#21 Real Estate Syndications vs. Funds

Welcome to the Passive Income MD Podcast where we talk about creating your ideal life through multiple streams of income. I'm your host, Peter Kim. If you enjoy hearing about this stuff, make sure to hit subscribe so I can bring it to you every week. Now let's get on with the show. Hey, what's up, everyone? Hope you had a great week. This week I'm going to talk about a topic that I've gotten a lot of questions on. People tend to ask us on our Facebook group Passive Income Docs. If you were to invest in one type of passive real estate investment, what would it be and why? I think they're essentially asking, would you invest in a real estate syndication or a real estate fund? And we're going to dive into that. So let's get to it. Now, the answer to this is not super clear cut. I mean, there's no perfect answer. There's pros and cons to each. On the surface, they actually have more similarities than differences. And we're going to jump into that. And I think ultimately you have to figure out what works best for you, figure out your goals and see what works the best for you. Well, let's talk a little side by side comparison today so that it might help you make a decision one way or the other. Now, what is a real estate syndication? Now, I've talked about it at great length on my blog, but I'll share that again with you. Essentially, it is the pooling of capital from multiple investors to invest in a single real estate opportunity. Now, for some people who've heard that term, they have no idea what that means. I've heard it in reference to syndicated TV shows. I've heard it in reference to the mafia or crime syndicates. But for our purposes, when it comes to real estate syndications, and essentially it's just the pooling of funds. Now, one of the most famous syndications in the past was the syndication led by a pair called Helmsley and Malkin. In the 1960s, they put together a group of investors that essentially bought the Empire State Building. It was for $65 million. And they put together a series of investors, a lot of them in fact, all putting in $10,000 for to buy this building. Now, you can think the same happens today. It happens all over the place. I mean, there are apartment buildings, high rises, and these type of things that are bought by a series of investors. Someone puts together this deal, organizes the investors, makes the investment, and actually owns and operates that property. Now, as a silent investor, like you or me, were able to Invest some capital and own a share of that apartment building. For example, my very first investment in a syndication, it was for $25,000. It was an investment in an apartment building kind of close to me. And I'm trying to remember the exact number of units. I think it was 27 units, and I was able to buy a share for $25,000. I did my due diligence the best I could. Honestly, at that time, I had never invested in syndication, so I had no idea what I was doing. But it seemed like a good investment. I made the investment, and honestly, I just sat back. I continued to get distributions on a quarterly basis. At this point, all of my capital has been returned. This investment was about three, four years ago. And I still get distributions, a check in my account on a quarterly basis. And it's been fantastic. But that was an example of a syndication. It's tied to one property, and I have a defined set amount that I invested in there, and I own a share of it. Now, what is a real estate fund, and how does that differ from syndication? Well, it's essentially like investing in a basket of apartment buildings or an investment or a basket of syndications. One easy way to think about it is that as a syndication, you own a stock. You own one particular company or a stock. When you invest in a mutual fund, you own a basket of stocks. Well, the same thing happens with real estate funds is that you invest in this fund, you make a capital investment, and then they go out and buy a bunch of apartment buildings under that umbrella with those funds. That's what's known as an equity real estate fund or real estate equity fund. Based on the sponsor's track record, they have a business plan that they put together. And based on that trust, you go out and invest money in them, and they go out and buy the properties, improve the operations, and sell them for a nice profit down the road. It is more of a blind trust because oftentimes when you invest in these type of things, they don't have all the properties in there already. They might have already bought one or two or three, depending on when you join that fund. But again, it's up to their discretion to use those funds and make those investments. Now, I've made a bunch of these investments as well. Sometimes they're $25,000 as well in terms of minimums, but oftentimes they're a little higher because, again, they're buying a basket of investments. Oftentimes it's somewhere in the $50,000 to $100,000 range. For some of these funds, that's an equity fund. There are things called debt funds as well. Now we're all familiar with the concept of debt. In this case, these funds take investors money and then lend it out. They act as the bank and essentially that means you act as the bank lending money out at a certain interest and expect to get paid on a monthly quarterly basis. So just know that those funds are available as well. And I've invested in those as well. Different return profile, different tax profile, but it's a good way to diversify, at least in my mind. So let's go ahead and compare syndications and funds. And I think the easy way to do that is to break it up in terms of category. Let's talk about the term or the length of investment for these type of investments. Now usually when you see the offering memorandum, or what might be called the DEC or the PPM, private placement memorandum or whatever it is, that really is the brochure essentially to help promote the investment, they will typically give you a range for what they actually expect that investment to take place over. And for syndications, I typically find that they expect this investment, this target range to be anywhere from three to seven years. That means that after you make the investment, don't expect to get your money back for three to seven years. And what are they doing during this time? Well, what they're doing is they're going to buy the property, they're going to improve operations, whether it's turnover of tenants, whether it's rehab as well, construction, fixing up the property itself, and some point down the line, they're going to find the best time to go ahead and sell that building for a nice profit for themselves. And for investors, they like to give themselves three to seven years because of the cycle of real estate. Who knows how long it'll take to get in the right place. Now when it comes to real estate funds, it kind of depends on whether you're dealing with an open or closed fund. Many of the funds that I see or I deal with are closed funds, meaning that they have a definitive start time and an end time, meaning that you have to get in within a certain period to make that investment, whether it's a one year period or a two year period. And then once it starts and it's on its way, you can no longer make an investment in it and you can't pull your money out till it's done. Now a lot of these real estate funds I tend to find again they tell you somewhere between three years up to 10 years, because if you think about it, they're buying multiple properties. So they may not buy all the properties at year one. They might buy the properties anywhere from year one through year five. And it takes time for all those properties to get fixed up, to get renovated, to be running at an optimal place, and then to get sold. So it might take anywhere from 5 to 7 to 10 years for all these investments to run full cycle. And what happens is the fund is ultimately closed and finished out when that last property is sold. Now, there are types of funds called open funds, which tend to be ongoing, meaning that you can just jump on the train whenever you want and hop off whenever you want as well. I mean, typically there's a minimum time that you need to stay in the investment, whether it's a year, two years, and that sort of thing. And they typically offer some sort of incentives for you to stay on a bit longer. But these type of funds exist where you can jump on and jump off, keep your money in there for two, three, five years, and to continually working with these buildings and operating buildings. So know that there is some liquidity when it comes to these type of investments. Whichever way you go, it's important to understand the term because know that the funds that you invest in there are not really accessible during the investment. Some people love that, though. I mean, when I make an investment, I don't really want to make the investment for short term. When it comes to these real estate fund syndications, I want my investment in there for a while, producing cash flow on a quarterly basis for me. And then when the property does sell, sure, I'd like to get a nice bolus of cash, my investment, you know, of capital plus some. But then I have to go out and find another investment. So if it's a great investment, I love the idea of having constant distributions. But hey, if it's a great time to sell, go ahead and sell, get the profits, and I'll find another investment to put that money in. Now, how do you get paid on these things, and is there a difference? Now, returns are typically offered the same way. When you're talking about a syndication or fundamental, look out for something called preferred returns, which are essentially distributions and a way of protecting investors to make sure you get paid first before the operators or the sponsors get paid. An example of a typical preferred return might be around the 8% range. And what that means is that on a year or quarterly basis, whenever they make the distributions, they make sure that as an investor, you get your 8% first before they participate in Any of the profits, there's usually something called a preferred return upfront and, and then some sort of equity split on the back, meaning that up to 8% you get paid first and then everything after that typically gets split. Whether it's a 70, 30 split, meaning 70% to the investors, 30% to the operators or sponsors, or 80, 20 or whatever that number might be, there's a number on the backside which is a split of the profits above and beyond that 8%, you essentially just have to look to see if that return structure makes sense for you in both cases. And syndications and funds, you're going to be dealing with fees, fees that go to the operators or sponsors for purchasing the property, taking care of it, operating, managing it, optimizing it, and taking care of all the investors. And that's to be expected. That's an additional cost that you're paying for not owning it and operating it yourself. But you have to figure out whether your time is worth it and whether you think the returns will justify the payment of those fees. Now, big difference comes when you go to actually vet the type of deal when it comes to a syndication. You know the property that you're investing in, that property is right there. You can essentially see how well it's operating currently, what the expected operations of that building will be, what market it's in, and all the different future assumptions. Sometimes it's easier to understand it because you're looking at a specific property. And so before you make the investment, you can really feel a little bit more secure knowing what you're investing in. Now it takes time to learn how to vet the sponsor. Obviously we talk about it quite a bit on our my blog. We talk about it in our Facebook group. So many people asked about it, which is why we created the Passive Real Estate Academy course. And the goal there is to help physicians and other high income professionals learn how to vet these deals in really just four short weeks instead of taking years of experience of trial and error like I did. But a lot of the resources can be found online. You have to go digging a little bit, but you just have to go look for those things. And again, with trial and error you will get there. It'll just take some time, energy and effort and hopefully you won't make a lot of mistakes on the way. But learning how to vet those syndications a little bit more concrete than some of the real estate funds. When you're investing in real estate fund again, you are investing your money and investing in those sponsors to make good investments. Oftentimes you have no idea what properties they're going to invest in, but you have an idea for what type of properties they're going to look for. You have their track record and so hopefully in the past you've seen how they've done and you're betting on that. There's sometimes when you are investing in the fund, they probably have a couple properties under their belt already because their fundraising period might be a year or two years. And once they start bringing in investments, their investors want them to use it and get it to work. So depending on when you actually invest in the deal, whether early or late in the fundraising period, you might find that they already have some properties and you have a good idea of what you're investing in. Now, whether it's better to invest early or late in a fund. We'll talk about that in a future podcast. Now, vetting a sponsor for a real estate fund deal, yes, that takes time, energy to learn how to do it, but again, it's important part of the process. Now let's talk about investment minimums a bit. Are they the same? Now? I think I've talked about this in one of my previous podcasts. Investment minimums for these syndications, for me, overall, this is just a generalization, tend to be a little lower, especially when you find them on crowdfunded sites. They might be anywhere from 10 to 25,000. I found that 25,000 is typically common. Sometimes you'll see it up to 50,000, but that's usually where it lands for syndications, especially the ones that I come across. When it comes to real estate funds, however, since they're going out and buying a basket or a bunch of multifamily properties, whatever it might be, I typically find that those minimum investments tend to be higher. I usually find that the minimums are often 50,000. Now, for the members of my investor club, I typically work on those investments and those sponsors to try to get some of those minimums a bit lower. And oftentimes we have success with that and try to bring it down to a little bit more accessible minimum, like $25,000. But sometimes you'll find a little disparity between syndications and funds. Now, let's talk about taxes. I mean, investing in real estate is one of the best ways to take advantage of a lot of the tax code that's written out there. As physicians, we often don't have a lot of ways to shelter our income. But when it comes to real estate, there are plenty of ways to do it within the tax code. As it is written, as an incentive for you as an investor to make an investment in real estate. When you invest in a syndication, you're investing in one single property in one state, in one area. So you only have to deal with that state and maybe the state that you live in in terms of tax returns. And so that's nice because it's a lot easier when you're investing in a fund depending on that particular state. Oftentimes you have to actually do tax returns in each of those states. And I thought it might be a lot more work for the accountant. To be honest with you, I haven't necessarily found that to be the case. Yes, there are some additional fees when it comes to that. But the beauty of investing in a lot of those real estate funds is that you get shares of multiple buildings and, and you get that instant diversification. So it becomes a numbers game or really valuing whether diversification is that important to you. Now, they can both be tax efficient investments. You are getting what's known as a K1 or an ownership statement to each of those. Because of the current tax laws in place. There are ways to offset your income with what's called depreciation or the government allowing you to write off some of your taxes knowing that the building is quote, unquote, deteriorating over time. So know that there are some tremendous tax benefits. I'll give you an example. I invested in a syndication last year. I invested $25,000 in it. When I got my K1 at the end of the year, which is my ownership statement, that goes to taxes. Yes, I had received distributions, but on paper it showed that I had a net loss. And that's great for my taxes, especially because I have something called real estate professional status. I'm able to offset my income with some of my doctor income, offset some of my other real estate income with some of the losses on paper that I show from owning some of these investments. It can be extremely powerful. And that's something that I recommend you talking about to your CPA to make sure that you optimize this. Because as physicians, again, we don't have opportunities to minimize and shelter our taxes. However, as a real estate investor, it is possible. Now, one of the biggest categories now that we're getting to the end of this is risk. Is it riskier to invest in a syndication, one single property, or invest in a fund? Now, I think that depends on how well you know that investment. Yes, you are concentrated. You have a risk concentration when you invest in a syndication. You invest in one property will that property do well? Is it in a great area? If it doesn't do well, you're totally in with that one property and all your funds are really going towards there. However, when you're investing in a fund, you're investing in multiple properties. So there is some diversification there. So what happens is that if one property does well, maybe one property doesn't do as well. They might be able to balance each other out, but it might minimize your upside. But in my opinion, it definitely does mitigate your risk on the downside. So you have to know whether that's important to you. So now we're getting to the end of this. Is it better to invest in a syndication or fund? That's a tough decision to make. I mean, we've talked about all the different categories, pros and cons for each. Everybody has a different risk profile and what is important to them. Again, the important thing to know is your goals, your income goals, and to figure out whether one of these or both help you accomplish your goals. What do I do? Just like with active or passive real estate investing, I invest in both. I see different opportunities all the time. Some of them I am totally down with the place in terms of a single property. If I know where it is, I know the operators. I am supremely confident in that one investment, I'll make that investment. Now, there are times when certain fund operators I know are raising money for their investments and I know their track record, or perhaps I've invested in their funds in the past and I know that they're going to do a fantastic job. I'm happy to put money with them as well and invest with them, knowing that they've done well in the past. They're going to provide instant diversification for me and still get great returns. So it kind of depends on what opportunities are available for me at that time, what capital I have ready to invest, and how close I am to my goals at the time. The key thing is for either these type investments, I can't tell you enough is to learn how to vet these type of investments properly. That is where all the work is done with passive real estate investing. Do the work upfront, do the proper due diligence, learn how to do it well, make good bets to minimize your risk, and ultimately you can create that passive income which will help free you up from your physician income and help you create financial freedom if it's something that interests you. We do have an investor club where we talk about some of these investments. Look for that link. It is absolutely free to join. It's just something that we offer because we want to make sure that we get in there as physicians or as high income professionals, talk about it together, even leverage the numbers in our group to try to get better deals for us. And that's what we try to do. And if you want to learn how to do due diligence well in a quicker, faster way in four weeks, to learn how to ultimately do this and gain the confidence to do it well and have this great community to do it with, then you can join our Passive Real Estate Academy as well. You can do it on your own. And that's what we did and I did over many years, making a lot of mistakes. But this is one way to kind of accelerate that learning and know that that's available for a short amount of time. Either way, I hope you got a ton from this. Let me know what you like doing in terms of investments. What do you like investing in syndications and funds and why? Let me know. Happy to hear from you. Have a great week. Take care everyone. Enjoy the show. Let me know by dropping a review in the podcast app you're listening to us in. And if you haven't already, make sure to hit subscribe. Are you a part of our community yet? Join thousands of physicians who are also on this journey to creating their ideal lives through multiple streams of income. You can join us on our Facebook group PassiveIncome Docs and you can always learn more at our website, passiveincomemd.com thanks again for allowing me to be a part of your journey. See you next time.