For investors interested in earning steady passive income through real estate, two appealing options are real estate syndication and real estate investment trusts (REITs). They offer a way to own part of income-producing real estate assets, minus the daily management headaches.
Real estate syndication involves pooling capital from multiple investors to acquire commercial properties, which are then operated by experienced professionals. On the other hand, REITs offer exposure to large portfolios of real estate by purchasing shares in a publicly traded trust.
While the passive nature of these options is attractive, there are notable differences between syndication and REIT investing related to asset types, investment amounts, risk exposure, investor involvement, and income potential.
This article outlines the differences between real estate syndication vs REIT investing. My goal is to assist potential investors in determining which option better fits their portfolio goals, time commitment abilities, and risk tolerance as part of their diversified real estate investment strategy.
Real estate syndication and REITs both offer passive real estate investing without the need for direct management. Syndication involves pooling funds to buy commercial properties, while REITs let you invest in a portfolio of real estate assets through publicly traded shares.
Syndication allows for more direct investment in specific properties and potentially offers higher returns but with greater risk and less liquidity. REITs provide easier access and liquidity, as they’re traded like stocks, but with less control over individual investments.
Investors should weigh factors like their risk tolerance, desired level of involvement, financial capacity, and investment timeline when deciding between the two.
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What is a Real Estate Investment Trust or REIT?
A REIT is a company that owns real estate properties that generate income by pooling money from a vast number of passive investors.
There are three main types of REITs:
Equity REITs are involved in owning and operating various real estate properties, including apartments, office buildings, malls, and hotels. They generate revenue primarily through the rents collected from these properties.
Mortgage REITs target financing real estate by originating or purchasing mortgages and mortgage-backed securities. Their income is derived mainly from the interest earned on these financial assets.
Hybrid REITs combine the strategies of both equity and mortgage REITs, engaging in a mix of property ownership and real estate financing, thereby diversifying their investment and revenue sources.
One of the benefits of REITs is that they provide a way for any investor, even those with limited capital, to gain exposure to the real estate market and earn dividend income without buying physical property.
REIT trades on major stock exchanges just like stocks, and it provides similar liquidity and ease of access.
What is Real Estate Syndication?
Real estate syndication is a method for pooling capital from various passive investors in order to invest in larger-scale commercial properties.
Typically, a general partner or sponsor forms a limited partnership (LP) or limited liability company (LLC). They act as the syndicators responsible for collecting funds from passive limited partners.
The key advantage of this model is that passive limited partners get exposure to commercial properties that would otherwise be unavailable to them as individual retail investors.
The capital requirement to buy apartment buildings, office towers, warehouses, or development land is normally high enough that access is restricted only to institutions, REITs, or ultra-high-net-worth investors.
Real Estate Syndication vs. REIT
Real estate syndications and REITs both offer practical and effective solutions for passive investors to put their capital into real estate investments without needing the skills, time, and resources that direct ownership demands.
Though comparable in many ways, REITs and syndications differ in some key aspects that passive investors should consider when evaluating each investment type:
Control Over Investments
In a real estate syndication, while the day-to-day management is typically handled by the syndication’s sponsor, investors often have more say in the overall strategy. For instance, you might have a vote in major decisions like when to sell the property. However, the level of control can depend on the structure of the syndication and your investment size.
With REIT investing, you do not directly own any underlying real estate properties, instead, you own a piece of the company that owns the properties. So you do not have direct control over which properties the REIT invests in.
Liquidity and accessibility of investments
REITs are known for their liquidity. Since they’re traded on major stock exchanges, just like stocks, you can buy and sell shares of a REIT quickly and easily. This means if you suddenly need cash, you can sell your REIT shares, usually on the same day. This level of liquidity is a big plus for investors who want the flexibility to access their money without much hassle.
In contrast, in real estate syndications, you’re typically in it for a predetermined period, often several years, and getting your money out early can be challenging and sometimes impossible without significant penalties.
Risk and potential returns
The returns on REITs can be influenced by various factors, including changes in real estate markets, interest rates, and the overall economy. While they offer the potential for solid returns, especially in strong real estate markets, they’re not immune to downturns.
In real estate syndication, the risk and potential returns are generally higher. Your investment’s success hinges on the specific properties you invest in. Good performance of these properties can yield high returns from direct income and appreciation. However, the risk is also elevated – poor property performance or issues like unexpected costs or vacancies can significantly affect your investment.
Another factor to consider is diversification. REITs typically invest in a range of properties and real estate sectors, which can help spread out risk. Real estate syndications often focus on fewer properties, which can heighten risk if these investments underperform.
Tax benefits and implications
The key point with REITs is that they have to distribute at least 90% of their income to investors as dividends. However, the tax treatment of these dividends varies. They can be taxed as ordinary income, capital gains, or return of capital, each with different tax rates. The portion taxed as ordinary income doesn’t get any special tax benefits, which can lead to a higher tax bill.
If you invest in a syndication, depreciation can reduce your taxable income from the property, potentially lowering your tax bill. However, when the property is sold, you might face capital gains tax unless you do a 1031 Exchange into a new syndication or investment property. Also, if depreciation reduced your taxes earlier, you might have to pay some of that back through depreciation recapture.
Minimum investment requirements
REITs have a low monetary barrier to entry, as shares can be purchased on the public exchange for just a few dollars. Real estate syndications typically require a higher minimum investment, often starting at $5,000 or more.
How to Decide Which is Right for You
Deciding between real estate syndication and REITs as part of your investment strategy involves taking a look at several personal factors.
Assess your investment goals and risk tolerance
Ask yourself what you’re aiming to achieve with your investment.
If your focus is on long-term growth and you’re comfortable with a higher degree of risk, real estate syndication might be more appealing due to its potential for significant capital appreciation.
But if you prefer a steady stream of income and are more risk-averse, REITs could be a better fit since they tend to offer more stable returns.
Consider your desired level of involvement
Your desired level of involvement is another factor. Reflect on how much time and energy you’re willing to invest in managing your real estate investment.
REITs provide lower risk, so they are ideal for those who prefer a more hands-off approach as a completely passive investor.
Evaluate your financial capacity and investment timeline
Finally, your financial capacity and investment timeline are key determinants. Real estate syndication often requires a larger initial investment compared to REITs.
Also, consider your liquidity needs. If you need to access your funds in the short term, the greater liquidity of publicly traded REITs is a better option.
If you have a longer investment timeline and can afford to have your capital tied up for several years, syndication could offer greater potential for appreciation.
How Can I Start Investing in Real Estate Syndication or REITs?
Having explored the differences and pondered which investment suits you best, you might now be wondering, “Where do I start?”
Here’s how you can get started with each.
Investing in Real Estate Syndication:
Start by educating yourself about real estate syndication. Understand the basics, the risks involved, and the typical structure of these investments. There are numerous online resources, books, and courses that can provide important information.
Real estate syndication opportunities are often found through networking and online investment clubs. For instance, SparkRental is an investing club that allows participation in syndication deals with minimum investments of only $5,000 to $10,000. They provide a 30-day money-back guarantee, along with bonuses such as opportunities to learn in the co-investing club.
Looking For An Easier Way To Invest In Real Estate?
When you come across a potential syndication deal, be sure to conduct due diligence. This includes scrutinizing the sponsor’s track record, analyzing the property’s market, and reviewing all the details in the Offering Memorandum (OM). If the deal aligns with your investment objectives and passes your scrutiny, you can proceed by signing the agreements and investing your capital.
Investing in REITs
For REIT investments, the process is more streamlined. Begin by understanding the various types of REITs and their operational mechanisms.
Opening a brokerage account is a key step since most REITs are traded on the stock market. Conduct thorough research on different REITs to identify those that match your investment goals, focusing on their performance history, dividend yields, and property types.
Diversifying your investment across various REITs and sectors is a smart move to reduce risk. After choosing a suitable REIT, you can buy shares through your brokerage account. Start with a modest investment and consider scaling up as you become more comfortable.
Keep a close eye on your REIT investment’s performance and stay updated on real estate market trends to adapt your investment strategy when necessary.
To wrap it up, deciding between real estate syndication and REITs depends on your individual needs and situation. It’s smart to begin with a smaller investment in either option, particularly if you’re new to real estate investing. Consulting with financial advisors or real estate professionals can provide valuable personalized advice.
Regardless of your choice – real estate syndication, REITs, or a combination of both, the key is to stay informed, understand the risks and benefits, and consider how each option fits into your broader investment portfolio.
Real Estate Syndication vs. REIT: FAQs
Can I invest in both Real Estate Syndication and REITs?
Yes, diversifying your portfolio by investing in both can balance the higher potential returns and direct ownership of syndications with the liquidity and ease of REITs.
How Important is Due Diligence in These Investments?
Extremely important. This process helps identify potential risks, ensure legal compliance, and make informed decisions, ultimately protecting your investment and maximizing the chances of success.
How Are Returns Distributed in Real Estate Syndication and REITs?
In syndication, cash flow returns are typically distributed to investors after operating expenses and debt service based on their ownership share. These can include rental income and profits from property sales. For REITs, returns are distributed as dividends to shareholders, usually on a quarterly basis, derived from the income generated by the REIT’s owned properties.