Real Estate Syndications — Are They Too Good to be True?

by | Mar 31, 2021 | Investing Process, Passive Investing, Real Estate Investing 101 | 0 comments

When you first hear what real estate syndications are and how passive investing in them works, your first question might be, “What’s the catch?”

Receiving a check in the mail — or an ACH deposit in your bank account — for doing seemingly nothing sounds too good to be true. What are the hidden risks of investing in a real estate syndication? What happens behind the scenes?

If these are things you’ve wondered about, then good for you — it means you’re not jumping in blindly. Instead, you’re thinking critically and doing your own due diligence. And for that, we applaud you!

What Are the Pros & Cons of Real Estate Syndications?

 Just like every major decision, there are both pros and cons to investing in real estate syndications. A specific pro or con may matter to you, or it may not. It completely depends on your investing goals, timeframe, comfort level, and
financial position.

Pros: 

  • No active responsibilities – You don’t have to deal with tenants, termites, or toilets. The property manager deals with those issues, with oversight by the deal sponsors.
  • Set it and forget it – Most syndication deals are several years in length. Ours are typically 3 to 5 years, but some syndicators plan for their deals to last 7 to 10 years. Once you’re invested, you don’t have to make other decisions for that cash for somewhere between 3 to 10 years.
  • Distributions just show up – As a passive investor, your monthly or quarterly cash flow checks arrive automatically — usually through ACH direct deposit.
  • Tax benefits – Wait, you can earn cash flow and grow your equity in the deal, all while getting tax benefits? Yes please!

Cons:

  • No control -​ As a passive investor, you’re hands-off. The sponsor team is in charge of the day-to-day operating decisions. Your decisions are mostly
    limited to deciding whether to invest with a particular syndicator or in a particular property.
  • Locked in long-term – Since most real estate syndications are 5 years or longer, you can’t just withdraw your capital when you feel like it.
  • The profit is split -​ As one of many investors, you’ll commonly receive an 80/20 or 70/30 split, where 70 to 80% of the profits are divided between the passive investors (based on the amount they invest), and 20 to 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. If you’re in new territory and still trying to decide if they’re right for you, we suggest keeping a running list and making notes about points that excite you or trouble you.

Why Aren’t Real Estate Syndications for Everybody?

Well first off, not everybody has $50,000 or more in cash or retirement account funds ready to invest. That’s not always the minimum, but it’s common.  Even if they do, is the timing right? Are they knowledgeable enough about how a deal works to make an educated decision? 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 a new child, wedding, graduation, or college is looming close for your family?

Those might be reasons someone would hesitate to invest $50,000 or more in a syndication for 5 years or more. Any major
life change comes with an impact to your financial situation.

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

Accreditation

Some syndication deals are only open to accredited investors, and becoming an accredited investor can be 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 $1million net worth (excluding any equity in your primary home) or have a certain income level ($200,000 per year if you’re single, or $300,000 joint income for married or similar couples), and have done so for the past two years, with the likelihood of it continuing this year.  There’s also a new way to qualify as accredited without meeting these criteria, but only for those who qualify with a certain professional status, such as having a securities license.

If you haven’t reached accredited status yet, you can still invest in real estate syndications, but only in certain deals. And they may be harder to find because they can’t be publicly advertised; you need to have some kind of relationship with the deal sponsors.

How Trusting Are You?

Investing passively requires you to have trust in your sponsor team, the people they hire, the renovations they choose to do, and the decisions they make on how to run the property efficiently and increase its value. If you’ve got a control freak gene inside you, these may not be the best investments for you unless you can overcome it. 

On the other hand, if you just want to lay by the pool and read your monthly update while the checks roll in, keep reading. 

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, mutual funds, or any other investment vehicle. None of them come with a guarantee, and risk always accompanies the opportunity for reward. The answer to the question, “What’s the worst-case scenario?” is always the same: you could lose up to 100% of your investment capital. 

Yep, there it is. The honest truth. 

However, unlike when buying a single-family rental property with a personally-guaranteed mortgage, your other personal assets can’t be touched if the deal goes badly. Only the funds you’ve invested in the deal are at risk.

And if you invest right, that shouldn’t happen anyway. The less experienced the operator or deal sponsor and the less savory the submarket, the greater the 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, someone who’s able to relax as the sponsor team works on your behalf, then it’s important that you learn to
invest smartly. 

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 before investing. 

Getting through the markets, metrics, interest, splits, and everything else you have to learn and understand before making an informed decision is imperative. There’s a lot of work to do up front 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 will you be able to sleep soundly at night while your passive investment earnings get deposited. 

Conclusion

While real estate syndications are awesome (very much so!), they aren’t perfect, and they aren’t for everyone. 

Real estate syndications have pros and cons, risks and rewards, and require research and time invested up front. 

If you’re willing to invest your time and do your research to facilitate wise investment decisions, I think you’ll find real estate syndications to be a fantastic experience.