Hi there. The last blog post explained the differences between actively investing in smaller properties and passively investing in larger apartment complexes. This blog post will explain how these passive opportunities are structured and why one may desire to invest in them.

What is passive investing in a real estate syndication?

A real estate syndication is when groups of individual investors combine resources to invest in an asset together as a team. Resources brought by team members can include expertise, experience, and capital. Instead of placing a downpayment on a smaller property, the syndication model allows you to invest in larger assets alongside experienced teams running day-to-day operations. Investing this way enables individuals to reap the benefits of real estate investing, such as portfolio diversification, cash flow, appreciation, and tax write-offs without the time required to locate, purchase and manage the asset.

The Team

The apartment complex team consists of two main groups—the general partners (GP) and the limited partner (LP) passive investors. The GP team will source the deal, secure financing, implement the business plan and manage the daily operations. Roles of the GP team can include acquisitions, financial modeling, asset and construction management, and investor relations.

The LP team will invest their capital into the deal but are not responsible for making operational decisions.

Additional team members that may or may not have ownership in the deal include property management companies, accountants, real estate attorneys, and lenders.

Structure

Let’s assume a GP team puts an apartment complex under contract. After detailed due diligence on the properties’ financial and physical health, the GP team decides to offer the opportunity to passive LP investors. The GP team will then form a Limited Liability Corporation (LLC), owned by both GP and LP investors, to hold the asset upon purchase.

The LLC will purchase the asset, and both the limited and general partners will split profits. The investment marketing materials and private placement memorandum (PPM) will explain the breakdown of the agreement in detail. Common profit-sharing splits between LPs and GPs (LP/GP) are 70/30 or 80/20, which translates to LP investors receiving 70-80% of the cash flow during the hold period and profits upon sale. The PPM also explains GP performance hurdles that may be in place to ensure LP investors received preferential pay before the general partners share profits.

The Business Plan

The GP team should clearly explain the business plan in each offering. If you do not understand the project, you should never be afraid to ask; after all, this is your hard-earned money. Capital preservation should be the primary GP goal above everything.

Often you will see the words “value-add” in these opportunities. In the previous blog, I discussed strategies to boost an asset’s net operating income (NOI), forcing appreciation. The GP team should clearly state these potential strategies during the funding period. Is this a heavy lift deal beginning with construction and a larger backend payout? Is this a management improvement plan with steady cash flow but less upside? Each investor should consider how the project’s plan fits into their personal financial goals.

Shortly after purchase, the GP team will initiate the business plan to add value to the property, likely through renovations and operational efficiencies. Once stabilization of the property occurs, investors should begin receiving quarterly or monthly distributions.

Exit Strategy

The exit strategy of a real estate investment refers to when the sponsorship team plans to exit (sell) the deal. When am I going to get my money back? Much like an anesthesia plan, I like to see multiple options for an exit. Syndications are often modeled on a 5-6 year hold period, though some capital may be returned to the investor before the property sale, depending on the business plan. Upon exiting the property, the LPs receive their initial capital back along with the 70-80% profit split.

Why might one consider passive investing in syndications?

Diversification

To answer this question, I like to use my family as an example. Five years ago, when assessing our financial goals, I realized that nearly all of our net worth was tied to the stock market. 401k, 403b, 529, and Roth IRAs, everything was invested in paper (stock) assets. Not only was it all stock market-related, but I could not access my wealth until retirement without significant taxes and penalties. My financial advisor kept modeling our entire life’s work on a 7% annual return, not including fees or inflation. Working 40 hours per week for 40 years and living on 60-70% of my current income did not sound attractive, so I set out on a journey to diversify our portfolio with tax-advantaged real estate assets that avoid the stock market’s volatility.

Time

The above story likely rings true for everyone reading this; however, time is scarce between work and family. Finding and managing real estate assets and tenants can be time-consuming. Passive investing allows all the benefits of owning real estate without a time commitment.

Inflation

Inflation is the buzzword of 2021, and nobody expects it to go away anytime soon. With additional stimulus and an enormous infrastructure bill on the horizon, the purchasing power of your cash is decreasing by 3-5% or more annually. Investing in cash-flowing assets such as real estate can effectively hedge against inflation because rents and property values often rise with inflation.

Returns

My goal for real estate investments is to exceed the 7% average annual return that my financial advisor told me to assume. I, therefore, expect higher than average stock market returns with less volatility and cash flow distributions that I can spend now if I desire.

Tax Benefits

Has your CPA told you to find tax write-offs or income not taxed at personal income rates? When investing in real estate actively or passively, the IRS allows investors to depreciate the asset. This depreciation can offset passive cash flows during the hold period allowing investors to put those funds to work in other investments before the IRS takes their share.

Conclusion

I hope this blog enhanced your basic understanding of passive investing in real estate syndications and the benefits it can provide. I plan to discuss evaluating passive real estate offerings in future posts and questions to ask before investing in a deal. Until then, happy investing!

Education + Action = Success!!