When making important decisions, it’s common to weigh the pros and cons to gain a better understanding of the overall benefits and drawbacks. This approach is particularly helpful when considering real estate syndication investments, as investors have varying levels of experience, knowledge, and risk tolerance. Let’s take a closer look at some of the main advantages and disadvantages associated with syndication investing.
First, let’s define real estate syndication. It is a method where multiple investors pool their funds to invest in large commercial real estate projects. A sponsor, also known as the general partner, contributes their expertise and experience, while the investors, referred to as limited partners, provide the necessary financing in exchange for returns on their investments.
Pros of Investing in Syndications:
- Passive Investment: Syndications offer a truly passive investment opportunity in today’s real estate market. Investors evaluate the sponsor and the deal thoroughly, but their primary role is to provide financial contributions. Once the funds are invested, investors trust the sponsor to manage the investment and patiently wait for returns.
- Passive Income: Syndication deals aim to provide regular financial returns to investors as the property becomes profitable. Investors receive truly passive income through a preferred return, which is a percentage of the initial investment. Additionally, investors can benefit from the residual income generated after preferred returns have been distributed, which further enhances the attractiveness of syndication investments.
- Tax Benefits: Real estate investing focuses on creating positive cash flow and utilizing tax strategies. Syndication deals offer various tax benefits, such as depreciation deductions. Depreciation allows investors to deduct the decrease in property value due to wear and tear over time. Additionally, implementing strategies like cost segregation can accelerate depreciation deductions. Syndication investors also enjoy tax advantages when applying a cash-out refinance strategy or participating in a 1031 exchange.
- Diversification: Diversification is a key benefit of fractional ownership in multiple syndications, providing investors with the opportunity to have a stake in different property types and locations. For instance, an investor can be a partial owner of a self-storage facility in Texas, while also holding a share in an apartment building located in Florida and a mobile home park in Arizona. This diversification spans both geographical locations and asset types, allowing investors to spread their risk and potentially maximize their returns.
- Calculated risk: Syndication investments offer the advantage of calculated risk, allowing investors to assess and manage risks based on various factors such as the sponsor’s experience, market conditions, and the specific deal at hand. Unlike investing in Real Estate Investment Trusts (REITs), where management makes all acquisition decisions and investors have no control over the projects their money is allocated to, syndication investors have the opportunity to choose the properties they invest in, granting them some level of control over property acquisitions that align with their investment strategy. Additionally, risk in syndication is spread across a large group of investors, minimizing potential individual losses and providing a sense of security.
Cons of Investing via Syndications:
- Lack of Control: Investors must understand that they have limited control once they enter syndication. They choose to work with a specific sponsor, but they are not involved in day-to-day operations or decision-making. While this lack of control may be acceptable for some, it can be a significant drawback for others.
- Lack of Liquidity: Syndication investments are illiquid until the property is sold and profits are distributed. Exiting syndication early can be challenging, and any potential sale may be subject to discounts. It’s advisable not to invest a significant portion of cash into a single deal due to this lack of liquidity.
- Holding Time: The duration of a syndication deal can vary based on the investment strategy and market conditions. Although sponsors provide anticipated timelines, external factors may impact the deal’s accuracy. Investors should be prepared for potential delays in recouping their investments, which can disrupt future investment plans.
These pros and cons should serve as a guide when evaluating syndication opportunities. While investors may have limited control, being well-prepared enables them to make informed decisions with due diligence. The combination of financial benefits and the ability to assess investment security based on the sponsor’s track record makes syndications an attractive investment option for individuals with diverse financial objectives and risk tolerances.
