Today, smart investors know that real estate is one of the absolute best investment vehicles because of the superior returns and relative security of the investment. To help busy professionals invest in real estate there are two main methods to do so passively. Most people choose between the Real Estate Investment Trust (REIT) and the real estate syndication. Both investment vehicles have their benefits and their drawbacks. My goal is to share with you enough information so that you can wisely choose which works best for you and your investment strategy.
“Ninety percent of all millionaires become so through owning real estate. More money has been made in real estate than in all industrial investments combined. The wise young man or wage earner of today invests his money in real estate.” - Andrew Carnegie
What is a REIT?
A Real Estate Investment Trust is a company that owns, operates, or finances income-producing real estate. Similar to mutual funds, REITs, pool the capital of multiple investors making it possible for an individual investor to earn dividends from real estate investments; without having to buy, manage, or finance any of the properties themselves. Many REITs are publicly traded on major security exchanges like the way stocks are traded.
What is a syndication?
Simply put a syndication is a group of persons or concerns who combine to carry out a particular transaction or project. Bruce Peterson, in his book, Syndicating is a B*tch, more clearly defines a syndication for real estate as a group of people coming together to put money into an investment, which will be managed by one person or one small group for the benefit of the larger group.
I am going to analyze 8 specific criteria and pit REITs vs Apartment Syndications against one another to declare a winner. The 8 criteria I will review are: minimum investment, liquidity, tax benefits, returns, diversification, ownership, length of investment, and risk.
One large consideration to make when weighing REITs vs syndications is the minimum accepted investment.
When you are investing in a REIT you are purchasing stock in a company. Most do not have a minimum amount that you need to invest, but they could require you to make purchases in blocks of 10 or 100 shares meaning you can likely start investing with less than $1,000.
Syndications, on the other hand, have a much higher barrier to entry. The amount varies from operator to operator and from deal to deal but typically, the minimum is going to usually be $25,000 or $50,000 but can also be $250,000 or more. Many syndications also require an investor to be certified as accredited which is another barrier to entry.
Because of the low barrier to entry I am going to give this point to REITs.
REIT - 1, Syndication - 0
Because REITs are traded on the open market like stocks, they are more or less immediately liquid. If you find yourself in a situation where you need access to your capital, you can sell the shares you own in a REIT.
Syndications are considered a non-liquid investment meaning once your funds are wired to the operator you should expect your capital to be tied up for the duration of the business plan. Often this can mean you will not receive a return of your equity for 3 to 7 years and sometimes longer. There may be a clause in the operating agreement which outlines the process for you to sell your shares, but it is not as fast or simple as selling your REIT shares.
Because the REIT investment is liquid and as easily traded as a stock, I give this point to REITs.
REIT - 2, Syndication - 0
One of the most powerful tools in the real estate investors tool belt is the tax benefits they can realize. Similarly, as a passive investor, one of the main goals is to try and utilize real estate to minimize your tax liability.
When you invest directly in real estate, including syndications, you are provided several tax advantages unavailable elsewhere. By far the most advantageous benefit is depreciation and especially the accelerated depreciation which was included in the 2017 JOBS act.
REITs can claim the depreciation benefit, but they do so before the dividend payout. There are also no additional tax breaks an investor can use to offset any of their income. Income from REITs is treated as dividend income like a stock or mutual bond because REITs are essentially stocks. Since REITs do not pay taxes at the corporate level, dividends are taxed as ordinary income and investors are taxed as an individual, both of which can lead to a larger tax bill.
Syndications can also benefit from the 1031 exchange which potentially allows an investor to defer the gain on the sale of a property into the future.
Because syndications benefit from both depreciation and the possibility of participating in a 1031 Exchange, I give this point to syndications.
REIT - 2, Syndication - 1
One of the great benefits to passively investing in real estate is the potential for high returns.
Over the last 5 years (October 2015 to October 2020) REITs have averaged a total annual return of 9.0% including dividends and distributions. If you had invested $100,000 in October 2015 then your total cashflow by October 2020 would be about $45,000.
Many syndication operators only consider offerings if the projected IRR is over 15% and some only consider it when the projected IRR is over 20%. On a 5-year investment with a projected IRR of 15% the return would be roughly $87,200. This would be an annualized return of about 13.35%. In some syndications the operator could have an opportunity to refinance the property and return a large portion of an investors original investment before the business plan is fulfilled which would allow an investor to reinvest that capital in another venture.
From a total return perspective, the syndication wins out.
REIT - 2, Syndication - 2
In the media today we are constantly bombarded by hedge fund managers who pound the drum for the diversification of investments.
With REITs you are, by its nature, investing in a diversified portfolio of properties whose goal is to provide a blended return based on risk tolerance. The portfolio should remain free from major value fluctuations because of the diversification.
In a syndication your return is directly tied to the performance of a single asset and if something negative happens in the local market or with the specific property then your returns could possibly be impacted. This risk can be greatly mitigated by carefully vetting the deal sponsor and their team. You can also create your own diversification by investing across multiple deals and sponsors.
Stating a clear winner for diversification is tough because both investment methods have their benefits. For that reason, this is a tie, and the score remains the same.
REIT - 2, Syndication - 2
When you invest in a REIT you are simply purchasing stock in a company that owns real estate the same as purchasing stock in Amazon or Apple.
In a syndication you are pooling your capital with other investors to purchase a specific property at a specific location. You have done your research on the general partners as well as the property and its location. There is transparency in its operation through periodic updates from the asset manager which can include pictures of the property and key performance indicators as the business plan is executed. Another huge win for syndications is that, as an investor, you have direct access to the sponsor. If you have a question you can reach out and you do not have to worry about being bounced around a call center in some other country.
This is another point for syndications.
REIT - 2, Syndication - 3
Length of investment
REITs are typically set up in one of two ways, they can be an open or a closed fund. The open fund is traded on the open market at any point during the lifecycle of the fund. You can invest, receive returns, and pull your money out at any time as it is allowed by the terms of the fund. Most funds offer incentives for staying in longer or penalties for selling earlier. A closed fund has a specific start and, like a syndication, a range for an end.
A syndication usually has loose terms for the length of the investment. The typical deal is structured with an expected duration of 5-7 years but if an operator can return the investors capital in a shorter amount of time and still hit or exceed the return expectation then many exercise the option to do so. I have seen some deals sold just after a year because they received an offer too good to pass up and I have seen some go for 9-10 years. This is dependent on the deal, the operator, and the market.
This is another toss up, both investments can close early if the market conditions warrant and both can run longer than expected. The score remains the same.
REIT - 2, Syndication - 3
All investments carry some level of risk and it is up to each individual investor to determine their tolerance level.
The built-in risk mitigation by REITs is that they are diversified portfolios across many sectors and many markets. Unfortunately, there are some REITs being sold without an SEC registration. This can be a dangerous endeavor and can be indicative of fraudulent behavior. For this reason, the SEC recommends investor to not invest in non-registered REITs. Proper due diligence on the fund and the fund manager is an absolute necessity.
On the other hand, the value of REIT shares is like stocks because they are traded on the open market. For this reason, the value can fluctuate with the same volatility of the stock market which can be a large disadvantage for some investors.
While investing in a single property is not well diversified, an investor can greatly reduce their risk by knowing who is running a deal and who is in charge. If you are confident in the deal sponsor's track record and they have shown a history of profitable syndications it is a good bet, they will continue to perform in future deals. The key here is getting to know, like, and trust the deal sponsor.
For risk I must give a slight edge to syndications. If the level of risk were only about diversification then the REIT would get the point but there is more to risk than that. In my opinion, the ability to get to know who is charge and who is making decisions is far more important for my investments, so I give the point to syndications.
REIT - 2, Syndication - 4
Whether you choose to invest in a REIT or a syndication, that choice is yours and yours alone (or with your spouse/partner) and it depends on what you value. After your due diligence is complete, both investment methods are great ways to enjoy passive income through real estate.
The differences are great enough that careful contemplation should be done as you weigh the pros and cons of each investment before diving in. Like so many things in real estate, the final decision to invest in a REIT vs a syndication depends. It depends on these 8 criteria and more and only you can decide what is best for you and your goals.
You do not need to do one or the other, you can always do both. The low barrier to entry for REITs can be great for someone who is starting their investing career while the higher returns can be great for someone who is more experienced. Investing in both can be yet another way to add diversification to your portfolio!
The one thing I ask before you decide to make this investment is that you perform a full due diligence on the investment and that you completely vet the deal or fund sponsors. This is the best way to reduce your risk and ensure a successful passive investment!
If you are interested in learning more about what a syndication is and how they work, please click here for a previous article I wrote that goes into those details.
If you have any questions or if there are any topics you would like to see covered please reach out to me at Mack@InfiniteFocusCapital.com.