Below, I explain the five reasons why I’m finally investing $35,000 into a real estate syndication after 4 years of only active real estate investment.
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This communication is intended solely for informational purposes and does not constitute legal, tax, or investment advice. You should consult with your own legal, tax, or investment advisor before making any decision based on this information.
As my readers will know, I’ve spent the last 4 years investing the majority of our excess capital into real estate. With the power of leverage via mortgages, our portfolio has grown rapidly to 28 units spread across four states. This has led to a fairly lopsided asset allocation, with the real estate part of our investments dwarfing the rest of our portfolio.
For the first half of this year, I’ve focused on cleaning up the business side of our real estate company. We moved our business bank accounts to Chase, our accounting to Quickbooks, and hired our first team member to assist with systematizing our operations. This was all in anticipation of an expansion of our holdings as we move more strongly into the apartment space later this year.
My concentration into real estate is connected to my strong belief that real estate investment is the fastest route to financial independence. This is because it has a unique mix of cash flow, leverage, tax benefits, appreciation, and inflation protection. I’ve outlined my case in blog posts in the past:
- The 401k vs Real Estate | What’s the Better Investment?
- Rental houses vs. stocks: a 25 year portfolio projection
- The 5 ways rental real estate makes you money
So far, all of my real estate investments have been through private ownership. This means that I personally own all the real estate myself (or via legal entities). While banks certainly have claim to the property since they provided the loans to purchase the property, no one else shares any ownership except for my wife.
But for the first time, I’m planning to invest $35,000 into a real estate syndication. Specifically, I’ll be investing into 286 units of Class A new construction outside of Phoenix via Ascent Equity Group. This is a real estate investment group led by three physician real estate investors who have successfully placed $73 million of capital into $250 million of real estate spread across 1200+ units. I went to med school with one of the founders and know another quite well from the Passive Income MD blog.
Why am I finally investing into a syndication? Please allow me to explain. Here’s what I’m going to cover below:
- The definition of a real estate syndication
- 5 reasons why I’m investing into a syndication
- The downsides of the syndication model
Note: This image below is how you can sign up to receive more information about the syndication deal in which I’ve decided to invest. It’s a “soft commit,” which is non-binding, and mainly gives permission to Ascent to send you information. If you’re reading this post after June 2023, the deal will probably be closed. To invest in this deal, you must be an accredited investor.
I’m a limited investor in this deal, just like you. But if you decide to invest alongside me, we could potentially get increased preferred returns upon deal exit if we bring enough capital to the deal. So make sure to sign up using this link or click on the image above!
Real Estate Syndication
While the term “syndication” might seem menacing, a real estate syndication is actually fairly straightforward. At its heart, a syndication is a form of group investment where individual real estate investors pool financial resources to purchase assets that are too large for most people to take down on their own.
In a typical syndication, there’s a lead investor or syndicator, often referred to as the “general partner.” The general partner identifies the investment opportunity, organizes the deal, manages the property, and makes major decisions. The other investors, or “limited partners,” provide the necessary capital and participate passively. The limited partners primarily benefit from income generation, capital gains, and tax benefits, all without the hassles of day-to-day property management.
General partners are often called “GPs” and limited partners are often called “LPs.”
1. The Ability to Invest into Larger Deals
One thing that attracted me to real estate syndication was the opportunity to participate in larger deals. As an individual investor, the purchase price of large commercial real estate projects, such as office buildings or an apartment complex, can be daunting.
Last week, I drove by a couple of garden style apartment complexes in Memphis, TN. They were by no means fancy buildings, but since they both had 30-40 units, they were worth between $3-6 million dollars each. When you are looking at even bigger real estate deals, you can easily start seeing purchase prices in the hundreds of millions of dollars. Except for the ultra-rich, it’s simply not possible for individual investors to take down assets like a $100 million apartment building on their own.
Thus, by joining together a group of investors, a syndication opens up possibilities that were once out of reach.
A larger real estate asset can have a multitude of advantages when compared to a smaller one. With multifamily, there are economies of scale that come into play with larger buildings. For example, a large apartment complex can employ an in-house property manager who works full time managing the property. With high unit count buildings, this can be significantly cheaper than using a third party property manager. Similarly, larger assets can generate enough income to offer better amenities like fitness centers, swimming pools, and playgrounds.
2. Risk Diversification
Anyone who’s been in real estate knows that risk comes with the territory. One of the attractive things about real estate syndication is how it disperses this risk. When I buy a property on my own, any potential downturn in the market or issues with the property impact me directly. In a syndication model, the risk is spread across a group of investors and operators.
When it comes to the specific deal in which I’ve decided to invest, it’s a Class A property that was constructed just last year. The majority of the long term rental assets I own privately are class B renovated properties. Class A property has lower infrastructure risk and attracts a different tenant class than Class B property. Therefore, by investing into this syndication, I’m slightly reducing the overall risk of my real estate investment portfolio.
The team behind this syndication also has a significant amount of collective experience operating large multifamily. This will also diversify the risk of operating and enacting the business plan.
3. Truly Passive Income
I love investing actively. There’s nothing more satisfying than taking a risk on an investment and seeing that risk pay off. By directly owning a rental property, I have complete control over the business plan. Whether this calls for a complete renovation of the investment property, or just a light polish prior to advertising it for rent, I’m calling the shots. But I’ll readily admit that with control comes work. Each property has its own myriad of tasks that only I can do. From establishing the legal entities for risk mitigation to the business bank accounts for the property, each asset takes dozens (if not hundreds of hours) of my time.
So for once, I’m happy to trial true passive investing via the real estate syndication model. In a syndication, the day-to-day operations and property management are typically taken care of by a professional property manager or the general partner.
This will leave me free to observe the process from the perspective of a passive investor and learn how syndications work.
In general, I think passive investors should consider syndications to get exposure to real estate without direct ownership. This can be a nice complement to other types of passive investing like index funds.
4. Expert Management
One of the undeniable advantages of syndication is the opportunity to benefit from expert management. I have property management in place for my long term rental portfolio. I think that overall they do a great job. But I look forward to seeing the operation of the property managment for a Class A large multifamily apartment building. I hope to see efficiencies in property renovation, turnover, and advertisement. I also hope to see best practices related to policies on a myriad of topics like pets, late rent, repairs, and maintenance.
Expert management is an essential part of a well-run apartment complex and is yet another advantage of investing into a real estate syndication. In fact, one of ways that syndicators can “add value” to a rental property is by cleaning up the management. Every single dollar of savings from improved management increases the value of the apartment building significantly.
5. Portfolio Diversification
Real estate syndication also presents an excellent opportunity for portfolio diversification.
As I mentioned above, I already have a lot of privately owned long term real estate. However, my assets are geographically concentrated and mainly exist in Indianapolis. So by investing into the Ascent Equity syndication, all of a sudden I’ll have a small piece of a deal in the red hot market of Phoenix, AZ.
With other syndications, you could also access completely different types of assets like commercial real estate ventures or mobile home parks. This would not be easily achievable through private ownership without substantial capital.
No discussion about an investment would be complete without mentioning the downsides. When it comes to a real estate syndication, I think the main downsides are lower potential returns, delayed gratification, and less control.
Lower potential returns
When you invest money into a syndication, the power of your money gets diluted. For example, inherent to most real estate syndications is an asset under management fee. This fee is generally at least 2% of the capital pool and is used to pay for everything from administrative team salaries to office supplies. Additionally, limited partners will generally only share in 70-80% of the upside once the asset is finally sold. The remainder of the profit is reserved for the general partners and represents the main way that the GPs make money from these deals.
While this situation could still represent a good return for the limited partners, this won’t ever match what’s possible if you do it all yourself.
In terms of delayed gratification, it’s common for most of the payoff from a syndication to come at the end of the deal lifespan. In year 1 of the Ascent Equity Encanto syndication, for example, the GPs are projecting a 3-5% return in the form of rental income distributions. No one would consider this a good return. But upon the eventual dela exit, they project a 13-15% internal rate of return, which is much more attractive.
Finally, to be a limited partner in a syndication model means lack of control. Though you may hope to be well informed, you are not in control of the management decisions in the deal. This entails putting a lot of trust into the deal operators and ceding control to them. While this is certainly the most efficient way to run a deal, it might not be the most comfortable arrangement for some investors.
Despite the downsides, syndications remain immensely popular as a way to get passive exposure to real estate deals. Given the amount of money flowing into this investment class, it’s a good idea for us to take a moment to discuss regulations.
If you’re going to invest into a syndication, you don’t necessarily need to understand the legal framework governing this investment model. But it’s not a bad idea. There are various organizations that either govern syndications or have affected how they operate. These include the Securities and Exchange Commission (SEC) and legislation like the JOBS Act and Regulation D. These laws are intended to protect potential investors by ensuring full transparency from the deal sponsor and the real estate syndication company.
These regulations are why real estate syndications can seem so mysterious. Depending on the type of syndication, it might be illegal for the syndication team to publicly advertise the real estate deal! If you are seeing a public advertisement for a real estate syndication, it is likely that to invest into that deal, you need to be an accredited investor. That’s the case for the Ascent Equity deal that I’m going to invest into, which makes the Encanto deal a 506(c) offering. In contrast, a 506(b) offering can only be advertised to “friends and family.”
To be an accredited investor, you must make more than $200k of income annually for the last two years or more than $300k annually as a couple for the last two years. Another way to qualify as an accredited investor is to have a net worth over $1 million without your primary residence.
While these regulations might seem onerous, they exist because there’s a higher than normal potential for fraud in real estate syndications. Unscrupulous GPs could run away with your capital, for example. Or more commonly, a deal could fail simply due to poor management decisions or bad luck. Regulations exist so that if this happens, an investor won’t be financially crippled by their investment.
The Path Forward
Diving into real estate syndication is not without its challenges. Since you’re not sourcing the deal yourself, it can be harder to have sufficient knowledge about the deal to feel comfortable placing your capital. However, a good real estate syndication will have a wealth of information about the deal for you to conduct your due diligence.
In this process, you should examine sponsor fees, scrutinize past performance, and evaluate the potential for cash flow distributions. You should investigate the local tenant base, demographic trends, employers, and competition for tenants near the property. All of this information should be provided by the GPs.
The idea is to ensure that you’re making an informed decision and that the potential returns justify your investment.
Understanding the Numbers
Just like any medical or professional specialty, there’s a special vocabulary to real estate syndications. To perform due diligence on an investment, you should understand the metrics that gauge the profitability of these deals. Understanding aspects such as acquisition fees, asset management fees, and the preferred return structure will help you understand the attractiveness of the deal. Other terms to learn include the projected internal rate of return (IRR), capital gains, and quarterly cash flow distributions.
The majority of these terms will make sense from context clues as you listen to discussions about real estate. But if there’s a specific term that you find puzzling, I encourage you to look it up! Investopedia has thorough definitions of all these terms.
Another worthy topic to understand are the tax benefits specific to real estate. I’ve talked about a number of tax specific topics on the blog. Here are a couple of articles to jumpstart your understanding of this topic:
- Tax benefits | Why I’m investing in real estate over stocks – Part 2
- Amazing Tax Deductions from Your Short Term Rental
The Power of Group Investment
As I progress through life, I’m more and more convinced of the power of collective effort. Humans are social animals and there’s a reason why we enjoy things like team sports and clubs. You need a team to invest in real estate successfully and the syndication model takes this to another level.
As part of a group of investors, you can pool together the necessary capital to acquire investment properties that would be out of reach for a single investor. Beyond the financial aspect, it’s also about leveraging collective wisdom.
In summary, venturing into real estate syndication has been an enlightening journey thus far. The idea of pooling resources with a group of investors to purchase large-scale properties is appealing. The prospect of earning passive income, benefitting from expert management, and diversifying the risk in my real estate portfolio is also attractive.
I’m excited to see how this new chapter in my investment journey unfolds. At the very least, I expect that my experience will provide valuable insight for my fellow investors contemplating a similar path. Real estate syndication might not be for everyone, but for those who want truly passive exposure to apartment buildings, it can be a great way to expand their real estate portfolio.
Remember, investing is a journey, and diversification is a long-term game. Here’s to your success!
— The Darwinian Doctor
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