Would you like to put your money into real estate and enjoy the benefits of passive income but hate being a landlord? You’re not alone. A lot of investors want the upside of investing in real estate without having to deal with property management and other responsibilities. Fortunately, there is a better way. This article compares two options that will help you enjoy passive income and free you from the obligations of becoming a landlord.
Real Estate Investment Trust (REIT)
REITs are companies that invest in income-producing commercial real estate. REITs buy, operate and sell properties. These companies usually specialize in specific property types such as industrial properties, retail shopping centers, office buildings, self-storage or multifamily apartments buildings. It is easy to invest in a publicly-traded REIT. You just need to buy shares through a broker as you would
when buying stocks.
Another way to passively participate in commercial real estate investments is through a Syndication. A Syndication is an investment opportunity sponsored by experienced active General Partners (GPs), or “operators” which commonly consists of a group of individuals. Limited Partners (LPs) are able to passively invest and rely on the operator’s expertise to manage the investment. Investment into a syndication is not generally available to the public. In fact, the SEC requires investors in a syndication to be sophisticated and/or accredited investors.
To help you decide which investment vehicle is most suitable for you, we have contrasted the differences between REITs and Syndications below.
When investing in a REIT, you are simply buying shares in a company. In other words, you do not actually own the real estate purchased by the REIT.
In a Syndication, however you have direct ownership in the property. Together, the General and Limited Partners hold title to the real estate inside of a LLC or Limited Partnership agreement.
Having direct ownership in investment real estate comes with many tax advantages, as you’ll see below.
2. Investment Minimum
The biggest advantage that REIT has is it’s minimum investment size. Because investors are only buying shares of stock in REITs, they can invest even just a few thousand dollars. This is appealing to many younger and less capitalized investors.
In Syndications, the minimum investment amount depends on the offering. While minimum investments can widely range from $10,000 to over $250,000. Most Syndications have minimums from around $25,000-$50,000.
REIT companies generally own a portfolio of properties, therefore investors in REITs, are diversified into many different properties. The biggest issue with this type of diversification is investors have no say in which properties are purchased. Many times, this “blind diversification” causes much of the potential high yielding properties to be mixed with average and sub-par yielding properties which greatly reduces investor returns. The investor has no say in which properties are purchased.
In a single asset Syndication, such as the investment opportunities presented by the Passive Wealth Investors Club, investors are able to look at each individual property and consider the potential risks and merits of the deal. The investor ultimately retains control of the decision to participate and can examine each opportunity before investing. Syndication investors decide which properties they purchase and can directly control the diversification of their portfolio.
4. Tax Benefits
REITS do not come with any significant tax benefits. In fact, the majority of REIT dividends are taxed as ordinary income and incur a separate 3.8% surtax on investment income (as of March 2022). High income earners can expect to pay close to 30% tax.
Syndications offer investors a variety of tax benefits including depreciation, accelerated depreciation, cost segregation, cash-out refinances (tax-free) and 1031 exchanges (tax deferred). These tax benefits offer investors a decreased tax burden and many investors have been able to create tax-free income during the holding period. Additionally, individuals/couples who qualify as Real Estate Professionals have access to other unique tax advantages.
Looking at after tax yields is of major importance when considering an investment. For example, if an investor receives $10,000 in annual income from an investment, but they have to pay 30% tax on that income, their after-tax income from that investment is only $7,000. Assuming that return came from a $100,000 investment, the cash-on-cash return goes from 10% down to a 7%.
Over time, that 30% difference can be substantial. The additional income amounts to a total of $90,000 over 30 years in the above example. When considering inflation and/or possible increases to the tax rate, the amount gets considerably greater. With taxes being one of the largest expenses over a lifetime, finding a tax efficient investment vehicle is of utmost importance.
Liquidity is one advantage in favor of REITs. An investor can buy or sell shares anytime. There is no specific lock-in period, so investors can pull out immediately.
Syndications are considered illiquid investments. Because it is a direct investment into a real piece of property, return of investment capital generally doesn’t occur until the end of the deal when the property is sold or refinanced. Most Syndications have a hold period of 3-5 years, but each investment will have an estimated time horizon associated with it. It is possible to sell your interest in a syndication before the property is sold or refinanced, but because securities are not available to the general public, it may take more time to find a suitable buyer.
Generally speaking, real estate investments perform better over long periods of time. The longer the property is held, the greater the income and equity yields.
The majority of REITs are listed on major stock exchanges which makes them quite accessible to the public and many people invest in them.
Syndications on the other hand, are a bit more difficult to find, with many deals not advertised publicly. Depending on the offering, some syndications are open only to accredited investors.
Investing in a REIT typically results in dividends averaging around 4.3% and an investor can expect average annual yields (including dividends) of around 9.6%.
Syndication yields vary depending on the deal, but on average we are seeing average annual returns in the 15-22% which includes distributed cash flows somewhere in the range of 6-8%. Make sure to review the offering documents on any deal you consider investing in for the projected returns of the project.
There are many things to consider when comparing REIT investing with Syndications. If you are looking to invest a smaller amount of money for a short term, a REIT will be a better option for you. REIT investments are highly favored by the middle class.
However, if you are looking to maximize yields by earning higher rates of return, increase your tax efficiency, and increase your control over-diversification all while creating a larger stream of passive income, Syndications are a more suitable investment choice. Syndications have been a favorite investment vehicle for the ultra-wealthy for decades and is also a great option for those who are looking to invest like the wealthy.
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