We are at the age in which people have increasingly become financially savvy in such a way that we get to talk about passive income now more than ever. The generations before us were fairly contented with the income they get from the usual 9–5 job, and rightly so because money had more value then than it has at present. Nowadays, you just can’t live with one source of income alone and expect to be financially free right away.
Hence, passive income comes into play. Passive is defined as something that happens without your direct participation. Income is, well, money derived from investments, work, or labor.
When we talk about passive income, what’s the first thing that comes to your mind? Is it effortless income? Income that goes directly into your bank account without you lifting a single finger? If those are your definitions of a passive income, then you belong to most of the population.
However, our definition of passive income is different. The notion that passive income requires no effort is dreamy at best. Let’s take income through dividends as an example. You can argue that to earn it, you won’t have to do anything; but in the first place, you must have the capital to earn interest as dividends.
Hence, passive income does not equate to effortless income. Nothing is free. Every form of passive income requires an initial investment in terms of time, capital, or effort. However, passive income differs from traditional income because, with passive income, you only have to spend time to set it up during the initial phase and leave it running once it’s set up, and it may be minimal time. So passive income is not directly tied to your time.
In traditional 9–5 jobs, you have to spend a uniform 8 hours per day 5 days a week to earn your salary. However, in passive income, time is typically necessary during the establishment only, and minimally after that.
With traditional income, your earnings are affected or interrupted if you take some time off. With passive income, a system is in place; thus, the benefits continue to pour regardless of whether you participate or not. Investing in passive real estate is the perfect example.
Passive real estate is a type of investing wherein you invest in other people’s deals through syndication. Syndications are managed by professionals. They are in the business of buying and selling properties and almost everything in between. They sometimes need outside capital to be able to expand, and that’s where you come in.
In this scenario, the large amount of work required in traditional methods of investing in real estate is reduced.
Although syndications are attractive, you have to take note that your first goal in investing is to protect your capital; thus, performing proper due diligence upfront is extremely important. Once this assessment is done and all goes well, you can just expect the investment to bear fruits soon.
This act of strategically using your available resources to generate a high amount of income is technically called leverage.
What Is Leverage?
In your science class in second or third grade, you may have learned that if you’re having trouble lifting something heavy, using a lever may be able to do the trick.
When you’re having a challenge in buying something with your own available resources, you use leverage. This concept is not new, and you probably have done this before. When you bought a house, you borrow from a bank so you only put up a 20% down payment instead of paying the full price of the house. In this scenario, the bank acted as your leverage (putting up the 80% remaining balance in exchange for the house in case of default).
How Leverage Is Applied in Real Estate
In real estate, leverage can be in different forms. The first, of course, is the example earlier regarding money or capital.
Let’s say you have $100,000. You can choose to use that as a down payment for a $500,000 property and earn income from that one property. That’s a great idea, right? Sure! But going through this route means your possible income is tied to that one property. What happens if it doesn’t pan out as planned?
This is where you can use your capital as leverage one step further. You can use the same investment capital of $100,000 as part of a syndicate. Syndications pool money from different investors.
Your initial $100,000 will have more purchasing power once pooled together with other investments pledges. That means your money can go toward a larger, more profitable deal than you could afford alone.
Financial strength is the second form of leverage that we’d like to discuss. Financial strength can be briefly described as how sound your inflow and outflow of cash are, namely your balance sheets, when getting into investments.
Think of it as your credit score but from a business perspective. When you undertake a real estate project on your own, you bear the necessary expenses and possible risks out of your own pocket. Again, if the deal doesn’t work out, you will bear the brunt of the damage.
However, if you invest in pooled investments such as syndications, you don’t have to worry about things such as balance sheets and financial health because banks look at the balance sheet of the company managing the syndications and not your own.
Why is participating in pooled investments crucial? First, doing so allows for a large room for expansion. Usually, the larger the syndication is, the sounder its position is. Large syndications have advantageous access to capital. Therefore, banks are inclined to further grant them loans, thereby allowing these companies to invest in other properties, and the cycle goes on.
At this juncture, you probably get the idea how joining a syndication might be in your best interest compared to getting in on your own. Another thing you can leverage by joining a syndication is their knowledge and experience.
How long does it take for one to master something? Let’s use physicians as an example. Before they acquire their license and become consultants, they have to go through 10 years of education. Similarly, no one becomes a real estate expert overnight. It takes years and years of experience to become one.
By investing in a syndication, you can have access to the company’s vast amount of knowledge and experience without having to go through all the process yourself. This situation is perfect for (1) those who are just getting started because you don’t have to devote much of your precious time learning the ropes because doing so may result in missing out on lots of opportunities and (2) those who don’t want to be bothered about the intricacies of real estate investing. They can just simply put their trust in the company (after due diligence, of course), and let the money run the investment for them.
Usually, a syndication already has a team of experts who are knowledgeable when it comes to spotting the best real estate deals in the market. This built-out team is another aspect you can leverage on. Imagine having access to a team of specialists who can give you sound business advice. This team also has the technical knowledge on how to make each property deal profitable consistently. The best part is you don’t have to build this team from scratch!
Last, but certainly not least because it is possibly the most important, is time. Building a profitable real estate portfolio entails mind-wracking effort and a huge amount of time. That is time that you may not have or may be better spent elsewhere (such as with the ones you love or with self-improvement activities).
When investing in passive real estate projects, you’re leveraging the limited time that you have. You may invest time upfront (during due diligence), but compared to the years of passive income a good investment can bring, that time is well worth it.
Instead of doing everything firsthand, that is, trading time for money, you will only spend a small amount of time for great, long-term benefits, like hanging out with family, friends, traveling, or just enjoying life in general.
You can argue that building a passive income should be worth your time, and you’re correct. Between working hard and working smart, why not choose the latter? If you can take advantage of a vehicle that can bring you to your destination (that is, financial freedom) quickly, why not choose that?
Conclusion
Leverage is a powerful tool. If you learn to use leverage together with passive income and real estate investments, you will become a sophisticated and efficient investor. Most importantly, you can achieve your financial goals quickly, thereby having time to spend on other important things in life.
At the end of the day, our ultimate goal isn’t simply to make a great investment but to make an investment that will allow us to live the life we want and to have the time to spend with the people who are special to us.
Maybe you realize you want to invest passively in real estate, but you’re not sure which is better for you – to invest in multifamily (through a syndication) or an REIT.
This article helps you understand the difference between passive investment in multifamily versus passive investment in REIT, and aims to help you make an informed decision.
What is REIT?
A Real Estate Investment Trust, or REIT, is a company that has a wide range of revenue-generating properties. It involves a pool of passive shareholders, who receive subsequent dividends on their investment. A REIT can be any registered corporation or association that invests in real estate intending to generate revenue. It treats an investment as buying stock.
What is Multifamily Property Syndication?
A multifamily property refers to a residential property with more than one unit of accommodation, such as apartment buildings, townhouses, duplex properties, and condos. Syndication offers multiple individuals a wonderful passive investment opportunity that can generate substantial revenue over time.
Comparing REIT with Multifamily Property Investment
Now that you have a basic idea of these two types of passive real estate investment that you can venture into, let’s see which one is better for you. There are several factors on which you can weigh the two types of investments against each other.
Minimum Investment
When it comes to REITs, there is no cap on the minimum or maximum amount that you can invest, which makes it a much more flexible form of passive investment than multifamily properties. But there may be a rule where you can only buy shares in blocks of 10 or 50, and this is predetermined by the company you are buying real estate stocks from. This means that you can start from as low as $1,000.
On the other hand, when you invest in multifamily property, usually there is a minimum investment. For example, some syndications require at least $50,000 as an initial investment. Plus, it may also ask for higher subsequent investments, which is not the case when you invest with REITs. This makes them much more flexible in terms of the minimum investment requirement.
Returns
One factor in which multifamily investments take the lead over REITs is the rate of return. With REITs, for the past five years the average annualized REIT return is under 6%, which is better than having it sit in a savings account, but could be better.
On the other hand, most multifamily property investments can bring you excellent yields of 9% and greater. Some properties have even brought wonderful returns of over 15%.
Liquidity
Liquidity refers to the ease with which an asset can be converted to cash, and while real estate investments don’t normally offer too much liquidity, you can actually experience it when you invest in REITsbecause you can trade them like a standard stock. If you have invested your capital recently but need to withdraw it for an emergency, you can do it quicker than you can with an investment directly in a multifamily property.
In a multifamily property syndication, your investment is locked in with the other investors, at least until the hold period is underway. However, there is a workaround to this problem and you can add it to your partnership or association agreement, which can help you get your capital amount back in a reasonable time.
Taxation
When it comes to taxes, whether you invest in REITs or a multifamily property syndication, there are depreciation benefits. With REITs, there is no way for you to defer the taxes on the profit that comes from the sale of your stocks.
On the other hand, investing in multifamily properties allows you to defer the taxes if you reinvest in another project by taking advantage of the 1031 exchange.
Diversification of Portfolio
No matter what investment you make, your financial advisors may have always advised you to invest in a diversified portfolio or to “never put all your eggs in one basket”. This is a sound strategy that you can also apply to passive real estate investments.
In REITs, your investment is distributed between an entire portfolio of properties, and their individual financial performance combines to bring you a safe and significant return.
On the contrary, with a multifamily syndication, your investment is tied to one multifamily property, and its financial performance constitutes the amount you get as a return on investment. But you can still diversify by investing with multiple syndicators, which is a viable option.
Risks
The risks also need to be assessed when you compare REITs with multifamily syndications. Since REITs are based on the buying and selling of stocks, the value of your investment may fall as the market value of the stocks goes down. This can present a risk.
Multifamily properties are typically a much lower risk, since they give you partial ownership in a physical asset, and the chances of the property value falling drastically are very unlikely.
Ease of Entry
The ease with which you can start investing in REITs or multifamily properties is also a deciding factor for some. As mentioned above, REITs have a smaller minimum investment requirement, and also don’t require any form of accreditation or validation about your financial condition or ability to invest.
However, when it comes to multifamily properties, depending on the route the company that you invest in is taking, they may require you to be accredited. If so, they may ask you to provide an income statement that shows you have an annual income of at least $200,000 to be able to invest in a property.
Ownership
When you invest in a REIT, you own stocks of the real estate portfolio that you invest in, which is somewhat abstract, and you don’t get your name on any property. This also means that you don’t reap the full benefits of the financial performance of that portfolio.
On the other hand, investing in a single multifamily property allows you to attain ownership of the asset. You have partial ownership of a real property that you can physically see. You can see how the investment progresses as the company you’ve invested with implements their plan to improve profitability. Your profits are tied to tangible things – improvements made, rents increased, occupancy rates, etc., which you can track.
Reachability
Reachability refers to the ease of access that you have with the people who manage your investment. With REITs, it can be quite difficult for you to reach out to fund managers or investment consultants. Rather, you will be directed to a manager or representative.
This is an area where investing in multifamily properties excels, because you have direct access to the general partner or sponsor you’ve invested with – the person managing your investment. You don’t have to go through some complicated process to speak to a real human, only to find out they can’t really do anything for you. You can pick up the phone and call the general partner / sponsor or send them an email directly.
Key Takeaway
Both REITs and multifamily syndications allow you to make sound passive investments, and they are generally more attractive than other types of investment. Do a little homework to determine what’s the best fit for you and then invest with a company you trust.
If you’re interested in high returns and great tax benefits, we would love to speak to you about investing passively in one of our upcoming multifamily property syndications. Contact us today to get started!
While many people tend to dread tax season each year, those who are proactive with multifamily real estate investing (specifically real estate syndications) are likely excited about it. That is because there are tons of multifamily syndication tax benefits and incentives that arise for passive investors that enable them to gain max profits from this dynamic stream.
In short, investing in multifamily syndications offers much more than a lucrative passive income stream; it is also one of the most tax-favoured investing avenues.
Before we dive into these benefits, here’s a quick disclaimer. Since we’re not tax professionals,the information in this article is from our experience and understanding only. You should speak to a qualified CPA for details and advice about your specific situation. This article should not be construed as tax advice.
Below are the leading multifamily syndication tax benefits that every investor should be knowledgeable of so they can be fully prepared to capitalize on their opportunities.
Depreciation
Depreciation is a huge tax deduction and is often overlooked. In tax terms, depreciation is an accounting method that calculates the cost of tangible business assets’ declined value over time and allows the owner to write it off. The most common form is called straight-line depreciation, which is a system that takes the annual deduction cost of items and divides it by its useful life. As for real estate, the IRS states that the useful life of residential properties is 27.5 years, and 39 years for commercial.
For example, if you have a property valued at $1 million. You can divide that by 27.5 years, which comes out to about $36K. That means that you can deduct $36K in depreciation each year for up to 27.5 years. The reason this is such a significant deal is because, hypothetically, let’s say you make about $10K profit in a year on your invested property. In such a case, you do not have to pay taxes on that $10K and you get to keep it completely tax-free. On paper it may look like you lost $26K, but in reality, you earned $10K.
Cost Segregation and Bonus Depreciation
Cost segregation is very similar to depreciation but accelerated. Cost segregation takes into account that some parts of the property depreciate much faster than 27.5 years. For example, flooring such as carpet has a much shorter life span.
You can have an engineer do a cost-segregation study where they evaluate the individual elements of a property and calculate the life span. This can allow you to depreciate many items over a much shorter time frame, for example, 5-15 years.
What’s the benefit of taking the depreciation deduction at a must faster rate?
You see, the hold time for most multifamily real estate syndications is about 5 years. That means that you may only get 5 years of those depreciation benefits listed above (5 out of 27.5 years), meaning you’d miss out on over 22 years of depreciation benefits.
So, if you have something that depreciates in 5 years instead of 27.5 years, and you only hold that property for 5 years, you may end up deducting the full depreciation amount for that part of the property. By being able to take a larger depreciation deduction earlier, you get more of the depreciation benefits and make a higher profit.
When a property is sold, capital gains tax is owed, and in some cases, deprecation recapture.
Another depreciation option, which is a result of new tax bills, is “bonus depreciation”, which gives the option to depreciate the entire value of a property in the first year. This way you can carry forward losses until the property is sold, which can offset capital gains.
1031 Exchange Tax
If you do not want to embark on capital gains just yet, a 1031 exchange would be an ideal alternative. A 1031 exchange is what allows investors to sell one investment property, and in an allocated amount of time, swap it for another. Essentially, instead of having the gains be rolled out to you, you would have the ability to invest them in a new real estate syndication. That all equates to you not needing to owe any capital gains tax to the IRS when the first investment property is sold. Note that not every real estate syndication offers a 1031 exchange outlet, but it is something to be mindful of and ask about during your venture.
Refinance Cash-Outs
It is not uncommon for multifamily real estate investors to invest in a property for about 1-3 years and then refinance the property after the value has increased due to renovations and rent increases. Doing this does not come with any tax obligations because it is not a taxable event when you return part of the investor’s equity.
Other tax benefits
Rental income is not subject to social security tax or Medicare tax, so that is a benefit as well.
Summary – The Tax Code Favors Real Estate Investors
In summary, multifamily real estate syndications can be a great investment that optimizes tax breaks and has been a proven channel to grow and preserve wealth. With the various multifamily syndication tax benefits, combined with typically excellent returns, it is clear how investing in real estate syndications can add up to significant short and long-term gains.
All in all, for any investor looking to convert their hard-earned capital to passive income in one of the most tax-friendly ways, then multifamily real estate syndication is certainly a prime avenue to think about.
Can I Invest in Multifamily Real Estate Syndications Using Funds From My IRA?
Yes you can, by transferring the funds from your IRA into a self-directed IRA. This article will explain how that works and how doing so will increase your investment options, allowing you to use those funds to invest in a multifamily real estate syndication.
Why would you want to do that? Regardless of the amount of money that you have been able to save, the gold standard is to have those savings tied to investments that are both stable and produce strong returns.
The main advantage of investing in a real estate syndication is the return. If you have money wrapped up in an IRA account that’s earning only 1-2% a year, you may wish to look into setting up a self-directed IRA (sometimes called a checkbook IRA) to allow you to invest in real estate.
Why A Self-Directed IRA?
Only the self-directed IRA can be set up to invest in real estate syndications. The tax code allows for this, and the key is to place your self-directed IRA account with a custodian that will accommodate investments for multifamily syndication. An IRA custodian is the financial institution responsible for record-keeping and IRS reporting requirements.
Multifamily, value-add syndications are a great type of investment for a self-directed IRA, they generate passive returns and then are liquidated for a bottom-line profit. That profit is usually taxed as a capital gain, but if it happens within your IRA, you won’t pay taxes until you actually retire and begin to withdraw income from that IRA.
You have to wait until you reach age 59½ to withdraw your funds, and the withdrawal will be included as ordinary income on your tax return. In the meantime, you have the right to invest in a real estate syndication deal or multiple deals, while maintaining the tax-deferral status of the IRA.
What is a Self-Directed IRA?
An IRA is an individual retirement account that allows the account owner to direct the account trustee to roll over all or part of their IRA and make investments in alternative assets such as real estate. Rolling the funds over from your IRA into a self-directed IRA gives you control of your own financial future. You control the investments instead of the company that handles your IRA.
With a self-directed IRA, you can create a Limited Liability Corporation, (LLC), and that entity invests in and holds your IRA funds. As the LLC General Manager, YOU can now handle the investing.
Tax Implications
Like a traditional IRA account, a self-directed IRA allows owners to defer taxes until retirement age.
When using a self-directed IRA for purchasing real estate, you can’t claim depreciation on property held within it. Also, there may not be a way to take advantage of operating losses as well.
Another thing to consider is income. Most people consider the income that is produced from their IRA as investment income. Occasionally, the IRS may categorize it as business income instead.
If it does, then that income can be subject to something called UBIT, or “Unrelated Business Income Tax” which can be taxed at rates as high as 39.6%.
UDFI, or “unrelated debt-financed income,” is primarily used in the context of IRA investments that generate income derived from debt-financed real estate or other property owned by the IRA. The UDFI is subject to UBIT.
You may be liable to this tax if your IRA participates in buying and selling a significant number of real estate properties in at least half of a year.
The best way to be certain about whether you owe UBIT is to talk with your tax professional.
A Roth Self-Directed IRA
You will eventually have to pay taxes on the tax-deferred income in your IRA when you take cash out. An alternative is to choose a Roth SDIRA. With a Roth SDIRA, there is no up-front tax break, it uses after-tax contributions, but you don’t have to pay tax on withdrawals in retirement. Your earnings will grow tax-free and when you take distributions from the account in retirement, you won’t owe any taxes on them.
Solo 401k
Making the choice between setting up a self-directed IRA or a solo 401(k) is an important decision. You need to consider all of the differences.
To be eligible to benefit for the Solo 401k Plan, investors must meet two eligibility requirements:
The presence of self-employment activity.
The absence of full-time employees.
If there will be debt on real estate investments you are much better off choosing a solo 401(k) over an IRA as solo 401(k)s are exempt from UDFI tax on leveraged real estate.
The Importance of A Good CPA
It is vitally important that you work with a good Certified Public Accountant (CPA) who understands the legal side of real estate investing. Getting the right tax advice is essential in making the best use of your retirement funds.
Setting up Your Self-Directed IRA
A Self-Directed IRA LLC may be funded by a transfer from another IRA account or through a Self-Directed IRA Rollover from an eligible defined contribution plan. Eligible defined contribution plans include qualified 401(k) retirement plans.
With the transfer, you do not receive the IRA assets. The transaction is carried out between the two financial institutions. In order for the IRA transfer to be tax-free and penalty-free, the IRA holder must not receive the IRA funds in a transfer. Rather, the check must be made payable to the new IRA custodian.
You can then instruct the new custodian that you select to request the transfer of IRA assets from your existing IRA custodian in a tax-free and penalty-free IRA transfer.
Once the IRA funds are either transferred to the new custodian, the new custodian will be able to invest the IRA assets into the new IRA LLC “checkbook control” structure.
Once the funds have been transferred to the new IRA LLC, you, as manager of the IRA LLC, would have “checkbook control” over your retirement funds so you can make traditional as well as non-traditional investments tax-free and penalty-free.
It is important to choose the right custodian, consider their experience, fees, and areas of expertise, and check out their rating with the Better Business Bureau.
A Word Of Caution
According to the Securities and Exchange Commission (SEC), you need to guard against criminals attempting to commit fraud against self-directed IRA account holders. Protect Yourself by:
Not taking unsolicited investment offers.
Asking lots of questions – be suspicious if these are not welcomed.
Being wary of those promising unrealistic returns on your investment.
Why Multifamily Syndications?
It’s true that you have many options when it comes to investing. Some high-risk investments yield a high rate of return. Then there are safer investments but the rate of return is low. Multifamily real estate combines low-risk with generous returns.
The most common use of self-directed IRA funds is an investment in syndicated real estate deals. A syndication is a group of investors pooling their funds for investment. The investment is typically larger than one the investor could accomplish on their own. These real estate investments are professionally managed and you are not required to do any of the legwork.
Investment returns & distributions are returned to the self-directed IRA as cash. Accumulated cash distributions can later be invested in another investment.
Pros and Cons
From what we have discussed so far you can see that using a self-directed IRA to invest in residential or commercial real estate which is not allowed through regular IRAs has pros and cons.
Let’s get specific and list them, starting with the positives.
Pros
Tax-free or tax-deferred account growth – With a self-directed IRA, you can invest in real estate as you normally would, but your gains are tax-free or tax-deferred, depending on the type of IRA account you use. There aren’t many other opportunities to invest in real estate in a tax-sheltered way.
Control over your investments – As the owner of the account, you get to decide what to do with your investments. It’s possible to create a limited liability company (LLC) for your SDIRA. Doing this gives you checkbook control.
Investing through an LLC can also provide other liability protections, though you should consult with a tax professional to better understand the LLC laws in your state.
Potential For Higher Returns – A self-directed IRA real estate investment has the potential to earn a higher ROI than investing with traditional securities.
Cons
Fees – The Internal Revenue Service requires that either a qualified trustee or a custodian hold assets on behalf of the IRA owner. This means costs that can eat up into your profits if you’re not careful.
Complex Regulations – Your SDIRA could be disqualified as a tax-advantaged account if you don’t follow all of the IRS regulations carefully.
UDFI – if your IRA owns property that has been financed, some of the income from the property is considered unrelated debt-financing income (UDFI), which is subject to taxes.
Are Self-Directed IRAs For You?
Those investors who choose to use self-directed IRAs do so to seek higher returns and greater diversification.
Self-directed IRAs may not be for everybody but if you want to take advantage of higher yields and less volatility you should seriously consider the possibility.
If you are creative and knowledgeable enough to use self-directed IRAs in the right way it could be a great option for you and your investment future.
Passive investment opportunities in real estate syndication can provide outstanding ways to generate attractive financial returns. In the very best scenarios, you and your fellow passive investors can earn consistent income with few of the headaches that come from other types of investments. Simply put, these passive investment opportunities offer great chances tobuild real wealth.
That being said, getting to these ideal scenarios doesn’t automatically happen. They require some diligence from your end. Because of this, it is worthwhile to explore some of the things that you should consider when analyzing a passive investment opportunity. By doing your homework now, you can avoid mistakes and find the best passive investment opportunity for you.
First Principles in Analyzing Passive Investment Opportunities
To be clear, these are several first principles that you should follow when considering a syndication opportunity. They aren’t the only things that you should consider. Generally speaking, by being measured, reserved, and rational, you will make great decisions.
One of the first things that you can do is research specific asset classes and markets. There are plenty of multifamily asset class types, ranging from new upscale luxury buildings to 40-year-old buildings that were built for low-income residents. Each asset class provides its challenges and opportunities, so you’ll need to evaluate your risk profile before proceeding. The same is true of markets. You may have some more familiarity with a local market, but there may be greater opportunities elsewhere. Make sure that you are soberly thinking about your opportunity set before proceeding.
As with any type of investment, another one of the first things that you should do is research your potential partners. Naturally, much of the attention will veer toward the sponsor or general partner. This is for good reason, as the sponsor is active in the day-to-day operations of the syndicate. But beyond the sponsor’s experience and background, you will also want to evaluate the relevant property management company, commercial real estate broker, and any real estate and securities attorneys. See how they evaluate potential deals and how quickly they can close potential deals.
It takes a team to create and run a real estate syndicate, so you want to have a good understanding of your new partners. Beyond doing simple Internet research, don’t hesitate to make some reference checks. Speak with other limited partners who have worked with any of these individuals or entities. Completing this primary research will give you the confidence that your partners will maximize the value of your investment.
From there, you will need to closely scrutinize your potential returns. After all, much of your interest in real estate syndicates likely comes from the fact that you can earn outsized returns. As a limited partner, you can be compensated in several different ways, including a preferred return, a profit split, or supplemental loan proceeds. Preferred returns and profit splits are more common, but you’ll want to read the fine print for more. For instance, you may discover that your preferred return is 8% before the general partner is paid. Or you may discover an unequal profit split in your favor after that preferred return. Make sure you understand your potential profit before entering the syndicate.
Finally, you will want to examine the opportunity’s underlying fee structure. Sponsors, real estate attorneys, property management companies, and others provide significant value to the overall syndicate. Because of this, they receive compensation for completing their work. This compensation may impact your overall return on the property. For instance, your sponsor may take a profit split on an ongoing basis or upon the sale of your property. Your property manager may take a 10% management fee on the collected income. Whatever the case may be, have a good understanding of how your partners are being compensated. No fee structure, in and of itself, is good or bad. It depends on the value you are getting from your partners and how those fees impact your total returns.
Get Started Today
Whether you are new to passive investment opportunities or have been making investments for some time, it is critical to keep these first principles in mind. They can both help you find attractive investment opportunities and avoid those that are less attractive to your financial goals. Ultimately, the best time to get started is today.
Are you searching for the bestpassive investment opportunities? Passive multifamily real estate investing is a tried-and-true method that lets you take advantage of real estate’s stability without the direct responsibilities of being a landlord.Steady cash flow and tax advantages are just a few of the great things about investing passively!
However, not all investments are equal, and many investors don’t know how to evaluate the quality of a passive investment opportunity.
When looking at properties, many people tend to only look at returns – but there are other parts to the puzzle! Here is our top advice for finding passive investment opportunities that will serve you well for years to come.
Know how to mitigate risk
Real estate is generally considered to be a low-risk investment in most cases. Property values can generally be trusted to increase year after year, and multifamily has historically performed better than many other asset classes during recessions.
That being said, no investment is devoid of risk, even if you’re working with a company that does everything it can to protect investors. So, what are the specific risks of the deal that you’re considering? And what is the operator of the deal doing to mitigate the risks?
There are different styles of underwriting, from aggressive to conservative. It’s often a good idea to work with a company that underwrites its deals conservatively. This gives you a margin of safety so that you can make more realistic plans. It’s smart to be conservative when it comes to debt structure, income projections, and budgeting for capital expenditures. This is far better than working with a company that will overpromise and underdeliver.
Understand cap rates
When looking for conservative underwriting, the capitalization rate – or cap rate – is one of the most important numbers to look at. This number helps to determine the value of the multifamily real estate property. Cap rate is calculated by dividing the property’s net operating income by its current market value.
The cap rate will depend heavily on how the market is doing, so it is subject to change over time. In many markets, the cap rate will be around 6%. Most likely, the cap rate will hold steady, but good financial projections will usually build in a margin of safety by projecting slightly lower cap rates in the future. Be wary of financial projections that show a steady cap rate 5 years in the future. While this is likely, it should not be promised. And, be especially wary if the cap rate is even lower in the financial projections.
Ask about reserves, cash flow management, and rent growth
Always make sure that there will be reserves at closing. In other words, make sure that there’s plenty of cash left at closing for renovation costs and a “safety net” for any unforeseen circumstances.
Ask about cash flow management and be sure that the company operating the deal operates above the line. In other words, ensure that they calculate the net operating income with plenty of room to take money out without hurting the bottom line. Keep in mind that this will reduce returns on paper, but it’s actually a good thing! You want to be wary of returns that seem too high to be true.
Also inquire about rent growth. When you’re investing in multifamily, the goal is to increase profit over time by improving the property and raising rental rates accordingly. Rent growth is definitely something that you’ll want to count on. Just be aware that it will take time. There’s no way to promise rent growth within the first year, because that would involve kicking out all the tenants and renovating the building instantaneously… which is clearly not realistic! Expect rent bumps to start no earlier than year two or three.
Work with a trusted syndicator
If you have already found a company that you want to work with, does the operator or syndicator of the deal have the chops for property management and passive investing? It takes a team of knowledgeable people to manage properties and make solid investment decisions. Make sure to find a team you can rely on with confidence!
Ask the syndicator questions. What’s their strategy for picking a good market, finding great deals, and operating multifamily properties to their highest potential? Will they conduct thorough due diligence? Do they take a scientific approach to real estate investing? Do they have good references from mentors or from real investors in their syndication? How will they work to protect their investors?
A trustworthy operator or syndicator will often put their money where their mouth is by passively investing in their own deals. You may want to consider working with someone who trusts their process well enough to invest in it themselves.
If the company is a large group of partners or a joint venture, then you may want to find out who has the bulk of the decision-making power in the group and determine whether they have a good track record. Property managers, attorneys, and board members are all important parts of the team.
And lastly, it is very important that the sponsor is willing to guide you through the passive investing process and answer all your questions with transparency. This will help you decide whether this is the right deal for your specific needs. If you’re putting your hard-earned money into the venture, you deserve to understand the process fully.
Go forward with confidence!
As you can see, the best passive investment opportunities will always come down to the syndicator of the deal. There’s no substitute for finding a good syndicator who will answer all your questions, make smart and educated decisions, and work to protect their investors.
A little bit of knowledge goes a long way when it comes to selecting a long-term partnership with a multifamily syndicator. When you’re prepared to ask questions and delve into the financials, you can confidently select the investment that is right for you!
