frequently asked questions about syndications and REITs
Can I invest in a syndication with retirement funds?
Absolutely. In fact, investing retirement funds through a self-directed IRA is one of the most common ways to passively invest in a real estate syndication. The process of rolling a preexisting retirement account (401(k), IRA, 403b, etc.) into a self-directed IRA (SDIRA) is relatively simple and the fees are generally quite low. If you’re looking for a great custodian, reach out to us through invictusmultifamily.com and we’ll connect you with some great intermediaries.
Setting up an account only requires a bit of paperwork, but it can take a couple of weeks. If there’s a particular deal you’re interested in contributing funds to, best start the process sooner rather than later.
The actual process of funding a deal through an SDIRA is straightforward. Simply provide the custodian with copies of the legal documents from the private placement (PPM, operating agreement, and subscription agreement), and they will direct the funds on your behalf.
A couple things worth noting.
- You can’t take personal possession of the money at any point without incurring fees. This is why the custodian is necessary.
- Talk with your CPA about any tax implications before making any decisions that could impact your financial situation.
- Typically, you’ll only be able to roll old retirement accounts from past employers into a self-directed IRA.
- Special tax liabilities (UBIT and UDFI) will be incurred when investing in an asset utilizing leverage.
- Certain transactions are restricted when utilizing a self-directed IRA. In particular, you cannot fund your own deal or the deal of a family member to whom you are related on the familial vertical axis (that means, parents, grandparents, children).
Last note, all returns flow back into the retirement account, so don’t expect to live off the cash flow of a project if investing in this way.
Where do I find apartment syndication opportunities?
Because many apartment syndications cannot be publicly advertised, finding great opportunities can be difficult. The offerings you’ll find publicly advertised are typically for accredited investors only.
Regardless, searching for deals is the wrong approach. First, find operators. The best way to find opportunities is to get out to networking events, speak to other investors, and get referrals. The community of apartment syndicators is rather small, so once you get over the initial introductions with a few investors, the world of possibilities opens up.
Want to invest with Invictus Capital? Connect with us at www.invictusmultifamily.
Even if we’re not a great fit for your investment goals, we can connect you with some rock-star operators who are!
How do private real estate syndications compare to real estate crowdfunding sites?
Real estate crowdfunding sites have become a popular way to passively invest in apartments.
It’s an exciting new area that still feels a bit like the wild, wild west. Many big players have come and gone in only the few years this avenue has been available to the general public, so tread carefully.
Offerings through these channels can be presented in a number of ways, which may or may not allow for non-accredited investors.
From a high level, these online portals operate in one of two ways. In the first, the portal itself is the sponsor, raising funds to be deployed in another operator’s deal. This is similar to the role of capital raisers we discussed in an earlier chapter. In this arrangement, you won’t have any interaction with the operating partner actually managing the property. All your communications, tax reports, and distributions will be handled through the crowdfunding platform.
There are two things we dislike about this structure.
The first obvious downside is the fact that you don’t know the people running the deal. This makes vetting them difficult. In this instance, the crowdfunding portal is no different than if you were to invest in a faceless corporation through the stock market.
The second downside is that the crowdfunding portal is skimming additional fees that wouldn’t be present had you gone directly to the managing operator. bNow, one could say you are paying for the crowdfunding portal’s expertise (in bvetting operators), ease of use (in distributions and filings), and accessibility (you wouldn’t have seen many of these opportunities otherwise), but that doesn’t change the fact that now there’s another middleman’s mouth to feed.
The other way these portals operate is by merely serving as the connection point between you and the operating partner. This solves the first issue of not knowing the operator, though it doesn’t change the second problem of additional fees. You might never directly see these fees (they’re generally passed onto the operating partner), but you can bet those expenses will land bsomewhere in the underwriting.
None of this should dissuade you from exploring this option. Through these platforms you’ll have access to offerings you couldn’t find elsewhere. Be aware that many of the largest crowdfunding sites have come and gone (seemingly overnight), and that you’ll be paying a bit more than you otherwise would if you went direct to the operators.
Our personal recommendation is that you spend the time and energy to network and find the operating partners yourself.
How much do I need to have to invest?
Minimum investment amounts vary by operator and by deal. We’ve seen minimums range anywhere between $5,000 all the way up to $500,000. Industry-standard is usually around $50,000–$100,000.
How long will my money be tied up?
This largely depends on the asset type and business model. Average project life on a value-add multifamily opportunity is between five and seven years. There’s always the possibility of an earlier exit, but keep in mind that real estate is an illiquid asset and that you shouldn’t commit any funds that you might need in the next couple years.
Usually there are ways for an investor to exit a deal prematurely. They aren’t easy, though, and usually mean taking a haircut on the returns to make it happen.
When does my preferred return start accruing? Does it roll over?
By now you understand that there are countless different ways to structurea syndication. It’s important you understand the nuances of the unique deal in front of you.
One aspect to pay particular attention to is the preferred return. It’s increasingly rare, in recent years, to find a deal that doesn’t offer a preferred return. But remember, not all preferred returns are created equal.
First, when does the preferred return begin accruing?
Often it’s day one, but not always. If the deal requires a heavy reposition or has a development component, there might not be any cash flow for the first year or two. You know if you’re entering into a deal like this and shouldn’t be surprised to find the delayed distribution of a preferred return.
Occasionally, however, you’ll find operators who, regardless of how aggressive the property reposition is, do not start paying out the preferred return immediately. Get clear on this before funding the deal.
The second question to ask is whether the preferred return rolls over. For example, if a deal projecting an annual 8% preferred return only delivers 6% in year one, what happens to the remaining 2%? Does it disappear or does it roll over, to be made up in the subsequent years?
Industry standard, at the time of this writing, is for the preferred return to roll over until it’s completely caught up.
Surely there are great deals that do not offer this, but you’d be hard-pressed to convince me to give them any money.
When should I expect my first distribution?
Again, this depends on the type of deal and the business plan being utilized. Some projects are basic yield plays that start churning out cash from day one. Other projects might require a renovation and reposition taking upwards of six months, so distributions might be light until the project hits its stride in years two or three. On the far other end of the spectrum you have ground-up development deals, which might not generate any sort of return for up to five years.
Even within this diverse spectrum of project types, there are countless ways operators could handle distributions. They might be monthly or quarterly or annually or… you get the idea.
The most common distribution schedule for value-add multifamily projects is monthly or quarterly, beginning sometime within the first year of acquisition.
Can I roll my 1031 exchange into this deal?
That’s a tricky question depending on a lot of factors unique to your situation. 1031 exchanges are a fantastic way to defer tax liabilities, but it’s a needle that must be threaded precisely.
Technically, yes, there are ways you could roll a 1031 exchange into a syndication or a joint venture. This is most frequently done through a tenant in common (TIC) arrangement. Practically speaking, there’s a lot of work and cost associated with going this route, and most operators aren’t interested in jumping through all those hoops or incurring those expenses.
An interesting option worth considering in this instance is the Delaware Statutory Trust. DSTs are beyond the scope of this book, though it’s worth looking into if you have a 1031 exchange in the foreseeable future.
Can I sell my shares early?
In many of the deals we’ve seen, there are ways for an investor to sell their shares prematurely (although this is by no means a given). Usually, this takes form in one of three ways:
- Sell your shares to the GP
- Sell your shares to other LPs in the deal
- Bring in a new investor into the deal to buy out your shares (with GP approval)
You should find the specific rules for early liquidation outlined in the Operating Agreement.
My recommendation to every investor posing this question is to come to terms with the fact that you’re investing in an illiquid asset and that your money will be inaccessible for the duration of the hold. Go into the deal having mentally written off needing the money in any sort of shorter time span, and I promise you’ll have a better investing experience overall.
What’s the difference between a syndication and a REIT?
The Four Differences between a REIT and an Apartment Syndication A while back, we sat down with a prospective passive investor to discuss a deal we were working on. He was excited about all the same things we get excited about when it comes to buying multifamily real estate.
The cash flow, the appreciation, the tax benefits, the control, the stability…he was psyched on all of it.
He went on to tell us that he loved investing in real estate so much that his portfolio was actually too heavily weighted in that sector and he was afraid of putting more money to work in that area. We were surprised to hear this because earlier in our conversation he’d made it clear he didn’t own any real estate and that he’d never passively invested in a syndication.
We probed a bit deeper and discovered that he actually had nothing invested in real estate. What he had was a misunderstanding and a whole lot of money in REITs.
One of the most common questions (and it’s one I wondered about, too, when I first started investing) is: What’s the difference between a REIT and a syndication?
As it turns out, there aren’t a ton of differences between a REIT and a syndication, but the differences that do exist are quite substantial.
That’s not to say one is better than the other (though obviously we’re biased toward syndications). Our goal in this section is to outline the major differences between these two investment vehicles so you can better understand how they fit into your portfolio.
What is a REIT?
REIT stands for Real Estate Investment Trust, and it’s a company that owns and operates income-generating real estate. These companies tend to be quite large and they focus within a particular asset class (industrial, multifamily, retail, office).
Funding a REIT is modeled after mutual funds, where a group of investors pool capital. So far, this doesn’t sound terribly different than a syndication, huh?
So let’s get into the weeds and discuss the four differences between a REIT and an apartment syndication:
The first thing to note is that, when you invest in a REIT, you’re not actually investing in real estate, you’re investing in a share of a company that owns and operates real estate. This is a subtle, but important, distinction (especially when it comes to the tax treatment of these vehicles).
Contrast this with investing in an apartment syndication whereby you and a group of investors each invest in an LLC, which in turn owns the real estate. As a result, direct ownership.
Here’s another aspect to consider. When buying into REITs, you don’t get a say in which properties are acquired. In fact, in many cases, it might be difficult to determine which buildings you’ve actually invested in. Your investment in these vehicles goes into what’s known as a blind pool that the operators disburse at their discretion.
Some apartment syndications are structured in a similar way, but most are what we refer to as single asset acquisitions. When presented with one of these deals you are looking at only one property (or a portfolio of properties grouped together) and you get to underwrite and vet those properties on the individual level. If you don’t like the location, business model, projected returns, or whatever, then you can opt out.
Not so with a REIT.
One of the strengths of a REIT is how easily you can buy and sell your shares. Then again, one of the weaknesses of a REIT is also how easily you can buy and sell your shares.
Why is this both a strength and weakness?
Well it’s obviously great for you if need quick access to your capital. If you need to free up some capital, no problem, just grab your phone and pop open your Vanguard app. You’ll be liquid within a couple minutes.
Also, because REITs are publicly traded in the same way as stocks, it’s incredibly easy to hop into this investment vehicle without having to plonk down tens of thousands of dollars.
So far these only sound like good things, right?
Not entirely. The sword cuts both ways, unfortunately. Because it’s easy for you to buy and sell, it’s also easy for everybody else to buy and sell. This means REITs are prone to the same volatility as the stock market, and a late-breaking news article or gang of Redditors can tank the value of your holding for no discernibly good underlying business reason.
Let’s contrast that with apartment syndications.
First, syndications are notoriously difficult to get into. You either have to be an accredited investor (in which case you have access to a smorgasbord of potential private placements), or, if you’re not part of the 10% of the population qualifying as an accredited investor, then you must establish a substantive preexisting relationship with an operator before you’re allowed to hop into one of their deals.
Second, regardless of which class of investor you fall into, apartment syndications aren’t something you can generally just jump into on a whim. Also, they’re notoriously illiquid investments running on average between five and seven years. Oh yeah, and let’s not forget that the minimum investment amount is usually around $50,000. That’s a high hurdle for many people.
In exchange for the lack of convenience, apartment syndications are notoriously secure investments that do not see wild valuation swings overnight.
Which do you value more? Liquidity or stability?
How you answer that question will go a long way toward determining which of these investment vehicles is right for you.
3. Tax Benefits
It’s not about what you make, it’s about what you keep.”
Your largest bill each year is likely to Uncle Sam. Nobody gets excited to pay taxes, but most people find the process to be so frustrating, obtuse, and demoralizing that they simply put it at the back of their mind until April 15th rolls around each year.
This head-in-the-sand method of wealth management won’t do. Thankfully, there are some simple and easily accessible ways to reduce your taxable liabilities. The most notable of these is by owning real estate. There’s a reason 80% of millionaires own investment real estate. Sure, the returns are great, but generally speaking, it’s because the tax benefits are second to none.
Passive investors in an apartment syndication benefit from depreciation. Depreciation, in the simplest terms, is the way the IRS recognizes that everything in this universe has a finite lifespan. This includes our buildings and everything comprising them.
Depreciation passes through to your K-1 (the tax return form you receive each year documenting how an investment performed) in the form of losses. These losses reduce your taxable liabilities on passively earned income, which, for our purposes here in an apartment syndication, would be the cash flow distributions.
So, if you invested in an apartment syndication, then at the end of the year it’s likely you’ll have earned some cash flow distributions. This very real income that hit your bank account will most likely be entirely offset by you share of the deprecation write-off.
The result? You pay nothing on the cash flow distributions until you sell the property and the depreciation is recaptured. In the meantime, that’s tax-free income, baby.
Let’s compare that to the tax treatment you’ll receive investing in a REIT. First, REITs do benefit from the power of depreciation, but this all occurs before the money ever hits your bank account. Sorry, you don’t get the personal benefits of depreciation in a REIT.
Second, REITs pay out dividends, which are taxed as ordinary income. Depending on what tax bracket you’re in, that can be a sizable chunk of change.
In short, not only do REITs not reduce your tax burden, they actually make it worse. These taxes really take a bite out of what would otherwise be considered pretty good returns. Speaking of returns… let’s tackle that next because the amount you stand to make investing in a REIT versus an apartment syndication are pretty bdarn different.
Obviously, returns vary by myriad factors, so let’s take this section with a grain of salt. We’re talking high-level averages here.
Historical data over the past twenty years shows REITs have outperformed the stock market, with an average annualized return of just under 12%. vThat’s not a terrible return, especially when compared against the stock market. It’s important to note that these returns don’t factor in tax treatment (as that’s entirely variable depending on the individual). If taxes were vfactored into the returns, then the effective return of REITs would likely be around 8–9%.
Again, not terrible, but also not something you’re likely to get too excited by, either.
Apartment syndications, by comparison, often generate well north of 20% average annual returns after cash flow, refinances, and sales are factored in. It’s not uncommon to double your money in five years in an apartment syndication. A REIT, on the other hand, would likely take closer to eight years. And once more, because it’s so important and bears repeating, this doesn’t take into consideration the tax benefits associated with owning actual real estate like you do in a syndication.
Okay, that horse is dead. We’ll stop beating it now.
Should you invest in a REIT or an apartment syndication?
As with most things in life, there is no one-size-fits-all solution. Which investment vehicle is right for you ultimately depends on your unique goals and context.
If you’re just starting your investing journey and only have a little capital to invest, a REIT might be your best option until you have saved enough to meet the $50,000 minimum investment most syndications require. A REIT might also be the right choice for you if you foresee needing your capital in the near future. Syndications are illiquid vehicles and your money will be tied up for between three and seven years in most cases. If you think you’re going to need that money next year for your daughter’s graduation, then a REIT, again, might be the right choice.
For us, syndications are our preferred choice of investment vehicle. I know, that’s not terribly surprising. We’re biased after all, but for good reason. Once you factor in the tax benefits, better returns, and additional security that comes from knowing the specific asset and the operating team, it’s a no-brainer for us.
Let’s finish this discussion of REITs versus apartment syndications by recalling the fact that life isn’t binary and that there’s nothing stopping you from diversifying into both investment vehicles. As the Buddhists would say, “The middle way is the way.”Posted by DRG *Mpls on