Are Real Estate Syndications Too Good To Be True?

“Sounds great. So, what’s the catch?” This may be your first response after hearing how wonderful real estate syndications are and how passive investing works.

Receiving money for doing, (seemingly) nothing may seem too good to be true, and sometimes we worry that if something sounds too good to be true, it’s not legit.

It’s ok if this thought crossed your mind; in fact, that’s actually  a good thing! 

It simply means you’re not blindly jumping in. Instead, you’re thinking critically, asking questions and gathering more information.  You’re doing your due diligence and that’s a smart strategy before you invest in anything!

Do you want to know the  hidden risks of investing and behind the scenes of real estate syndications? Are real estate syndications really too good to be true? That’s exactly what we’ll cover in this article. Ready? Let’s do it.

What Are The Pros & Cons of Real Estate Syndications?

Just like for every purchase, investment, or decision, there are pros and cons to real estate syndications as well. Each one may matter to you … or not. It completely depends upon your investing goals, timeframe, and financial position.

Pros: 

  • No active responsibilities – You don’t have to worry about or deal with tenants, renovations, or midnight emergencies. 
  • Set it and forget it – Most syndication deals are several years in length. Once invested, you don’t have to make other decisions for that cash for 3-10 years.
  • Checks just show up – As a passive investor, your monthly or quarterly cash flow checks get automatically deposited directly into your bank account..

Cons:

  • No control – As a passive investor, you’re hands-off. The sponsor team is 100% in charge of the day-to-day decisions and you don’t get a vote. 
  • Locked in long-term – Since most real estate syndications are 5 years or longer, you can’t just withdraw your capital willy-nilly.
  • The profit is split – As one of many investors, you’ll commonly receive a 70/30 split where 70% of the profits are divided between the passive investors (there could be hundreds just like you), and 30% is split between the sponsor team. 

You’ll learn more pros and cons as you dig into the details of investing in real estate syndications. We suggest keeping a running list and making notes around points that either excite or bother you.

Why Aren’t Real Estate Syndications for EVERYONE?

Not everyone has $50,000 or more in readily investable cash. Even if they do, is the timing right? Have they ever heard of real estate syndications? Are they well informed? Do they trust a deal with so many moving parts?

Life Events

Among other things, consider the challenges life events bring into the picture. What if an adoption, wedding, graduation, or college is on the horizon for your family? 

Those may be reasons someone might hesitate to invest $50,000 or more in an investment for 5  (or more) long years. Any major life change comes with an impact to your financial situation. 

Dependent upon your cash situation and life event timing, it may or may not be the best time to invest in a real estate syndication, regardless of what the market is doing.

Accreditation

As it stands, becoming an accredited investor is a pretty hefty barrier to entry. 

An accredited investor can invest in nearly anything they want. To qualify as an accredited investor, you must have either over $1mil net worth (excluding your primary home) or make $200,000 per year ($300,000 joint income), have done so for the past two years, and intend to make the same this year. 

Even if you haven’t reached accredited status yet, you can still invest in real estate syndications, although these deals may be much harder to find since they cannot be publicly advertised. 

How Trusting Are You?

Investing passively requires you to have mountains of trust in your sponsor team, the decisions they make, the people they hire, and the renovations they choose. If you’ve got a control freak gene deep down inside, this may not be the best investment for you. 

On the other hand, if you just want to chill while reading your monthly update while the checks roll in, stay with me here. 

How Could You LOSE Money Investing in a Real Estate Syndication?

So, let’s address the elephant in the room. Yes, you could lose money investing in a real estate syndication. 

Real estate syndications are just like stocks, or mutual funds or any other investment vehicle and none of them come with a guarantee. If things go South, you could lose some or all of your original investment capital. 

Yep, there it is. The honest truth. 

If you invest right, that shouldn’t happen. The less experienced the operator and the less savory the submarket then the greater likelihood of losing money. But if you’re smart about the deals you invest in, that shouldn’t happen. Which brings us to my last point.

Why Smart Investing Isn’t Truly Passive

If you want to be a true passive investor, who’s able to relax as the sponsor team works on your behalf, then it’s imperative you learn to invest smartly. 

In order to maintain a level of trust in the investment and the sponsor team and truly enjoy the passive income without lifting a finger, you have to practice due diligence and critical thinking at the front-end of the deal. 

Pushing through the overwhelm of markets, metrics, interest, splits, accreditation, and everything you have to learn and understand before making an informed decision is imperative. There’s a TON of work you have to do upfront in order to attain the comfort level a true passive investor has. 

You wouldn’t just throw around $50,000 of your hard-earned cash without educating yourself about where it’s going first, right? Only after you put in the work, connect with the right people, and do your own research to attain a level of comfort toward your investment deal, will you be able to sleep soundly at night while your passive investment earnings get deposited. 

Conclusion

While real estate syndications are awesome, they aren’t perfect, and they are not for everyone. 

Real estate syndications have pros and cons, risks and rewards, and require lots of research and time invested upfront. 

If you’re willing to invest your time and do your research in order to facilitate wise investments on your part, I think you’ll find real estate syndication to be a fabulous experience. 

Five Strategies for Capital Preservation

2022 has been a roller coaster of a year. 

Between rising interest rates, inflation hitting a 40-year high and a war in Ukraine, leading economists have been forecasting a recession all year.

As investors, we all love good returns.  In fact, passive income is a key reason why many of us invest in real estate.

But the most important thing that we need to focus on in real estate syndications – regardless of what the economy is doing – is CAPITAL PRESERVATION. 

Put simply, how do we NOT LOSE OUR MONEY?

It’s still a great time to invest and capital preservation is all about mitigating risk.  As Warren Buffett puts it, there are two rules to investing: 

Rule #1: Never lose money

Rule #2: Never forget Rule #1

Here are the five strategies for capital preservation that will minimize risk in a real estate syndication deal: 

#1 – Raise money to cover capital expenditures upfront

Imagine the avalanche of problems that can accumulate when capital expenditures (like renovations) must be funded purely by cash flow. In this case, cash-on-cash returns, which vary based on occupancy and maintenance costs, would have to fund sudden HVAC repairs instead of unit renovations according to the business plan. In this case, the business plan falls behind schedule, units aren’t ready as planned, and vacancy persists. 

Instead, we ensure the funds for capital expenditures are set aside upfront. As an example, if we need $2 million for the down payment and $1 million for renovations, we will raise $3 million upfront. This means we have $1 million cash for renovations and won’t have to rely on monthly cash-on-cash returns. 

#2 – Purchase cash-flowing properties

One great option to preserve capital is to purchase properties that produce cash flow immediately, even before improvements. If units don’t fill as planned or the business plan isn’t going smoothly, just holding the property would still allow positive cash flow. 

#3 – Stress test every investment

Performing a sensitivity analysis on the business plan prior to investing allows us to see if the investment can weather the worst conditions. What if vacancy rose to 15% and what would happen if the exit cap rate was higher than expected? 

Properties look wonderful when they’re featured in fancy marketing brochures with attractive proformas (i.e., projected budgets), but stress testing those numbers helps us take a look at how the performance of the investment may adjust based on potentially unpredictable variables. 

#4 – Have multiple exit strategies in place

In any disaster or emergency, you want to have several ways out. In case of a fire, you want a door and window. The same goes for real estate syndications. 

Even if the plan is to hold the property for 5 years, no one really knows what the market conditions will be upon that 5-year mark. So, it’s important to account for contingency plans, in case you need to hold the property longer, and the possibility of preparing the property for different types of end buyers (private investors, institutional buyers, etc.).

#5 – Put together an experienced team that values capital preservation

Possibly the most critical strategy of all is to have a team that values capital preservation. This includes both the sponsor and operator team(s) and the property management team. All of these people should be passionate about their role and display a strong track record of success. 

The more experience they have in successfully navigating tough situations, the better and more likely they will be able to protect investor capital.

Conclusion

While capital preservation may not seem very exciting, it is a key building block of a solid deal. Every decision and initiative by the sponsor team should be rooted in preserving investor capital.

The five strategies for capital preservation we use in our real estate syndication deals include:

  • Raise money to cover capital expenditures upfront
  • Purchase cash-flowing properties
  • Stress test every investment
  • Have multiple exit strategies in place
  • Put together an experienced team that values capital preservation

So, when you are browsing for your next real estate syndication investment, go ahead and admire the pretty pictures, daydream about the projected returns, and imagine how smoothly that business plan might go. 

Then, take a second pass, read between the lines, and look back through the deck with an investigative eye. Look for hints that capital preservation is as important to the sponsor team as it is to you. 

Taking the time to dig into the business plan will enable you to make an educated decision as to whether or not this particular project is right for you.