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Is Real Estate Syndication Suitable for a Passive Investor?

Real Estate Investment

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 hundred percent actively involved in the acquisition and day-to-day management.  The choice of the level of involvement in any real estate syndication investment can also vary from one investment to another. 

The beauty of passive income real estate investing is that there are multiple avenues for growing wealth.  If you are wondering what to do with savings, real estate investing for passive income when done through well structured apartment syndication has excellent potential to provide a very attractive return on investment.  A passive income stream developed through real estate syndication investing is a remarkably realistic avenue to grow your wealth and actually attain financial and time freedom while still continuing in the profession, avocation, or retirement endeavor for which you have a calling. 

What Is Real Estate 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.  

What does syndication mean in real estate?

In the realm of real estate syndication that turns out to be a contractually organized group of people who pool their finances and resources to purchase real estate property assets that they could not do individually.

Houses

How Real Estate Syndication Works

The most meaningful way to define real estate syndication is through the illustration of how a real estate syndication structure is designed.  Most frequently, though there is no rule that requires it, there are generally two limited liability company (LLC) that are formed.  One LLC, generally the parent LLC holds the management team – generally referred to as general partners or sponsors.  The child LLC is the organizational entity of the real estate syndication structure that holds title to the asset.  

The passive real estate syndicator investors are members of the child LLC.  The passive income investor (limited partner) provides the equity for the real estate syndication with their capital investment. Frequently, the limited partners receive preferred status and thus are the first to receive profit distributions and a return on real estate investment.  

The real estate syndicator, the general partners (active investors), locate the asset, do the underwriting and due diligence, obtain the debt financing, secure equity investors (passive investors), take all steps necessary for the completion of the acquisition, and oversee the ongoing property management through disposition.  The general partners provide the management of the real estate syndication and the management of the real estate property that is owned by the syndication.  In addition to providing their time, effort, and expertise in the management of the syndication and the real estate property, the general partners often invest their own money.  

What to expect in a Real Estate Syndication Structure?

The expectation is that investors in the real estate syndication will receive quarterly dividends from the cash flow generated by the asset (the real estate property).  It is generally expected that the rental income from the real estate property will produce profits that will deliver dividends of at least 8% return on investment.  Frequently, the largest return on investment comes, not with the quarterly dividends produced from real estate rental income but with the refinance or sale of the real estate property.  Upon the refinance or sale of the real estate property syndication deal the original principal investment (the equity) plus any profit that has been generated is distributed to all investors in the syndication.  It is not unusual for investors in real estate syndications to expect double digit returns on their investment, frequently in the range of 14% to 18%.  

One benefit of real estate syndication is the flexibility offered to investors.  Due to the flexibility offered syndication investors, there are variations on the degree of passivity.  The degree of passive/active involvement is not left to chance.  It is established up front before any money exchanges hands.  The real estate investors will know before investing exactly what are the levels of expected participation of both the sponsors and the limited passive real estate investor partners.  

The income projections for both general partners and limited partners plus the detailed structure and operation of the real estate syndication are defined and determined in what is referred to as a Private Placement Memorandum (PPM).  Sometimes it is referred to as an Agreement rather than a Memorandum but this is just semantics.  By either name it is the same.  A well written PPM 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.

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Passive Investor vs Active Investor

In a real estate syndication, the active investors are generally referred to as the general partners or sponsors. The passive investors are referred to as limited partners, passive income real estate investors, or equity investors.  As both active and passive real estate investors are playing a part in the real estate syndication both can be referred to as syndicators.   

Passive Investor

For those seeking passive income, the investment in a real estate syndication can be structured so that it is hundred percent hands-off in terms of time commitment and all other management responsibilities. Hundred percent passive investors provide their capital investment and have no other responsibilities other than receiving their passive income through quarterly dividends and final pay off.  

Active Investor

In this respect it is much the same as investing in the stock market but is much less vulnerable to the volatility of stocks.  The active investor, on the other hand, provides the expertise, does all the work, and makes all management decisions.  For their efforts they also receive dividends and a portion of the final pay off.  

Though this description is overly simplified it does provide a broad brush overview of real estate syndication and illustrates the different roles between the real estate passive income investor and the real estate active investor.

Many novices begin investing as passive income investors in real estate syndication 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 real estate syndication investors continue as passive income investors never developing a desire or interest in being actively involved in the acquisition and operation of a real estate syndicate.  

Why Passive Income Investments

The reasons as to why passive income investments are attractive vary from individual to individual.   The obvious main reason anyone invests in anything is to preserve and grow wealth.  Beyond this most basic reason, though, the motivations as to why passive income investments are the choice vary greatly.  Some choose passive investing to grow wealth while at the same time providing more time freedom.  Others choose passive investing because they are committed to other endeavors and have less time to focus on investment activities.  Some choose passive income to build legacy wealth to transfer to the generations that follow them.  More often than not, passive income investing is chosen as a vehicle for institutional endowments.

Looking into the lives of those who have explored passive income investments will provide insight into the question as to why passive income investments are attractive to some.

Steven RinaldiSteven Rinaldi, Creek Side Chats (CSC 129) & (CSC 79) is a knowledgeable and seasoned attorney.  He has written hundreds of PPMs.  According to Steven a well written memorandum is essential for the success of a real estate syndication.  He states that one of the biggest mistakes an inexperienced investor can make is to neglect to read and understand the memorandum. 

Steven indicates that a well written memorandum will provide not just the overall information regard the real estate syndication structure but it will provide the regional and community demographics pertaining to crime rates, employment rates, and proximity of the real estate property being syndicated to businesses, shopping, schools and recreation.  In terms of the multifamily syndication under consideration vacancy rates will be disclosed and the plan of renovation and property management will be disclosed.  The amount of required reserves and the use of the reserves will be explained. 

The PPM will explain the structure of multifamily syndication under consideration.  It will detail the profit distribution for the sponsor and the passive investor.  The memorandum will disclose whether or not the passive investor receives preferred status and provides the projected return on the real estate investment.  The PPM will define when and now dividend distributions will be advanced to both sponsor and investor.  It will detail the share of profit distribution for the general and limited partner and will disclose the directives and the circumstances for determining if and when distributions will occur. 

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Steven reminds passive real estate investors that there is no such thing as a risk free investment.  He warns those seeking passive income real estate investment opportunities that it is their responsibility to do their due diligence.  He advises that a return on real estate investment can be lucrative if the syndication deal is sound and if experienced sponsors are participating in the real estate syndication structure.

Sandhya Seshadri

Sandhya Seshadri, Creek Side Chats (CSC 100) & (CSC 143): One example is Sandhya who 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.  However, 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 syndication investing has to offer.  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 syndication 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 syndication provides but that Wall Street investing does not.

As her real estate syndication investment journey continued, she grew more confident and started to become more active in the real estate syndication process.  Today, Sandhya is a general partner in multifamily syndication playing a very hands-on major syndication management and property management.  The transition from passive to active investor 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 real estate syndication projects that she has personally helped to bring to fruition.

Edna

Edna Keep, Creek Side Chats  (CSC 10) & (CSC 144): Not every investor enters the world of real estate syndication via 100% passive income investing.  Edna Keep took a different path into the world of multifamily apartment syndication.  She began her multifamily syndication process as a very active real estate syndication investor.  She bought and self managed small to mid-sized apartment complexes.  Well into her real estate syndication investment career she continues as a general partner and has acquired over 400 multifamily syndication doors.  

An opportunity came along for her to shift roles and to become a passive real estate syndication investor.  In this role she does have some limited syndication management responsibilities in terms of making overall decisions.  From the acquisition through to the daily ongoing property management, Edna is hands off.  She is thrilled with this, new to her, passive income real estate structure and has plans to continue in this limited partnership in a passive income real estate syndication investor capacity for the purchase of at least another 500 units.

While Edna is expanding her role as a passive income real estate syndicator, she continues her active investor role in currently held multifamily syndications.

Bob: Another example is Bob.  He, like Edna, began his real estate syndication journey as a general partner.  As a general partner in real estate syndication he acquired several thousand doors before taking on the role of what is often referred to as the key principle syndicator.  The key principle is a general partner in the real estate syndication who because of exceptional credit worthiness becomes the lead on the debt (loan) acquisition for the apartment syndication.  In Bob’s case, this is often his sole role in the multifamily syndication though he does take a monthly look at the books to ensure that the apartment syndication is being managed appropriately to bring maximum returns for investors.   Bob acted as general partner in real estate syndication on many syndication deals before becoming a key principle.  Having the extensive experience and background in real estate syndications gives Bob a thorough understanding of the process of syndication and supports him in the extensive due diligence of any apartment syndication deal.

Why Syndicated Passive Real Estate Investing?

There are many reasons why syndicated passive real estate investing attracts so many investors and has made more millionaires than any other investment strategy.  In general the overall reason for investing in real estate syndication though, is the ability for passive investing real estate syndicators to grow wealth and develop financial freedom without interrupting the career or lifestyle choices they’ve made that bring them fulfillment and the ability to flourish abundantly in all areas of life.  Beyond this there are five pretty standard reasons as to why passive real estate syndication investing has made more millionaires than any other investment vehicle and answers the question as to what to do with savings to maximize your return on investment and to live a life worth living.

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The tax advantages offered in the real estate syndication class of investments is far superior to just about any other investment vehicle.  The passive investor, limited partner, in a real estate syndication deal is afforded many of the same tax advantages that come with ownership of all classes of commercial real estate investing.  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 syndication tax advantages, a passive syndicator not only earns high returns on real estate investment but also keeps more of what they earn.

If taxes are not enough, another perk of real estate syndication passive investment income is that the hassles and headaches of managing the real estate property fall in the lap of the general partner syndicators.  The general partner syndicators take care of all tenant and maintenance issues.  The general partner takes care of the accounting and the legal issues.  All that is required of the passive investor is to sleep easy while their capital investment produces an attractive return on investment.

The real estate syndication is generally structured so that the limited partners (the passive real estate investor) is 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 outside assets are free from liability.  The investment is all that is at risk.  Once again the appropriately attorney drafted PPA will dictate how the LLCs are structured.  As you can see an experienced and knowledgeable securities attorney is an essential partner in any real estate syndication.

As the limited partner in a real estate syndication, the passive investor does 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 real estate syndication management team will already have established relationships with real estate lenders and as such the sponsors will be the ones dealing with the real estate debt lender.

In terms of scaling your investment faster and to heights perhaps here to fore not yet imagined, private passive real estate syndication investing surpasses fix-and-flip and single family hold and rent real estate deals.  Rather than working with one real estate deal at a time, with multifamily syndication the investor is investing in many doors at once.  This provides that opportunity to multiply investments rather than just add one door at a time.  The scalability makes real estate syndication the ideal tool for developing wealth that leads to time freedom and independence.

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About the Author - Dr. Allen Lomax

With careers in academia,photo of author dr. allen lomax podcasting, and real estate investing, Dr. Allen Lomax inspires us to break open our minds’ secrets to discover individual and universal well-being. Through passive real estate investments, he helps enlightened investors create time freedom to live abundantly in all life’s areas.

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