Real estate syndications are an attractive option if you’re thinking about expanding your investment portfolio. You can become a real estate investor and yet not have to deal with the complications of managing a property. Instead, a general partner will do this for you. They also locate suitable properties, negotiate the deals, and may handle financing options.
As a passive investor, you foot a percentage of the capital needed to acquire the real estate. Your return potential is based on the percentage of the property’s capital you contribute. Say you’re one of three passive investors in a commercial building. Each of you has put forward 33% of the funds necessary to buy and maintain the property. Therefore, each of you would potentially earn 33% of the returns according to the deal’s structure.
The deal’s structure refers to the overall percentage of profits that go to the active investor(s) versus the passive investor(s). A deal structure could involve a straight or tiered split. Straight splits are relatively uncomplicated, with a set percentage of profits allocated to the syndicators and silent partners. Tiered splits can involve preferred returns going to the syndicators, with additional profits being split among all investors according to various ratios.
Regardless of the real estate syndication deal’s structure, there is potential to use the profits to fuel further financial success. Typically, your returns will come from renting, refinancing, and selling the property. Let’s take a closer look at how these profits can become your blueprint for achieving your long-term investment goals.
Rental Income Provides Immediate Cash Flow
One of the advantages of real estate syndications is that these investments can provide both short- and long-term cash flows. The short-term cash comes from the rental income a property generates. Whether you’ve invested in a vacation or commercial office property, everyday people or businesses want to use the space.
Your tenants’ rent payments will ideally exceed the property’s operating costs. Hopefully, there will be extra left over to split among the investors in the syndication partnership. The short-term income could go toward funding your lifestyle, or you could reinvest it. You could also take a split approach, designating a portion toward your household budget and some toward your savings.
How you use short-term cash flows will depend on your financial goals. Are you investing in real estate to generate enough passive income to leave your full-time job? Or have you left years ago and want to continue to build wealth? If you’re in the first camp, you’ll want to invest in real syndications with high, steady rental income. Those in the second group may focus on opportunities with higher long-term payout potential.
“For millionaires, investing in real estate has been the most popular way to preserve their wealth,” observes Lifestyle Investing expert Justin Donald. It typically makes a good investment because it tends to appreciate in value. However, real estate is not usually an investment you can turn around and liquidate quickly. Long-term gains typically come from holding the property for five years or more. This makes real estate syndications an attractive opportunity for high net worth investors, who can afford to wait if the result is wealth preservation.
Appreciation in Value Can Build Wealth
As the above discussion suggests, real estate syndication profits also come from long-term cash flows. These are the gains you realize when the property is refinanced or sold. Most of the time, you’ll gain more from selling the property than refinancing. The rate at which properties appreciate varies depending on local market conditions, the economy, and property type.
Historically, however, real estate tends to increase in value over time. For example, nationwide home value averages were up 19.1% in January 2022. At the same time, you can’t always count on what’s happening with real estate values from moment to moment. What matters most is what’s happening in the market when you and your partners are ready to sell.
You’ll need to look at what you paid for the property and the cost of any improvements you’ve made. You’ll also want to consider the current average asking prices for similar properties. Naturally, your long-term ROI will increase if there’s a wider gap between your initial investment and potential sale price. Accumulated equity is where you’ll build long-term wealth, so syndications that don’t involve loans generally have higher potential returns.
It all depends on how much the property could sell for and any outstanding loan balance. Take a six-unit apartment building as an example. You purchase it for $450,000 by putting $300,000 down and taking out a $250,000 loan. The loan balance would cover the remaining purchase cost and allow for a $100,000 remodeling budget.
Five years later, if your market speculation and building improvements pay off, you could sell the apartment building for $850,000. This would garner your syndicate a gain of $300,000 on the property.
You Gain Access to Properties With Less Risk
Another advantage of real estate syndications is access to larger assets with fewer cash flow risks. Those who invest in smaller properties can face higher risks because there aren’t as many tenants involved. When you own and rent out a condo, for example, you can usually only secure one tenant at a time. Once your tenant ends the lease agreement, the property is vacant until you find someone else.
While your property is empty, you lose rental income. Plus, you still have to pay to maintain the unit. You continue getting utility bills and paying the association dues. You don’t know how long the property will sit vacant, either. And there are risks associated with entering into a lease agreement with a delinquent or unreliable tenant.
Real estate syndications can involve properties with hundreds of units. Therefore, you’re able to mitigate risks from vacancies, late payments, and repair costs. If one tenant turns out to be a bad apple, the remainder can make up for it. Likewise, if one unit stays vacant for an extended period, rent still comes in from the others. Less of your investment is on the line.
Certain Expenses Are Tax Deductible
Owing real estate comes with a tax bill. There are property taxes, of course. And there are the taxes on the income you earn from short- and long-term gains. Nonetheless, you can reduce your tax burden if you know how to navigate Uncle Sam’s rules.
Operational expenses are costs you can deduct from your real estate income. These expenses include repairs, routine maintenance projects, and improvements. Say you and your partners decide to recarpet all the rooms in a hotel you’ve invested in. The costs for the carpet and installation labor are expenses you can deduct.
If you hire a property manager to oversee the hotel, this is another tax-deductible expense. So is the interest you pay on the property’s mortgage, if you have one. Yet another expense you can deduct is depreciation. Depreciation accounts for losses in market value plus costs associated with buying and improving real estate.
The IRS will let you deduct a specific percentage from your income for each year you own and rent the property. For example, the annual amount is usually 3.636% for residential rental properties. You can only claim depreciation expenses for the building and not the land it sits on. But it is a tax advantage that comes with investment properties, including syndications.
Drawing Your Blueprint to Success With Real Estate Syndications
Real estate syndication returns can contribute to your wealth-building aspirations. The top advantages are short-term cash flows, long-term profits, fewer financial risks, and tax deductions. Assessing these with every potential syndication investment will help you choose opportunities aligned with your goals. And you can do it all without dealing with the headaches of hands-on property management.