How Do They Stack Up? REITs vs Syndication
You may have heard about REITs (Real Estate Investments Trusts) in the news during the 2008 financial crisis or in the more recent market crash that occurred when the Coronavirus hit the US in March 2020. What you probably didn’t hear about during those events is what happened to syndications. This is because real estate syndications are less widely known and are private investments.
If you have been thinking about investing in real estate or possibly expanding your investment portfolio this question may have been on your mind; what is the better passive investment between REITs and Real Estate Syndications?
REITs originated in the 1960s in the US and have gained popularity amongst investors over the last few decades and are a more common household name but what exactly is a REIT?
What is a REIT?
A REIT is an entity that invests in several different real estate assets based on the mandate of that REIT. Someone that invests in a REIT is effectively investing in the company that invests in this portfolio of assets in a similar manner that an investor invests in a basket of stocks when they buy an Exchange Traded Fund/Mutual Fund. A REIT is like a mutual fund that has real estate.
What is a Syndication?
Syndications, on the other hand, involve numerous investors pooling cash together for the direct purchase and investment in real estate using an LLC (limited liability company) to purchase that property. In this LLC structure each investor is a partner and owns a share of the LLC. Syndications have only started to get more attention recently due to the advent of equity crowdfunding with the 2012 JOBS act that allowed for equity crowdfunding. Crowdfunding is now taking something that was previously private and making it a more house hold concept.
We will focus on single asset purchases in this article as opposed to pooled funds which may share some similarities with REITS.
How do REITs compare to Syndications?
So how do REITs stack up against Syndications? What are the similarities and differences between REITs and Syndications? We will look at several different categories to see how the two compare:
Work Required By The Passive Investor
Diversity
Barriers to entry
Returns
Cash Flow
Taxes
Liquidity
Volatility In Value
Work Required By The Passive Investor
REITs
Investing in (public) REITs is like investing in stocks and investors enjoy the passive income of real estate without the headaches that come with being a landlord. As with any investment in the stock market, investors should do their upfront due diligence to select the best REIT to invest in.
Syndication
Passive investing in syndication provides hands off income for the investor. There is work required upfront to find syndication opportunities and reviewing investment opportunities to choose which one to invest in. No on-going work is needed from the investor, just sit back relax and collect your cash flow.
Diversity
REITs
Due to the nature of REITs (an investment vehicle that holds several different assets) it inherently provides diversity and risk mitigation. A REIT may allow an individual investor to purchase one REIT stock and the underlying assets in the REIT may be of different markets and asset classes ranging from residential to commercial real estate.
Syndications
When investing in a syndication you are purchasing one asset. The result of your investment is concentrated and highly dependent on the performance of that one property and investment sponsor. It is harder to diversify in a syndication than when investing in REITs. An investor may need to have a decent sum of money to diversify their investment portfolio of real estate syndications.
Barriers to Entry
REITs
There are many REITs available on the stock market. This allows practically anyone with enough money, often less than $100, to purchase a share in a REIT.
Syndications
Syndications require a more rigorous review of the investor to ensure that they qualify to invest in a syndication based on SEC regulation requirements. Depending on the type of syndication an investor may need to be accredited or have a pre-existing relationship with the investment sponsor. Minimums for Syndications are typically $25,000 or more although you may be able to find opportunities with lower minimums.
Returns
REITs
Based on a study done by the National Council of Real Estate Investment Fiduciaries, REITs have returned 10.5% average annual return over the last 25 year ending March 2019. Other studies by NARIET have shown this average to rise to 10.9% for the 25 years ending January 2020. This means that on average for every $100 you invest in a REIT you will earn $10.9 and for every $100,000 you invest you will earn $10,900. These returns are averages over several decades and may be subject to volatility as we will discuss later.
Syndications
Most syndications aim for a minimum annual cash flow of 8% or more during the hold period of the investment (returns can increase to double digit returns later in the hold period). This means that for every $100,000 you invest in a syndication you would earn $8,000 at the end of the year. This ongoing cash flow is great but one of the benefits of syndications are the outsized returns that may be received on the sale of the property. Once this additional income from the increased value of the property at sale is distributed, investors may find that their annualized returns top 30% or more. Unfortunately, investors in REITs do not participate in this upside of profit at the sale of the property.
Cash flow
REITs
As discussed above REITs provide dividends (cash distributions) on an ongoing basis through out your holding of the investment. You may be able to earn additional income from the sale of your shares but this valuation (and your consequential gain or loss) is subject to market volatility as discussed later in this article.
Syndications
Syndications provide regular ongoing cash distributions on a monthly or quarterly basis while the investment is held. There is additional benefit of a lump sum payment at the end of the investment as well with the return of your original capital.
Taxes
REITs
REITs operate like stocks and pay out dividends as their cash distribution. These dividends are taxed as ordinary income as opposed to passive income so you may find yourself paying more taxes than expected based on the distributions from your REIT holdings. You probably invested in REITs because you know real estate has great tax benefits. Well, this is true; REITs do receive tax benefits of depreciation however this is factored in before you receive your distribution. When investing in REITS you will have no additional tax shelters to save more of your income and pay less taxes.
Syndication
You receive all the tax benefits of owning rental real estate when you invest in a syndication. That means that you can take “paper losses” from depreciation and reduce your tax liability to 0. You would effectively pay no money on the income that you earned from the syndication and may be able to use these tax benefits to reduce tax liabilities from other passive income streams. You can also perform 1031 exchanges (immediate reinvestment of profits into another investment in line with tax regulations) with your gains from sale of the investment and defer paying taxes until you die; at this point your children will receive your investment income at a stepped-up valuation and will owe no taxes.
Liquidity
REITs
There are both publicly traded and “untraded” or private REITs. Publicly traded REITS are more likely the type that you are more familiar with and think about when you hear about REITs on the news or see them in your retirement account. Publicly traded REITs are registered with the SEC and are freely bought and sold on the stock market. These shares are highly liquid and there is a clear market indication of pricing and related demand as they are traded on the stock market.
Untraded REITs, in comparison to public REIT stocks, are not easily traded or may not be able to be traded as their name implies. These securities are not on public markets and they may have restrictions and fees around their redemption.
Syndications
All syndications are private investments governed by SEC regulation but not available on public markets such as the stock market. These “off market” investments will differ on a case by case basis on what are the requirements for early exit of the investment and sale of your shares. The investment circulars will include details around restrictions around the time frame that needs to expire before you can sell your shares and who would get first rights to purchase your shares. As these shares are private securities, they are not very liquid, and you would have to find individuals who would be interested in purchasing these shares who also meet the requirements of the syndication.
Volatility in Value
REITs
Public REITs are traded on the stock market and as such they are subject to similar volatility that the overall stock market experiences. If you have invested in the stock market you know that values change very quickly and market valuations (or reactions) may be more connected to emotional responses (such as fear or exuberance) as opposed to the true underlying reality. As REITs are stocks that are connected to real estate, the REIT stock itself may be significantly devalued (or over-valued) due to stock market fluctuations while the actual real estate owned by the REIT is not facing any issues and has a sound valuation.
Syndications
Syndications are not directly connected to the stock market which makes them relatively very stable and predictable in value. No investment is completely invincible against large scale macro-economic events; syndicated real estate investments do get impacted and valuations and performance may be reduced if black swan events occur. Syndications do have a benefit; they are not directly connected to the stock market and are illiquid, so investors and owners of real estate have more opportunity and time to take actions that preserve the value of their investments. Even in cases where real estate values may change (either increasing or decreasing) market data can often be such that investors are able to accurately predict the pricing changes as commercial real estate’s value is tied to several factors many of which are controllable.
Should you invest in REITs or Syndications?
As you can see there are many pros and cons for both syndications and REITs. The main differences between REITs and Syndications fall in the following categories.
Work Required By The Passive Investor
Diversity
Barriers to entry
Returns
Cash Flow
Taxes
Liquidity
Volatility In Value
Which one should you invest in? At the end of the day it really depends on your goals. Knowing the barriers to entry and related returns which better fits your investor profile? Do you prefer to invest small amounts and have a lot of diversity? Do you prioritize direct ownership and tax benefits? Do you need liquidity? Try to stack up all the things that you need for an investment and you will see whether a REIT or a syndication most aligns with that goal.
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DISCLAIMER: InvestUp! and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Consult your own personal tax, legal and accounting advisers before engaging in any transaction.
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