Well, well, well, so you want to invest in real estate?
Welcome to the wealthiest club in the history of time.
Ever since the dawn of time, humans have been vying amongst themselves to control the land.
And he who controls the most land, wins.
Real estate is inherently valuable, and the ultra-wealthy know this.
So here’s the question, where do you begin? We’ll dive into one of those possibilities today, and compare that to investing passively in a commercial real estate deal.
If you ask your financial advisor about investing in real estate, he’ll likely tell you to invest in a real estate investment trust, aka a REIT.
What is a REIT? A REIT is a company that invests in real estate. So just like a traditional stock, when investing in a REIT, you’re buying stock in that company. Just like investing directly in an apartment building, right?
No. And here’s the differences between investing in a REIT and investing in a real estate syndication.
When you invest in a REIT, you are buying shares in a company, similar to buying shares of Apple or Gamestop stock. You do not own the underlying real estate that the REIT owns.
On the other hand, when you invest in a real estate syndication, you, together with the other passive limited partners and active general partners, contribute directly to the purchase of a specific property held by an entity, typically a limited liability company (an “LLC”). Therefore, you have direct ownership interests in that property.
Just like traditional stocks, most REITs are listed on major stock exchanges. And again, just like stocks, you can invest in REITS directly or through mutual funds, exchange traded funds, etc. Since most REITS are publicly traded, they are easy to find and easy to invest in.
On the other hand, real estate syndications are not as easily accessible, are sometimes more difficult to find, and require a bit more effort to get involved. Prior to the JOBS Act of 2012, only the ultra-wealthy and the good ole boys at the country club knew, and therefore could, invest in real estate syndications. Even now, many investors still don’t know about them, although that is rapidly changing as investors become more aware of these attractive, alternative options.
Many syndications fall under certain SEC regulations that disallow public advertising. What does that mean for you? You’ll have to be connected with someone who has a deal to invest in.
For other syndications falling under a difference SEC regulation that does allow for public advertising, you’ll need jump over an additional hurdle, and that is to be an accredited investor. Once you find a deal, it will take more than the click of a button to invest. Instead, you’ll need to carefully review the opportunity, sign the legal documents and send your funds.
Number of Assets
A REIT will typically hold a portfolio of properties in a particular asset class across particular markets. This could mean great portfolio diversification for its investors.
On the other side, a real estate syndication typically involves a single commercial property. You’ll know the exact property. You’ll know the exact location. You’ll have access to property data, financials and a business plan tailored specifically for that asset.
When you invest in a REIT, it’s just like buying a stock. The price of a share varies depending on the REIT, but the investment minimum is therefore low. Real estate syndications, on the other hand, typically have investment minimums of $50,000, $75,000 or more, although you may occasionally come across investment minimums of $25,000 or $10,000.
Shares of REITs can be bought and sold at any time with the click of a button, just like stocks. Very liquid.
On the other hand, real estate syndications are considered illiquid, given that most business plans for these types of projects are for 3, 5, 7 or 10 year hold periods, during which your money is not easily accessible. Just like when you buy your home, it takes more than the click of a button when it comes time to sell.
One thing to point out here, liquidity is typically noted as the biggest negative for investing directly in real estate. However, note that because of this same reason, real estate is consistent, stable and predictable, while stocks and REITs are susceptible to panic selling, market fluctuations and higher volatility.
Whether we’re talking about stocks and REITS, or single family houses and real estate syndications, returns can vary significantly. That being said, let’s look at some data.
Over the last 40 years or so, publicly traded U.S. REITS have an average return of 12.87%. On a $100,000 investment, you could then expect a $12,870 per year return. That’s pretty damn good.
For a typical multifamily real estate syndication, we set our expectations a bit higher. When factoring in both quarterly cash flows and profits from sale, our projected returns over the hold period hover around 20%. On a $100,000 investment, you could then expect a $20,000 per year average annual return. Now that’s what I’m talkin’ about.
Herein lies the rub. You may have heard, but one of the biggest, baddest, best reasons to invest in real estate, is the tax benefits. Just like investing in a single family house, when you invest in a real estate syndication, you are investing directly in real estate and receive a variety of tax benefits, including depreciation. Most of the deals we invest in take advantage of a special kind of accelerated depreciation called cost segregation.
But to keep it simple, those tax benefits turn into “paper losses” which often offset most, if not all, of the cash flow you receive from the property, meaning you could pay zero (yes, zero) in taxes.
On the other hand, when you invest in a REIT, you invest in a company that is in the business of buying real estate. Therefore, you are indirectly investing in real estate and lose a significant portion of the tax benefits of directly owning real estate. When you go to sell your shares, you’ll pay capital gains taxes and potentially ordinary income taxes on any dividends. No bueno.
So what should you invest in? It depends. Consider all of the key differences we went though above and make the best choice for you in your particular situation.
If you only have $2,000 to invest, go for that REIT. If you have $50,000, then you have more options. Consider your liquidity needs, tax benefits and return expectations. Maybe do both!
The key is getting educated (which you’re doing right now!), formulating a plan, and then taking action. Taking action is where most people get hung up. Don’t be that guy or gal.