possibility of stronger returns than single-family homes.
Real estate syndication limits liability. When you self-manage a single-family home, you can be held liable for accidents and other mishaps that occur at the property. That’s not the case with real estate syndication. The general partners absorb the liability.
Real estate syndication provides reliable cash flow plus a return upon sale. Nothing is guaranteed in real estate investing, but an income-producing multifamily property can provide reliable cash flow plus the potentially larger return upon sale.
Real Estate Syndication vs. REITs
Prospective investors often want to know the difference between real estate syndications and REITs, which are real estate investment trusts. While both are foundationally real estate investments, there are key differences that are important to understand.
Through a real estate syndication, investors passively buy a share of a specific asset. Cash flow and returns are based on the performance of that specific asset. Because the syndication owns real property, there are several tax benefits related to these transactions.
Through a REIT, investors passively buy a share of a company that in turn owns multiple properties. Returns are based on the performance of that company and its portfolio.
Create Your Blueprint for Passive Real Estate Investing
Many people want to invest in real estate. But they often don’t know where to start. What they need is a blueprint that matches their financial goals with a strategy for using real estate to build wealth.
At Madison Investing, we offer a free, seven-part course called Your Blueprint for Passive Real Estate Investing. This course walks you step-by-step through the key considerations that are so essential to finding success in real estate investing.
Disclaimer: This article is provided for informational purposes and does not constitute investment or tax advice. You should seek advice tailored to your own particular circumstances from an independent advisor.
The impact of depreciation losses in a private real estate investment are dependent on your own unique situation. Make sure to discuss the impact of these losses with your professional tax advisor or financial advisor.