The thing about real estate syndication that most people don’t know is that you can choose your level of involvement from an absolute passive income to being 100% actively involved in the acquisition and day-to-day management. The choice of the level of involvement in any real estate investment can also vary from one investment to another. Many novices begin investing as passive income investors and gradually take a more active role as their comfort levels increase with the acquisition of knowledge and experience. On the other hand, many who begin as passive investors continue as passive income investors never developing a desire or interest in being actively involved in the acquisition and operation of real estate.
The beauty of real estate investing is that there are multiple avenues for growing wealth. Real estate investing for passive income, if done correctly, can be the best way to invest savings. A passive income stream developed through real estate investing is a remarkably realistic avenue to grow your wealth and actually attain financial and time freedom while still continuing in the profession for which you have a calling.
As an example my friend Sandhya had a very successful career in IT. She began as an engineer and after several years in engineering she began to ask why it is that the marketing people were the ones making the decisions rather than the engineers. This led her to explore career opportunities in marketing. She acquired her MBA and moved into marketing and became a high income earner.
Along the way she began to invest savings in Wall Street stock. She came to the point where her investment income surpassed the income from her marketing career and she left the corporate world to become a full time investor. Every April, the thrill of having an income from Wall Street stocks was diminished as much of her earnings were eaten away by taxes.
Sandhya began to look for tax shelters and soon discovered the many tax advantages that real estate investing offers. As she became familiar with the world of real estate investing she made her first investments as a completely passive investor. She discovered that investing savings in passive income producing real estate wasn’t any more difficult than investing in Wall Street. Even better was the fact that her returns on investment usually brought her better returns than her stocks. Best of all, though, when April rolled around she was keeping most if not all of her earnings due to the tax advantages that real estate provides but that Wall Street investing does not.
As her real estate investment journey continued, she grew more confident and started to become more active in the syndication process. Today, Sandhya is a general partner in multifamily apartment syndication playing a very hands-on major management role. The transition from passive to active has been smooth and rewarding. Though it has been very rewarding financially, the experience has also been personally fulfilling. She takes pleasure and pride in sharing with her family the before and after aspects of the projects that she has personally helped to bring to fruition.
What is Syndication
Before going any further, let’s talk about what syndication is for those who are not familiar with the concept. Merriam-Webster defines syndicate as a group of persons or concerns who combine to carry out a particular transaction or project. In the realm of real estate that turns out to be a contractually organized group of people who pool their finances and resources to purchase real estate assets that they could not do individually.
This is an over simplification for the purpose of illustration but most frequently, though there is no rule that requires it, a limited liability company (LLC) is formed as the organizational entity that holds title to the asset. The LLC is made up of different classes of members. The passive income investor (limited partner) provides the equity with their capital investment. The general partners (active investor) locate the asset, do the underwriting and due diligence, obtain the debt financing, take all steps necessary for the completion of the acquisition, and oversee the ongoing management of the asset through disposition. The general partners frequently invest their own money as well as their time, effort, and expertise.
The expectation is that investors receive quarterly dividends from the cash flow generated by the asset (the real property). It is generally expect that the rental income from the property will produce dividends of at least 8% return on investment. Frequently, the largest return on investment comes, not with the quarterly dividends produced from rental income but with the refinance or sale of the property. Upon the refinance or sale of the property the original principle investment (the equity) is returned to all investors plus their share of the profits from the refinance or sale of the property. It is not unusual for investors to expect double digit returns on their investment.
In summation, a 100% passive investor provides their capital investment and has no other responsibilities other than receiving their quarterly dividends and final pay off. It is 100% hands-off in terms of time commitment and all other management responsibilities. In this respect it is much the same as investing in the stock market. The active investor, on the other hand, provides the expertise and does all the work but also receives dividends and a cut of the final pay off. Though this description is overly simplified it does provide a broad brush overview of real estate syndication and illustrations the different roles between passive income investor and active investor.
Private Placement Agreement
As was stated above, there are variations on the degree of passivity. The degree of involvement is not left to chance. It is established up front before any money exchanges hands. These relationships and the many other details are determined in what is referred to as a Private Placement Agreement (PPA). A well written PPA will spell out all the roles and details of the operation so that there are no misunderstandings as the project progresses from acquisition through disposition.
Not every investor enters the world of syndication via 100% passive income investing. Edna Keep (CSC 10) took a different path into the world of multifamily apartment syndication. She began her apartment syndication process as a very active investor. She bought and self managed small to mid-sized apartment complexes. Well into her investment career she continues as a general partner and has acquired over 400 doors.
An opportunity came along for her to shift roles and to become a passive investor. In this role she does have some limited management responsibilities in terms of making overall decisions. From the acquisition through to the daily ongoing management, Edna is hands off. She is thrilled with this, new to her, arrangement and has plans to continue in this partnership in a passive income investor capacity for the purchase of at least another 500 units.
Another example is Bob. He, like Edna, began his syndication journey as a general partner. As a general partner he acquired several thousand doors before taking on the role of what is often referred to as the key principle. The key principle is a general partner who because of exceptional credit worthiness becomes the lead on the debt (loan) acquisition. In Bob’s case, this is often his sole role though he does take a monthly look at the books to insure that the asset is being managed appropriately to bring maximum returns for investors.
There is a wide continuum of levels of passive to active involvement in a real estate syndication. Being intimately familiar with the PPA is important whether one is a limited partner or a general partner because that is the only way you can be sure of how each relationship is defined.
Yes, Investing for Passive Income Is A good Way to Invest Savings
The reasons will vary from individual to individual just as the level of involvement will vary. One big reason though, is the ability to grow wealth and develop financial freedom without interrupting the career that brings fulfillment.
Beyond this there are five pretty standard reasons to take the leap into passive syndicated real estate investing.
Taxes: The tax advantages offered in the real estate class of investment is far superior to just about any other investment vehicle. The passive investor, limited partner, is afforded the very same tax advantages that come with ownership of all classes of commercial real estate. This translates to keeping more of what you earn. I don’t know who first coined the phrase, “It isn’t how much you earn that counts. It is how much you keep that matters.”
With the real estate tax advantages, a passive investor not only earns high returns but also keeps more of what they earn.
No tenant or management hassles: If taxes are not enough, another perk of passive investment income is that the hassles and headaches of managing the asset fall in the lap of the general partner. The general partner takes care of all tenant and maintenance issues. The general takes care of the accounting and the legal issues. All that is required of the passive investor is to sleep easy while their capital works for them.
Liability Protection: The way that most syndications are structured, the limited partners are personally protected from external liability. If the LLC is structured appropriately and a tenant trips and falls due to a crack in the sidewalk, the limited partners are free from liability. Once again the appropriately drafted PPA will dictate how the LLCs are constructed. As you can see an experienced and knowledgeable securities attorney is an essential partner in any real estate syndication.
No banks to deal with: As the limited partner, you do not have to be the one dealing with banks and banking regulation. Even acquiring financing for your own home and small real estate holding can be a hassle with all the documentation required in today’s lending environment. In a syndicated situation, the experienced management team will already have established relationships with lenders they will be the ones dealing with the debt lender.
Scalability: In terms of scaling your investment faster and to heights perhaps here to for not yet imagined, private passive investing surpasses fix-and-flip and single family hold and rent.
The huge advantage of passive income investing in commercial syndicated real estate makes educating oneself worth the effort.
I am told that an ancient Chinese proverb goes like this: The best time to plant a tree was 20 years ago. The next best time is now.
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