In What Ways Are REITs and Real Estate Syndications Different
If you’ve decided that real estate investing seems interesting, but you’d rather avoid becoming a landlord, you’re not alone. Fixing toilet emergencies at 3 am isn’t appealing to most people, myself included.
Or maybe you’re trying to figure out the best ratio of homes versus the cost of a property management firm so you can optimize for the best margins. You’re expecting that with rental property management in place, you can break through to the lifestyle you dream of - the ability to enjoy passive income and less pressure from your career.
I hate to break it to you, but even with rental property management in place, you’re still on the hook for tenant requests, repairs, and decisions having to do with maintaining and improving the property.
If you’re searching for genuine passive real estate investment opportunities, a simple Google search will turn up REITs (real estate investment trusts), which are easy to access, just like stocks.
What’s A REIT… In Plain English
A real estate investment trust is formed when a company purchases and invests in commercial real estate properties. When investing in a REIT, you’re buying stock in a company that holds those commercial real estate investments.
So, it would be easy to assume, if you invest in an apartment REIT, it’s the same as investing directly in an apartment building.
That couldn’t be further from the truth.
If you’re looking for direct yet limited ownership of real estate assets, syndications are a more appropriate option. The trouble is, most people don’t understand the differences between real estate investment trusts versus real estate syndications. But not you; you’re here doing the research and spending your coffee (snack?) break with me.
So, in this article, you’ll learn about the seven most significant differences between REITs and real estate syndications:
Difference #1: Number of Assets
A REIT is a company that holds a portfolio of properties across multiple markets in an asset class, which could mean significant diversification for investors. For example, individual REITs are available for apartment buildings, shopping malls, office buildings, elderly care, etc.
On the flip side, with real estate syndications, you invest in a single property in a single market. You know the exact location, the number of units, the financials specific to that property, and the business plan for your investment.
Difference #2: Ownership
When investing in a REIT, you purchase shares in the company that owns the real estate assets.
When you invest in a real estate syndication, you and others contribute directly to the purchase of a specific property through the entity (usually an LLC) that holds the asset.
Difference #3: Access to Invest
Most REITs are listed on major stock exchanges, and you may invest in them directly, through mutual funds, or via exchange-traded funds, quickly and easily online.
On the other hand, real estate syndications are often under an SEC regulation that disallows public advertising, which makes them difficult to find without knowing the sponsor or other passive investors. An additional existing hurdle is that many syndications are only open to accredited investors.
Even once you have obtained a connection, become accredited, and found a deal, you should allow several weeks to review the investment opportunity, sign the legal documents, and send in your funds.
Difference #4: Investment Minimums
When you invest in a REIT, you are purchasing shares on the public exchange, some of which can be just a few bucks. Thus, the monetary barrier to entry is low.
Alternatively, syndications have higher minimum investments, often $50,000 or more. Though they can range from $10,000 up to $100,000 or more, real estate syndication investments require significantly higher capital than REITs.
Difference #5: Liquidity
At any time, you can buy or sell shares of your REIT, and your money is liquid.
However, real estate syndications are accompanied by a business plan that often defines holding the asset for a certain amount of time (usually five years or more), during which your money is locked in.
Difference #6: Tax Benefits
One of the most significant benefits of investing in real estate syndications versus REITs is tax savings. When you invest directly in a property (real estate syndications included), you receive various tax deductions, the main benefit being depreciation (i.e., writing off the value of an asset over time).
In many cases, the depreciation benefits surpass the cash flow distributions in a given year. So, you may show a loss on paper but have positive cash flow. Those paper losses can offset your other income, like that from an employer.
When you invest in a REIT, because you’re investing in the company and not directly in the real estate, you get depreciation benefits, but those are factored in before dividend payouts. There are no tax breaks on top of that, and you can’t use that depreciation to offset any of your other income.
Unfortunately, dividends from REITs are taxed as ordinary income, which can contribute to a larger, rather than smaller, tax bill.
Difference #7: Returns
While returns for any real estate investment can vary wildly, the historical data over the last forty years reflects an average of 12.87 percent per year total returns for exchange-traded U.S. equity REITs. By comparison, stocks averaged 11.64 percent per year over that same period.
This means, on average, if you invested $100,000 in a REIT, you could expect somewhere around $12,870 per year in dividends, which is excellent ROI.
Real estate syndications can potentially offer even higher returns between the cash flow and the profits from the sale of the asset. Again you have to compare each deal’s metrics and make sure it meets your expectations for risk and returns.
As an example, a $100,000 syndication deal with a 5-year hold period and a 20 percent average annual return may make $20,000 per year for five years, or $100,000 (this takes into account both cash flow and profits from the sale), which means your money has the potential to double within five years.
What’s The Difference - Are REITs or Syndications Your Cup Of Tea?
So, which one should you invest in? It ultimately depends upon if the seven differences we went through caught your attention and made you lean one way or the other.
All in all, there’s no one best investment for everyone (but you knew that, right?). Again, it’s entirely dependent upon the goals you expect to achieve through investing in real estate and which path will support you toward them.
If you have just a few thousand dollars to invest and want it to remain liquid so you can access it at any time, REITs may be a great option. However, if you have fifty or one hundred thousand dollars to invest and want direct ownership, the ability to connect with sponsors directly, and are seeking tax benefits, a real estate syndication may be a better fit.
And remember, it doesn’t have to be one or the other. For example, you might begin with REITs and then migrate toward real estate syndications later. Or you might dabble in both to diversify—either way, investing in real estate, whether directly or indirectly, is forward progress.
There are numerous risks with owning physical real estate via private placements including weather and natural disaster risks, interest rate risk, operator and business risks, and overall real estate market volatility which can effect the performance of the investments. Investing in private placement securities entails a high degree of risk, including illiquidity of the investment and loss of principal. Please read the offering document before investing.
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