As a real estate investor, taxes aren’t the most exciting aspect of real estate investing, but they’re important to understand nonetheless.
As a real estate investor, it’s much more fun to focus on great returns and upgrading your lifestyle, but you must be sure to not overlook taxes completely.
As a passive investor in a real estate syndication, your sponsor team will guide you through tax season and help you ensure you’re getting the tax benefits you deserve. The beauty of investing in real estate is that your investments lower your tax obligation rather than increase it, unlike some other investment vehicles, such as mutual funds and stocks.
Any time you’re investing your hard-earned money, you should do your due diligence to gain a working knowledge about how you may be taxed as a result of your investment and explore the best strategies to decrease your tax bill.
There are different kinds of tax strategies, and knowing the best one will give you a great advantage and savings as a real estate syndication investor.
How does Depreciation and Cost Segregation work?
Wear and tear on a property over time is expected and you’re allowed to write off the depreciated value of an asset over time. You’re allowed to write off the value of residential rental assets over 27.5 years and commercial properties can be written off for 39 years.
Depreciation affects you, as the investor, because when you earn cash-on-cash returns, the tax on the amount you receive is deferred. This means you aren’t required to pay taxes on the earnings from the asset until it’s sold. You also have the option to elect bonus depreciation, if you choose, which can even further maximize your tax benefit.
Cost segregation amps up the tax advantages even further. In typical real estate syndications, the property is held for around five years. With straight-line depreciation, properties held for many years receive the most benefit. By utilizing cost segregation, you’re able to take into account the various aspects of the property that will depreciate at a quicker rate. For instance, the signage of an apartment complex is expected to deteriorate quicker than the roof. Cost segregation can speed up depreciation benefits, so investors can have further tax advantages even within five years’ time.
Tax Benefits Of Investing In Real Estate
By investing in real estate, either actively or passively, you can qualify for significant tax advantages. You can use the deductions earned from real estate investments to offset your other income and ultimately greatly decrease your tax bill each year.
In order to build wealth, it’s not enough to earn income, you also have to know what strategies can best help you maximize the tax benefits available to you. Investing in real estate syndications gives regular people the chance to build wealth quickly and sustainably, while also mitigating risk.
As always, be sure to consult your CPA or tax advisor to assess your personal situation and determine what strategies best fit your needs and financial goals.
When you first begin to consider real estate syndication as an investment option, it can feel lonely, intimidating, or even like you’re going in blindfolded.
I personally experienced fears around investing in a property I’d never seen, concern about how I’d get my money back, and doubt around the inability to log into an account and see my money.
These fears were addressed head-on through research. Every article I read and every conversation I had built my certainty until I began to feel confident toward taking the plunge.
If you’re considering your first syndication and feeling hesitant, I recommend doing your research, connecting with other investors, reading through previous deals, and taking your time.
Do Your Research
The best way to build your investing confidence is through self-education and research. Listen to podcasts, read books, and find websites on real estate.
Rich Dad, Poor Dad by Robert Kiyosaki
It’s a Whole New Business by Gene Trowbridge
Principles of Real Estate Syndication by Samuel Freshman
Best Real Estate Investing Advice Ever with Joe Fairless
The Real Wealth Show with Kathy Fettke
Relevant Facebook groups and forums like BiggerPockets can help you learn what questions you should be asking.
It’s likely that other people have asked about your same concerns and, just by reading through the forum’s questions and answers, you’ll gain clarity.
Remember there are no dumb questions and that you have the right to be diligent about gathering answers to your concerns.
Connect with Other Investors
A successful investor needs a supportive community, and considering that syndication is a group investment, you’ll want to get networking.
Any new investors will share similar anxieties, questions, confusion, and excitement. Experienced investors can provide invaluable firsthand accounts of their experience with various projects and sponsors.
Find other investors through online forums like BiggerPockets, local networking events, or by asking sponsors if they’ll connect you to their current investors.
Review Previous Deals
Finding comfort with financial projections, summary data, and investment lingo may feel overwhelming.
As you review more investment summaries, you’ll start to understand the flow of the deal packages, how each sponsor communicates, and exactly which investments interest you.
Take Your Time
Each new investment opportunity fills up quickly. This can make new investors panic and start to believe they are missing the best deals.
Remember, there will always be another opportunity.
Allow yourself time to complete the steps laid out here, so that when you make your syndication choice, you are confident about every step.
If you take nothing else from this article, remember it’s completely normal to feel skeptical, anxious, and even timid when making your first syndication commitment.
The ability to take action is what separates the successful from those who give up.
Your first real estate syndication deal is a huge milestone in your investing journey, and, even though your head might be spinning now, this is a time to savor.
As you probably know, no two real estate investments are exactly the same. There are a million ways to structure a real estate deal, and just as many potential outcomes.
Some deals offer a huge potential upside, but also come with huge risks. Others offer steady cash flow, but without the potential for appreciation.
We look for deals that we would invest in ourselves, do our due diligence to ensure we feel comfortable investing our own money in the deal, and only then do we offer those opportunities to our investors.
We look at a lot of deals. And just like snowflakes, no two are the same. But we’ve established some criteria that we look for when evaluating deals, and these are the benchmarks we typically aim for in the investment opportunities we offer.
In this post, we’ll look at some of the typical returns we aim to offer investors.
Big Fat Disclaimer
You probably saw this coming from a mile away, but I gotta do it anyway. Before we get into the numbers, I have to insert a big fat disclaimer here, for the one percent of you who will, at some point, get all up in arms because we didn’t deliver these exact returns. Yes, I see you, don’t be trying to hide.
As the title of this post suggests, these are only PROJECTED returns. As with any investment, we cannot guarantee any returns, and there’s risk associated with any investment. This is only meant to give you a rough ballpark of the kinds of returns we’re typically considering.
With that, let’s get to it.
Three Main Criteria
If you’ve ever seen an investment summary for a real estate syndication, you know that there are a TON of facts and figures in there. #chartloversunite
Each metric has its merits and tells you a certain something about the asset and the deal at hand. When doing our quick synopsis of a deal, we look at three main criteria:
Projected hold time
Projected cash-on-cash returns
Projected profits at the sale of the asset
Projected Hold Time: ~5 Years
This is perhaps the easiest of the three criteria to understand. As the name would suggest, projected hold time is the amount of time we plan to hold the asset before selling it. Typically, we look at projects that have a hold time of around five years.
Why five years? Well, a few reasons.
First, five years is a relatively long time, if you think about it. Technically, you could have six children during that time (yes, I did the math). You could start and complete a college degree. You could binge-watch five seasons of your favorite Netflix show. You get the point. Five years is a decent chunk of time.
There are certainly some investors who are at a point in their lives where they want to invest for a longer period of time. However, we find that five years is a good length of time for most investors. Long enough to see some healthy returns, but not too long that you feel like your kids will have graduated from high school before you get access to that money again.
In addition, given real estate market cycles, five years is a modest timeline for us to get in, update the property, give the asset and market a little time to appreciate, and get out before lingering for too long (when it’ll be time to update those units all over again).
Plus, commercial real estate loans are often on a seven- or ten-year fixed term, so with a five-year projected hold time, that gives us a bit of buffer to hold the asset a little longer if needed, in case the market is soft at the time we’d originally projected a sale.
Projected Cash-on-Cash Returns: 8-10% Per Year
The next core metric we look at are the cash-on-cash returns, also known as the cash flow, which makes up the passive income you get during the course of the investment.
Cash-on-cash returns are what’s left after you factor in vacancy costs, mortgage, and expenses, and it’s the pot of money that gets distributed to investors, usually on a monthly or quarterly basis.
For the projects we’re looking at, we like to see cash-on-cash returns of about eight to ten percent per year.
That is, if you were to invest $100,000, the projected cash-on-cash returns for each of the five years would be about $8,000, roughly $2,000 per quarter or $666.67 per month.
This comes out to roughly $40,000 over the course of a five-year hold.
Just for kicks, let’s compare that to what you would get from a savings account during that same amount of time. Average interest rates on savings accounts sit south of one percent, but let’s just stick with one percent for simplicity’s sake.
If you were to put $100,000 into a savings account over five years, you would make about $5,000 in interest over the course of five years ($1,000 per year for 5 years).
That means that, at the end of 5 years, you’d have a grand total of $105,000. When you compare that to the $140,000 with the real estate syndication, it’s a total no-brainer.
Projected Profit Upon Sale: 40-60%
But of course, that’s not all. Perhaps the biggest piece of the puzzle is the projected profit upon sale of the asset in year five.
At this point, the units have been updated, the tenant base is strong, and rents are at market rates. Each of these improvements contributes to the overall revenue that the asset is able to generate, thereby increasing the property value. (Remember that commercial properties are valued based on the amount of income the asset generates rather than comparables, so these improvements typically add significant value to the property by the time of the sale.)
For the projects we’re looking at, the projected profit at sale is around forty to sixty percent.
Sticking with the previous example, if you were to invest $100,000, you would receive $40-60,000 in profits upon the sale of the asset in year five.
This is on top of the cash-on-cash returns you’re receiving throughout the hold time.
I should also point out that the projected profit on sale takes into account the improvements and efficiencies the sponsor team plans to implement, but it does NOT factor in appreciation of that particular market.
When we choose markets to invest in, we’re always looking for areas where job growth is strong, and as a by-product of that, population is increasing as well. This leads to increased demand for housing, which, in turn, leads to increased rents.
However, when putting together these projected returns, we always underwrite conservatively, and we never count on that market appreciation.
We factor in baseline inflation, but anything on top of that is a bonus. This is so that, even if the market tanks during the course of the hold, we can make sure that the investment can still stay afloat, and that investor capital is protected.
Summing It All Up
So there you have it. Projected returns for our middle-of-the road typical investment looks like this:
8-10% annual cash-on-cash returns
40-60% profits upon sale of the asset in year five
If you were to invest $100,000 in a real estate syndication deal with these projected returns, you would end up with roughly $200,000 at the end of five years.
Double your money in five years? Try asking for that from a savings account, and let us know how that goes.
For most people, the process of buying a house is fairly familiar.
You decide you want to buy a house, think about the neighborhoods and features in your must-have versus nice-to-have columns, talk with a lender to see how big a loan they’re willing to give you, consequently move some things from your must-have to your nice-to-have column after you get your lender’s pre-approval letter, then get together with a broker to tour properties until you find the home of your dreams and put in that offer package that the seller would be crazy to turn down. [Insert your own variations and horror stories here.]
By extension, the traditional types of real estate investing that involve buying a house and making some sort of profit on it, are also fairly easy to grasp. Fix-and-flip: buy a house, renovate it, sell it for a profit. Buy and hold: buy a house, rent it out, get monthly rent checks.
Beyond that, the edges can get a little fuzzy, especially when you start talking about things like group investments (aka, syndications), in which you invest passively alongside several, sometimes hundreds of, other investors to purchase a large asset, like an apartment building.
In this post, I’d like to take you through that process from start to finish, so you have a clear understanding of all the steps involved in investing passively in your first real estate syndication.
While the timeline can vary with different deals, the overall steps of investing in a real estate syndication are largely the same:
1. Decide whether to invest in real estate, period
2. Determine your investing goals
3. Find an investment opportunity that fits
4. Reserve your spot in the deal
5. Review the PPM (private placement memorandum)
6. Send in your funds
I tend to think of this process as a funnel, each step of which helps you gain a little more clarity on what you want and helps you get a little closer to your goals of finding and investing in a specific deal.
Step #1 – Decide Whether to Invest in Real Estate, Period
This is perhaps the most important step of all, the decision of whether you want to invest in real estate, period. After all, there are many other things you could invest in, from gold to coffee plantations to stocks and bonds.
This is a decision that I won’t be able to make for you. You’ll have to look at your overall portfolio, reflect on your goals, and decide whether investing in real estate can help you reach those goals.
What I can tell you, is a bit about how I got into real estate investing.
For me, I more or less fell into real estate investing. The first house my husband and I bought was a duplex, so right out of college, we became landlords. We quickly glommed onto this idea of passive rental income, and we had fun doing the renovations ourselves and finding tenants (some of whom are still good friends to this day).
Over the years, as we acquired more rental properties, we really started to grasp the power of passive income. Today, we have a number of rental properties in a number of different markets. Some we purchased ourselves, and others we invested in through group syndications.
Has every investment been a homerun? Absolutely not. But am I glad we made each and every investment that we did? Yes. 100% yes. Real estate has taught us about people and relationships, leverage, tax benefits, passive income, and the power of community. For us, real estate is a critical part of our personal portfolio and of our long-term strategy of building wealth for our family.
Once you decide that you want to invest in real estate, think about what you’re hoping to get out of it. Are you looking for a long-term or short-term investment? Are you hoping for a lump sum fairly quickly, or a steady stream of passive income over time? How much do you have to invest, both in terms of money and in terms of time?
If you’re not afraid to roll up your sleeves and put in some sweat equity, or you want to choose your own tenants or cabinets or flooring, you might consider trying a fix-and-flip, or buying and holding a small rental property.
If, on the other hand, you want more of a set-it-and-forget-it type of investment, a real estate syndication might be a better fit. You can invest your money alongside other investors, then have an asset manager take the helm, manage the asset, and carry out the business plan to update the units and maximize impact and returns.
Step #3 – Find an Investment Opportunity That Fits
If, at this point, you’ve decided that a real estate syndication is the best fit for you, the next step is to find a syndication opportunity that works for you. Just as there are a variety of different real estate assets you can invest in personally, there are a variety of real estate syndication projects available as well, from ground-up construction to value-add assets, and even turnkey syndications.
To help investors learn about investment opportunities, deal sponsors typically provide some variation on the following materials:
Full investment summary
These are the core materials that will give you a full 360-degree view of the asset, market, deal sponsor team, business plan, and the projected financials.
Personally, when I review these materials, I’m looking first and foremost at the team who’s running the project. I want to make sure they have a solid track record and that they’re good people. As you know, you can give a great project to a terrible team, and they’ll drive it into the ground. On the flip side, you can give a struggling project into a terrific team, and they’ll turn the whole thing around.
Beyond the team, I look to see if the business plan makes sense, given the asset class, submarket, and where we are in the economic cycle. I do my own research on the market, looking at job growth, population growth, and other trends. I look at the minimum investment amount, projected hold time, and projected returns. I look to make sure that the team has multiple exit strategies in place, in case their Plan A doesn’t pan out. I look for conservative underwriting. I attend or review the investor webinar and ask tough questions.
If, after all my research and analysis pans out, I consider investing in the deal.
But again, this is my personal philosophy and methodology. As you review different investment summaries, you’ll come up with your own criteria of what you’re looking for. The more you review, the better you’ll know exactly what you’re looking for.
Step #4 – Reserve Your Spot in the Deal
One thing to note about real estate syndications is that the opportunity to invest in the deal is on a first-come, first-served basis.
This can be especially important for deals in hot markets with strong deal sponsors.
That’s why it’s important to do your research ahead of time, to know how much money you want to invest, and what you’re looking for in an investment opportunity.
That way, when the opportunity opens up, you can jump on it.
Often, there will be an opportunity to put in a soft reserve amount. This is to hold a spot for you in the deal while you take some time to review the investment materials. If you decide to back out or reduce your investment amount later, you can do so with no penalty.
The flip side is, if you don’t hold a place, but then later decide you want to invest, there may no longer be room for you in the deal, and you’ll have to join the backup list.
Not every deal offers a soft reserve, but when there is one, and I think I might be interested, I always put in a soft reserve to buy myself some more time to think about the deal, review the materials, and do my own research.
For deals with a soft reserve, this step and the previous step #3 might be flipped or more fluid, so I tend to review the executive summary, reserve my spot in the deal, then review the rest of the materials.
Step #5 – Review the PPM
Once you’ve decided to invest in a deal, the first “official” (aka, legal) step is the signing of the PPM (private placement memorandum).
This is a legal document, often quite lengthy, that goes into detail about the investment opportunity, the risks involved, and your role as an investor in the project.
The PPM is certainly not the most fun document to review, but it’s very important that you read through it, so you fully understand all aspects of the investment opportunity, including the risks, subscription agreement, and operating agreement.
As part of signing the PPM, you’ll also need to decide how you want to hold your shares of the entity that’s holding the asset. Often, you can also specify whether you want your cashflow distributions sent via check or direct deposit.
Step #6 – Send in Your Funds
Once you’ve completed the PPM, the next step will be to send in your funds (aka, the amount you’re investing into the deal).
Typically, you will have the option to either wire in your funds or to send in a check. I’ve used both methods before and have had no issues with either method.
Pro tip: Before wiring in your funds, be sure to double check the wiring information, and let the deal sponsor know to expect your funds so they can be on the lookout.
Step #7 – Celebrate
You did it! By this point in the process, you’ve done your due diligence on the investment, reserved your spot in the deal, reviewed all the legal documents, and sent in your funds.
That means you’re done with all the active parts of your role as an investor. If we’re using the syndication-as-an-airplane-ride analogy, that means you’ve picked your destination, bought your ticket, checked your bags, reviewed the safety information, buckled your seat belt, and now you’re ready for a cocktail and a movie.
The next piece of communication you’ll likely receive is a note once the property has closed. Deal sponsors typically like to put lots of smiley emojis and exclamation points in these emails.
After that, expect monthly updates on the project, more detailed quarterly reports on the financials, quarterly cashflow distributions, and an annual K-1 for your tax returns.
So, there you have it. Hopefully, the process of investing in a real estate syndication is a bit clearer now, and perhaps, a little less intimidating.
Real estate syndications are more of a set-it-and-forget-it type of investment, so most of your active participation is up front. After you decide to invest in a syndication, you review the investor materials (executive summary, full investment summary, and investor webinar), reserve your spot in the deal, review and sign the PPM, and send in your funds.
The first time you do it, it might seem a bit confusing as to what to expect and what questions to ask. However, as you review and invest in more deals, the process will become second-nature.
Let me ask you a question. How did you find the home you’re currently living in?
I’m guessing that you didn’t just close your eyes and blindly point to a spot on the map. You probably had a specific area in mind, probably something fairly close to school or work, near some shopping or amenities you like, and with a specific number of bedrooms, bathrooms and price range in mind.
Let’s say you were looking for a three-bedroom home in the middle of the city, near public transit. Knowing your criteria, you likely would have turned down a one-bedroom condo in the suburbs, even if it had a beautiful view and a rooftop patio. You could picture beautiful summer evenings on that rooftop patio, but you could also picture your kids crammed into that one bedroom with you, so no. Cross that one off the list.
The same thing goes for investing in real estate. Before you do so, you have to know what you’re looking for, so that you’re anchored by the must-haves and not distracted by the nice-to-haves.
Without clear goals, you’re more likely to get swayed by any ol’ investment opportunity that comes along, because, hey, the numbers seem like they work, and the property photos look nice. Or, on the flip side, you might be paralyzed with fear because you’re not sure which opportunity is best for you, since they all look decent.
Once you have your investing goals in mind, you’ll have a clear idea of what you’re looking for from an investment, so when that next opportunity comes along, you can easily determine whether it’s a good fit for you.
Let’s take a closer look at a few examples, so you can try them on for size and see if any of these investing goals resonate with you and your life.
Investing Goal Example #1: Investing for Cash Flow
Meet Janet. She’s a working mom who’s been in the corporate world longer than she cares to admit. Her job pays well, but she doesn’t love it, especially because it comes with long hours and lots of meetings. Meetings upon meetings.
Janet’s investing goal is to create passive income streams that will cover her family’s living expenses, so she can eventually quit her job.
In other words, Janet is investing for cash flow. She’s interested in investments that will provide a steady and ongoing return for her family now, rather than years in the future. She’s looking for an investment whose returns will help offset her income, so that she can eventually quit her job.
Janet’s goal is to generate $2,000 per month in cash flow. If she’s able to do that through passive income, she’ll switch from a full-time to a part-time role, giving her more time to spend with her family.
When reviewing passive investing opportunities, she sees that she can make about eight to ten percent in cash flow per year from many of the multifamily real estate syndications she’s looking at.
As such, in order to get $2,000 per month, or $24,000 per year, in cash flow, Janet would need to invest roughly $300,000.
$300,000 x 8% = $24,000
With that benchmark in mind, Janet can easily turn down any investment opportunities with projected cash flow returns lower than eight percent. If she sees any opportunities with cash flow higher than ten percent, she knows she would be highly interested.
Investing Goal Example #2: Investing for Appreciation
Meet Ricardo. Unlike Janet, Ricardo isn’t interested in cash flow. He has plenty of good, steady income coming in every month, both from active and passive sources.
Ricardo doesn’t mind some cash flow, but that’s not why he’s investing. Ricardo is investing for potential appreciation. He’s seen how coastal cities like New York and San Francisco have had huge upswings in real estate values, and he wants a piece of that. He knows that these kinds of investments come with higher risk, but he’s okay with that.
Ricardo is also okay waiting a bit longer for a potentially bigger payout, rather than getting returns immediately. Because he has multiple streams of passive income and has a fair amount of assets, he’s okay with taking a bit more risk. If the appreciation doesn’t play out as predicted, and he doesn’t get as high a return as expected, he’s fine with that. He just wants to invest for the chance of appreciation.
Many investors will tell you that it’s way riskier to invest for appreciation, and that you should always invest for cash flow first and foremost. While this is true for many investors, there are some investors with a higher risk tolerance who want to gamble on that appreciation, for the possibility of a higher payout. There are definitely people who have made some great money through appreciation. But there are also many who have lost money investing for appreciation.
Ricardo knows his risks, though. So he looks for investments in appreciating markets, as well as value-add deals, so he can maximize his chances for appreciation.
The Hybrid: Investing for Cash Flow AND Appreciation
Most investors are not strictly like Janet nor strictly like Ricardo. Rather, most investors are looking for a combination of cash flow and appreciation.
You get some cash flow throughout the lifecycle of the project, but you also add value and invest in an appreciating market, to maximize the potential for appreciation.
Hybrid investments like this give you the best of both worlds. Hybrid investments are our sweet spot, mainly because it’s what we like to invest in ourselves. We get ongoing cash flow to help with our current living expenses, as well as the potential for appreciation later on in the project.
Know Your Goals
I’ve been in the field of graphic design for several years now, and I’ll tell you, when you see one of the investment summaries for a real estate syndication investment opportunity, you’re going to get distracted by the pretty colors and beautiful photos. I certainly did.
That’s why it’s so important to know what you’re investing for, so you can set the photos aside and really scrutinize the core of the investment opportunity, and determine whether it fits with your investing goals.
That way, when a deal comes along that fits your criteria, you can pounce on it with full confidence that it’s the right thing to do for you and your family.