Power + Risks of Investing in Real Estate Syndications
Real estate tends to be one of the most valuable assets in an investment portfolio. Unlike stocks and bonds, it’s a tangible asset that remains standing regardless of market conditions, which is why syndicated real estate funds have become a popular type of passive real estate investment for building wealth.
How does this work? The syndicator/sponsor opens up a large real estate project, usually commercial or multi-family, to multiple investors who pool their capital to jointly purchase the property. As the manager and operator of the deal, a sponsor invests not only sweat equity but also a portion of the equity capital needed.
For developers, it offers new options to fund and build their projects. It also makes real estate investing less cost-prohibitive and more accessible to individual investors. Real estate syndications can help investors reap the rewards of owning an investment property—without the hassle and hands-on commitment of being a landlord themselves.
Here are some of the most important rules, benefits, and risks to keep in mind when considering investing in syndicated real estate funds:
You must either be an accredited or experienced investor to be eligible for a real estate syndication and have an annual income of at least $200K ($300K with a spouse) or a net worth exceeding $1M.
First, make sure you’ve selected an experienced and trustworthy real estate syndicator. If you actively network with other investors, check with them or your advisors on recommendations.
How much do you need to invest? Depending on where you look for these opportunities, you might find minimums as low as $10K, but they are typically $25-50K—and frequently go even higher.
Once you’ve invested in the property you choose, you’re usually locked in for the entire term without the ability to remove the capital you invested. The date when the property is sold is ultimately up to the deal operator and depends on when they see it as the right time to sell, which could be several years. A year range is usually provided with the investment.
What type of return can you expect?
Generally speaking, return on investment comes in the form of rental income and property appreciation. A tenant’s rent covers the mortgage while the owners/investors build equity. Investors receive a predictable (monthly or quarterly) passive income distribution, called a preferred return, of about 5-10% annually of the initial money invested in the property.
On top of that, if there are remaining profits, they are split between the investors and operators. There is also a return on investment when an asset is sold. Each deal is different, and the potential for returns varies.
Typically, syndicators will have a “pro forma” document used to project and make certain assumptions about the investment or project. We recommend requesting a copy of this pro forma or other related information to review the outlay and better understand the investment deal. It is essential to review both a subscription agreement and an operating agreement to understand the terms and conditions of your investment.
What are the risks?
Like with any investment, it’s essential to evaluate the deal by taking a close look at the property and the sponsor and review the terms carefully for fees and fine print. While the potential return on investment can be high, some risks include construction cost overruns, project delays, and increased vacancies because of market conditions.
While the investor is taking a passive role, the onus is on the sponsor for the project’s success. Because the sponsor is the expert and has personal funds invested in the venture, their interests align with the investors, making it a win-win structure.
Real estate is an inflation-hedged asset. Overall, it offers more than traditional assets regarding performance, risk levels, and tax advantages. Also, when investing in a smaller share of multiple properties, investors achieve a more diversified portfolio, thus further spreading their risk.
Tax benefits in the form of real estate tax deductions that reduce taxable income and taxes owed are passed on to investors through their K-1 tax filings. As a result, you can compound your money for years without paying taxes until the property is sold.
Typically these syndications pass through a net loss for tax purposes while returning cash as operational cash flows allow. For passive investors, losses are generally limited to your passive income. Any loss in excess of passive income is suspended until there is sufficient passive income or until the project is ultimately liquidated.
Depreciation is considered one of the most powerful tax benefits of investing in real estate that is passed on to investors. However, when depreciation is combined with interest payments and other expenses, a property may show a loss for tax purposes even though it’s generating a positive cash flow.
While you must account for a capital gains tax on the profits you receive from the sale of a property, the tax rate is lower than for ordinary income from operations. Overall, the passive income from long-term real estate investments is far more tax-efficient than earned income.
Qualified Opportunity Zones Investing
The U.S. government created qualified opportunity zones (QOZs) to stimulate growth in certain areas around the country, and tax incentives were established for investing in these zones. QOZs typically have buildings that need to be substantially improved/repaired or newly constructed. These tax incentives allow for deferral of capital gains and eliminate future capital gains associated with the investment.
Real estate syndicate deal sponsors do not benefit from QOZ tax breaks because transactions with related parties are prohibited. However, this tool can help a syndicator create a value-add to their project that otherwise would not be available.
Aldrich is Here to Help
While real estate syndication presents an opportunity for both developers and investors, the perks and tax benefits should be evaluated carefully, along with the risks. Our real estate team is here to help you make informed decisions about investing. If you have questions, reach out to our real estate expert, Jonathan McGuire.
Meet the Author
Partner - Real Estate
Jonathan McGuire, CPA
Aldrich CPAs + Advisors LLP
Jonathan McGuire has over eight years of experience providing strategic tax planning and compliance expertise to private middle-market clients. He has a deep focus as a real estate accountant, working with investors, developers, realtors, property managers, and other professional service providers in real estate. He works with a wide range of property types ranging from... Read more Jonathan McGuire, CPA
- Real estate
- Partnership taxation
- Tax planning and compliance
- Certified Public Accountant
- Repair regulations
- Qualified Opportunity Zones
- Qualified Opportunity Funds