Over the years, investing in real estate has been one popular strategy people use to make more money. It never gets old; it works every time as long as you know the right way to do it.
Plus, there are about a thousand ways to invest in real estate. This ranges from taking a home mortgage, building a property from scratch, paying for a property upfront, investing in real estate investment trusts (REITs), to investing in real estate syndication – the list is just endless.
While there are many ways to invest in real estate, two methods have been making waves presently: REITs and real estate syndication. There has also been lots of investing in real estate syndication vs REIT debates to determine which method yields better profits.
Well, before you jump into the next argument about which method is best, it doesn’t hurt to gain more knowledge about both methods. This article will do just that – tell you all you need to know about both methods.
What Is Real Estate Syndication?
It isn’t unusual to find out that some people who debate about investing in REITs vs real estate have little or no clue what real estate syndication actually means. What is syndication in real estate? you may ask.
Simple, real estate syndication is more like crowdfunding to invest in real estate. It’s a partnership between two or more investors who combine their skills, capital, and resources to acquire and manage a property they can’t otherwise afford on their own.
Two significant players function together to make most real estate syndication investments work; the syndicator(s) and the passive investors. A real estate syndicator is responsible for handling everything involved in structuring and making the real estate syndication operational.
This involves scouting for excellent properties to invest in, negotiating with the seller, building a business plan, looking for investors to acquire the property, handling asset management, and many more. They handle everything involved in running the partnership to deliver good returns to the passive investors in the partnership.
On the other hand, the passive investor is to provide capital or a portion of it to acquire the property. In return for providing the finances for acquiring such property, they’ll receive ownership shares for the property. This may yield income monthly, quarterly, annually, or even an ROI when such property is sold.
Real Estate Syndication Structure
Real estate syndications are structured to dictate the ownership percentages, how voting rights are established, and the claims to the returns each party has during the project period.
In most cases, syndications are structured with operating agreements; a Limited Liability Company (LLC) agreement, or a Limited Partnership (LP) agreement. In a limited partnership, the syndicator is the General Partner (GP).
The passive investors are the Limited Partners (LP) or simply members. These documents outline how the distribution of returns will be made and other things needed for the smooth running of the project.
There are various structures of real estate syndication deals. Some of them are:
● Straight Split
This is one of the most straightforward syndication structures. In this structure, all the returns the syndication generates; cash flow, capital gains, and even the money made from the property sales are split based on ownership percentages of the limited partner(s) and general partner.
For example, a syndication deal may have a simple split structure of 80/20 (LP/GP) which means that 80 percent of the ROI will go to the limited partner and 20 percent to the general partner.
● Waterfall Structure
The Waterfall structure is another popular real estate syndication structure allowing for an uneven distribution of ROI when certain LP’s returns conditions are met. This structure can be customized, but they generally follow a set of traditional and sequential tiers such as; return of capital, preferred return, GP catch-up, carried interest, and so on.
For example, a waterfall structure may look like this: the first return hurdle is to pay the LP’s a ten percent preferred return; when this goal has been met, the syndication structure is changed to a 70/20 straight split.
This will continue until the 20 percent rate of return threshold is met. When this 20 percent is met, a 50/50 straight split is activated and the profits are equally divided between the LP(s) and the GP in the real estate syndication.
What are REITs?
Real estate investment trusts (REITs) are companies that own, operate and generate income from managing real estate assets. REIT operates on a model like that of mutual funds, it pools the capital of numerous investors. The investors, in turn, earn dividends from real estate dividends. REITs own properties like office buildings, apartment buildings, shopping complexes, and many more.
Types of REITs
● Equity REITs
This REIT owns or manages real estate properties that yield high income. Properties like apartment complexes, office buildings, amongst others.
● Mortgage REITs (mREITs)
Under this type of REIT, the focus is on purchasing income-yielding real estate. The group does this by either buying or originating mortgages and mortgage-backed securities. Thus, generating income from the interest on the investment.
● Private REITs
Private REIT shares don’t trade on national stock exchanges; they are exempted from SEC registration. They’re mostly sold to institutional investors.
● Public Non-listed REITs
This type of REIT is registered with the SEC but is still not traded on the national stock exchange.
Investing in Real Estate Syndication vs. REIT – Major Differences
Investing in REIT is like buying shares in a company. You don’t own and hence have no access to the underlying real estate. All you have are shares in the company that owns the real estate.
On the other hand, when you invest in real estate syndication, you’re investing directly in a property. This means that you and other LPs and GP have direct ownership of the property.
2. Tax Benefits
Investing in real estate means that you’ll enjoy some tax benefits such as tax deductions. Since real estate syndication gives you direct ownership of the property acquired, you tend to enjoy these tax benefits more as compared to REITs.
It’s a known fact that returns for any investment can vary widely and depend on factors like; the people involved, assets, and time. However, there seems to be a significant difference between the returns of both real estate syndication and REIT, with real estate syndication on the higher side.
On average, a REIT investment yields about 12 to 13 percent ROI annually. The ROI for real estate syndications isn’t fixed but is generally higher since all deals are direct and there are fewer parties involved. Even when the real estate market is down, you’re still guaranteed steady returns.
Which One Is the Best to Invest in?
Now, you can see why the investing in REITs vs real estate debate always comes up a lot. They’re very similar yet different. The best one to invest in? That is your call to make since you now know the major differences between both of them. It depends on what you want and what you have.
If you want direct ownership, a higher ROI, and a say about how you want things to be run, then real estate syndication is your best bet. However, if you want to invest in real estate with little or no idea of how your assets are being run and managed, then look into investing in REITs.
The Bottom Line
As an investor, whatever method you choose – investing in REITs vs real estate – is ultimately your choice. However, real estate syndication deals are slightly the best of the two as long as you’re dealing with great real estate syndication companies. They’ll handle everything involved in ensuring your investments yield maximum profits. Remember, you call the shots!