When people first think about real estate investing, some may start by thinking about buying one or more rental properties. Others may want to be more hands-on and think about small “fix and flips” by buying a property below market value and renovating it to increase the value in order to benefit from the profits when they sell. We’ve all seen the many TV programs that make this sound very easy and attractive.
Others still may think about doing the same, but on a grander scale.
Both can be profitable, but to some this may all sound like too much work and they would like something more passive.
The above are just two of the many ways to invest in real estate.
Below we’ll look at an alternative way to invest in real estate that allows investors to invest in a passive way in larger projects than they would otherwise be able to purchase on their own. This is called “syndication.”
Real estate syndication is simply the pooling of funds from numerous investors (sometimes referred to as “equity partners”) to invest in one more real estate projects. These funds can be used to acquire a property in its entirety, or they can be used as an equity contribution to the project in addition to a commercial mortgage, which would fund the majority of the projects costs.
What is multi-family commercial syndication?
Syndication is where a number of investors join together to purchase a real estate property. In our case, we would offer a high quality Class A investment property, like an apartment complex, mixed-use building and commercial office building.
These investments are passive because the management company performs the necessary day-to-day decisions, while the investors sit back and collect their share of the rental income and profits at sale, usually in 3-5 years.
During the “holding period,” the property’s income from tenants is distributed as a “preferred return.” (A preferred return is paid to investors before the sponsor is paid anything.)
Upon sale of the asset, the profit is split between the investors and the sponsor.
In a nutshell, syndications are a “hands-off,” passive way for real estate investors to quickly and easily buy high quality properties for less money and excellent returns.
What are the benefits for investors?
- Investors can purchase a large property that hedges against downturns or volatility in the real estate market. Investors usually could not afford to buy these outright on their own.
- There is no investor day-to-day management required.
- We offer easy access to excellent multi-family projects.
- Investor liability is only limited to their original investment amount.
What is the structure of a syndication?
- All deals have a minimum investment required.
- Our deals are only for accredited investor participation.
- As an accredited investor, there are some income and net worth requirements.
- Syndications offer “preferred returns,” which are accrued during the holding period and are paid before all other types of profit sharing.
- Dividends are paid towards these returns from rents accrued from tenants of the property.
- These dividends are tax deferred, paid on a K-1, which has the advantage of depreciation, offsetting income.* Most investors pay little if any taxes on their dividend income!
- Profit sharing occurs at the end of the syndication when the property sells, and after sale expenses and preferred returns are satisfied.
- All remaining profits are split between the sponsor and investors in a predetermined split.
- These profits are taxed as favorable long-term capital gains.
- From a business standpoint, a syndication is generally structured using an LLC. This is done because of the ease and low cost of the formation. Additionally, LLCs can have multiple owners and as a “pass-through” entity; the LLC is not a separate tax entity like a corporation.
It is important to understand all aspects of a syndication in order to make an informed decision towards reaching your diversified investment goals.
Investors’ preferred return (at year’s end) = 8%
Acquisition of building $1,000,000 (no mortgage – investors’ fund total amount)
Net income = $120,000 each year
Split at year end = 50%/50%
Investors’ preferred return – 8% x $1,000,000 = $80,000 (per year)
Net income = $120,000 – $80,000 = $40,000
50% of $40,000 = $20,000
$80,000 + $20,000 = $100,000
Total income for the Year = $100,000 or 10% cash-on-cash return
Plus, investors would still maintain an equity percentage (agreed upon at the start) in the appreciation of the property, so there is still an opportunity to make more money on the back end, once the property is refinanced or sold.
The K-1 tax depreciation advantage can also increase the return.
Investors’ preferred return (at years’ end) = 8%
Initial investment = $100,000
Net income = $14,000 each year
Split at year end = 50%/50%
Investors preferred return – 8% x $100,000 = $8,000 (per year)
Net income = $14,000 – $8,000 = $6,000
50% of $6,000 = $3000
$6,000 + $3000 = $9,000
Total income for the year = $9,000 or 9% cash-on-cash return
Plus, investors would still have an equity percentage (agreed upon at the start) in the appreciation of the property, so there is still an opportunity to make more money on the back end, once the property is refinanced or sold.
The K-1 Tax Depreciation advantage can also increase the return.
*Tax depreciation is the depreciation that can be listed as an expense on a tax return for a given reporting period under the applicable tax laws. It is used to reduce the amount of taxable income. Depreciation is the gradual charging to expense of a fixed asset’s cost over its useful life. You take a depreciation deduction by filing Form 4562 with your tax return.