Real Estate syndication is one of the ways that you can participate in the industry, without much work. Perhaps you’ve heard the term? Maybe you read about it somewhere? But what is it, exactly? How does it work? Who invests in syndications?
Let’s dive into it and see if this investment strategy is right for you.
What Is Syndication?
The simplest way to describe syndication is to look at it as a partnership of sorts.
Syndication is often formed for management of a particular asset or group of assets that focus on large transactions that would be impossible for each individual investor or entity to pull off on their own.
By joining a syndication, the investors (whether a real person or an entity) are able to pull their money together to realize those investments and reduce risk.
While syndications can be used for all kinds of investments, I will use real estate as an example to explain how syndications work.
Let’s assume you are looking to invest in real estate. And let’s also assume that you have $100,000 to invest.
You have a few different options for your investment strategy:
- Purchase an asset all cash for $100,000
- Purchase an asset that you finance (we’ll assume 20% down)
- Join a syndication
All Cash Purchase
If you make a cash purchase, you get $100,000 asset for your money. Based on the price you’re likely purchasing a 1-4-unit property, most likely a condo, maybe a single family. You rent it out to one person or family and as long as that one person is paying and the property is occupied you are doing okay.
The risk with all cash purchase is that your property can only be 100% vacant or 100% occupied. You are not leveraging the cash you have and as such there is a gain risk loss that you are experiencing. Further, you have an opportunity lost cost as well.
Let’s look at the growth of your investment. Assuming 3% annual appreciation, you are looking at $3,000 for year 1.
Financing Your Purchase
If you were to take your $100,000 as 20% down payment, you’d be able to purchase a $500,000 property. Now you own something that is much larger in value and assuming the same appreciation from the example above, your growth is exponentially higher, even if we weren’t to focus on the financing piece, but mere growth on the value of the property.
If $100,000 would buy you a condo or single-family home, you’d likely be able to get a small apartment building, let’s assume 6 units.
Your property being 100% vacant has a really low probability and as such your risk is reduced. However, with higher number of occupants you will likely experience higher management (both in time and money). While you can get a property manager to help you with the property, the margins are so narrow, that you’d be eating into most of your earnings.
This strategy, while better than the first one (my opinion), has some risks and costs associated with it, mostly in the amount of time commitment to learn the process and properly manage your investment.
Following the same suit from the above example and assuming a 3% appreciation, you are looking at $15,000 for year 1.
Much better, wouldn’t you agree?
Joining A Syndication
Now, let’s place your cash into a syndication deal and see what happens.
We’ll assume that syndication is looking for a minimum of $100,000 for the example purpose and ease of math (many ask for $50,000 and there are some that allow you to get in for as low as $25,000). They are looking for 10 individuals to make an investment, so $1 million combined.
Syndication will finance the deal, so that $1 million is a down payment. Assuming the same 20% down, they are looking to purchase a $5 million property. This is likely an apartment complex, further reducing the risk, increasing returns and allowing for a professional management team to be hired.
This means the investment is truly passive for you and other investors. You get to do whatever you want and collect a paycheck on regular basis. So, not only is risk reduced and you don’t have to worry about time to manage the investment, you are also able to grow your money at a much higher pace and passively. Which means you can focus on your business, career, family, life, etc.
Following the same 3% growth, we are now looking at $150,000 appreciation in year one. Of course, you have 10% of that because you only put up 10% of the money, so you make the same as if you were to finance your own deal, except you don’t have to deal with any issues that arise from the day to day operations.
Comparing The Three And Drawing Conclusions
Let’s summarize the three options that we have.
Cash purchase while seemingly safe does have a lot of downside. You lose on many opportunities to expand your portfolio. This type of purchase locks your cash into property, making it illiquid. Additionally, your earnings are minimized because there is no leverage.
The financing option appears to be a much better deal. Unless you are looking to be a professional property manager, spending a lot of your time managing the place and learning how to efficiently do it, it can feel like a lot to a newbie investor. Especially if you are looking to grow in your career or business.
The thought of dealing with tenants, toilets, and termites is what sends many investors away from real estate as they fear the management of it all.
This is where the syndication comes in. You:
- put money into it.
- know exactly what is being purchased.
- have a team that does all the hard work in finding, financing, and managing the deal.
Often, professional syndicators look for value add deals where they can go in and fix up the place and increase the rents. The value of these properties is calculated on the cash flow basis, not the market comparison model. Unlike the single-family homes, the value can be increased through equity increase. This means that you could beat the market appreciation rate, which could potentially render you a much higher return.
A Word About Risk
Clearly nothing is without risk. Invest and you can lose. Do not invest and you are guaranteed to lose. If for nothing more than the mere fact that the inflation is eating the value of your money. True investors understand that there is risk in everything and they look for ways to reduce the risk. Syndication is a way to drastically reduce risk and potentially increase your returns.
As part of syndication you diversify your portfolio holding. You get a better and bigger deal than going into it by yourself. And you are able to hire a team of professionals to help ensure profitability and success with the deal.
Want to learn more about investing in real estate? Consider taking Instant Wealth Through Real Estate course.
Looking to get into a real estate syndication? Consider Global Network Capital.