How Does a Real Estate Syndication Work? Your Top Questions Answered
What is a real estate syndication?
A real estate syndication is the pooling of resources (capital, expertise, etc.,) by a group of investors – general partners and passive investors – for the common goal of acquiring larger real estate assets that otherwise would be difficult or impossible for any single investor to acquire.
Real estate syndication opportunities are somewhat similar to real estate crowdfunding in this respect.
The objective of real estate syndication deals is to provide the individual investors with passive income (oftentimes by way of a preferred return) and, depending on how the real estate syndicate is structured, the potential investors also partake in the share of the profits when the investment property is sold.
Prospective investors do not need a background or any expertise in real estate investing – neither residential real estate nor commercial properties. There are, however, important considerations that you should know about these types of investment opportunities.
There are a lot of questions that potential real estate investors will have about investing in a syndication deal. Today we’re going to address these top questions that are frequently asked by investors:
- What kind of returns can I expect in a real estate syndication?
- What’s the required investment amount?
- Can I use retirement funds to invest in syndications?
- What about tax benefits and any implications?
So, how does real estate syndication work?
#1 – Returns
As with most commercial real estate investing opportunities, investors are drawn to and inquisitive about the potential returns on a commercial real estate investment opportunity. As a passive investor in a real estate syndication, you have the ability to earn two different ways: quarterly or monthly cash flow and sharing in the profits from the sale of the property.
Quarterly or monthly cash flow returns are the passive income distributions that investors receive from the time the real estate deal is acquired until the property is sold. The private placement memorandum will outline how the real estate syndicators will distribute the profit split returns to all investors when the asset is sold.
Let’s Review An Example
Let’s say you have invested $100K into a multifamily syndication, and let’s say that you could potentially earn 8% in annual income from the cash flow distributions or $8,000 per year, which would be approximately $667 per month.
Then when the asset is liquidated (approximately 5 – 7 years), you could then expect up to 40-60% returns on your initial capital investment. This means you’ll receive your $100K original capital back – your initial investment – plus the potential for additional income of $50K as your share of the profit when the apartment building is sold.
Is this resonating with you yet? Do you see how this is a great way to build your net worth and create passive income for yourself so that you can live your life by design?
So let’s do a recap: if you were to receive $8K in distributions each year plus the projected $50K profit split this would mean that your $100K initial investment would have doubled in 5 years. Not bad, right?
Now, of course, I have to emphasize that returns are never guaranteed, they are simply projected based on sound expertise, market conditions, location of the real estate projects, the execution of the business plan, the deal sponsor, the deal structure, and a variety of other factors. I can’t emphasize enough that no one can (or should) guarantee that you will double your money in 5 years. We are, however, saying that it is possible.
#2 – Minimum Investment Amount
Typically the necessary capital needed to make the minimum investment amount to participate in a real estate syndication is $50K.
Any individuals who would be investing in a commercial real estate property at this level can be a sophisticated investor or an accredited investor depending on the structure of the offering. Investors should have liquidity beyond that particular investment amount and they should be aware that there is always the possibility that they could lose their investment capital.
Another consideration that all investors should take into account is that the investment capital will be illiquid during the project hold term and until an exit strategy is executed.
#3 – Retirement Funds For Investing
The good news is that certain retirement funds CAN be used to passively invest in commercial real estate syndications. In fact, this is the main way that most investors begin their passive investing journey.
To be able to utilize your retirement funds to invest in this way, you will first need to roll your current retirement account(401K or IRA, etc.) into a self-directed IRA account.
There are many companies that can help guide you on how to roll your retirement account. Once you have rolled your funds into a self-directed IRA, you can then start investing in real estate syndications.
To start the investment process using your self-directed IRA, you will want to work with your custodian and they can release the funds necessary for you to invest in your next real estate syndication project.
One of the requirements in using these funds for your investment is that as you are receiving distributions, this cash flow must go directly back into your self-directed IRA account and not into your personal account.
#4 – Tax Benefits
There are tax implications with every investment. But the good news is that there are also tax benefits when you are passively investing in and are part owner of a real estate asset. Investing in real estate has enormous tax advantages and one of them is depreciation, specifically cost segregation which is a form of accelerated depreciation, which can really offset your taxable income.
By owning real estate you are able to depreciate the value of the asset over a specified period of time. When you invest in commercial real estate syndications, the deal sponsors will often conduct what is called a cost segregation study. A cost segregation study can accelerate depreciation because instead of depreciating the building as a whole it compartmentalizes the building into different depreciation schedules that can really give you extraordinary tax benefits.
In short, this method of depreciation front-loads the depreciation schedule into a much shorter time period of a few years instead of the 27.5-year timeline that residential real estate is normally depreciated over in a straight-line method. This works particularly well if you will only be holding the asset for 5 to 7 years.
Confidence in the Details
You learned that self-directed IRA retirement funds can be utilized to invest, that the typical investment minimum is $50K, and that real estate syndications can allow you to receive some amazing tax advantages while also giving you great returns. We also discussed that no investment is risk-free and that investing in real estate syndications is no exception.
If you want to start investing using your retirement funds, then you now know that you should start working with a company that specializes in self-direct IRA accounts and a company that knows the rules that surround these investment vehicles. Most importantly, you now know that you could, potentially, double your investment capital in just a few short years.
Now that we covered some common questions individuals have when investing passively in commercial real estate syndications you can hopefully have more confidence moving forward in pursuing your next deal.
Ready to Learn More?
The best way for you to learn more about commercial real estate syndications is to join the PCRP Passive Investor Club.
Through the PCRP Passive Investor Club, you’ll get a priority review of all the deals we offer. We’ll work with you to determine your investing goals and then present you with the best deals to meet those goals. We’ll then guide you every step of the way as you invest in those deals.
So if you’re ready to start investing passively in institutional-grade, commercial real estate in fast-growing, climate-resilient markets in the U.S., join the PCRP Passive Investor Club – IT’S FREE! – and get started on your path to EARN PASSIVELY and LIVE ABUNDANTLY!
If you would like to know more about what we do and how it may be of value to you, please reach out to us anytime. We’re always happy to help!