Many real estate investors have no desire to be full-time landlords.
Specifically, they have no desire to be the point of contact for tenant emergencies or building emergencies, etc. Instead, they prefer to put their money into a real estate asset and enjoy the benefits of passive income.
If this describes you, then you are probably looking for your next passive real estate opportunity. If you‘ve done a preliminary search or have been in the real estate industry for a while, then you‘ve undoubtedly heard about REITs, probably because the majority of REITs are publicly traded, just like stocks. You may have also heard about real estate syndications, which are frequently confused with REITS.
However, while both types of investments can be lucrative forms of passive income, REITs are quite different from private real estate syndication opportunities. This article will walk you through real estate syndication vs REITs and the pros and cons of each of these real estate investment vehicles!
What are REITs?
A real estate investment trusts or REITs are entities that invest, own, and operate income-producing real estate.
REITs pool money together from several investors. The individual investors are compensated through regular dividends earnings from the REIT without having to purchase or manage properties themselves.
What is a Real Estate Syndication?
A real estate syndication more is a partnership between a pool of investors that combine their skills, resources, and money to acquire a real estate property. Typically, contributing to a real estate syndication allows investors the opportunity to invest in real estate projects that they would otherwise be unable to afford.
There are some significant differences between investing in REITs vs. real estate syndications.
Below, we will compare and contrast these differences to help you understand why investing in multifamily real estate syndications may be better for your investment portfolio compared with REITs.
When you invest in REITs, you are actually purchasing shares in a company. You do not own the real estate asset. Instead, you own shares in the company that owns those assets.
On the other hand, when you invest in a real estate syndication, you invest directly in a particular property. Specifically, you will own a percentage of an LLC that will own the property. Therefore, you have direct ownership of the real estate asset.
Number of Assets
When you invest in a REIT, typically, this means that you are investing in a firm that manages and owns a portfolio of properties in various markets. In general, each REIT will focus on a specific asset class. (i.e., shopping malls, apartment buildings, office buildings, healthcare facilities, etc.)
Hence, when you invest in a REIT, you do not get to pick which assets the REIT purchases. In any event, REITs are great for diversifying your investment portfolio.
On the contrary, when you invest in a real estate syndication, you invest in one property in one market. You will have all the information about the property, such as where it is located, what landmarks it is around, the business plan for the property, the financials, etc.
How You Invest
REITs are typically listed on major stock exchanges, just like public stock.
Since they are listed publicly, you can find and invest in them easily. You have the option of investing in REITs through mutual funds or with them directly.
With that being said, you can locate a REIT and invest in it within the next 30 minutes. However, you should be aware that many REITs come with many fees and several middlemen, who all, in the end, have to be paid.
On the other hand, real estate syndications are a little bit more challenging to find. This is mainly because real estate syndications fall under SEC regulations and many offerings do not allow public advertising. As such, you must be connected with a firm or individual who can offer you a real estate syndication to invest in.
Additionally, investing in a real estate syndication will take more than just 30 minutes. You will have to review the investment opportunity, review and sign the legal documents, and pay the funds.
Once the deal is complete and you have invested your money into the syndication, you will probably receive some sort of passive income as soon as a month after the deal closes. Overall, the fees involved with real estate syndication are often way less and increasingly more transparent than investing in a REIT.
REITs are more liquid than real estate syndication. Since you invest in REITs just like stocks, you can buy and sell your shares in a RET any time you want.
However, with real estate syndications, your money is locked into the deal for, on average, three to five years.
Remember, when you invest in a real estate syndication, you invest in a physical asset, similar to when you purchase a home.
You can‘t click a button and sell a home, and likewise, you can‘t do that with a real estate syndication. In general, the real estate syndication business plan will set the timeframe for holding the asset, which could be up to 10 years; during the holding period, your money will be illiquid.
In most cases, you will receive quarterly or monthly distributions from the asset.
Real estate syndications typically require higher minimums. Like when you purchase stocks when you invest in a REIT, you are buying shares, some of which can be just a few bucks. Thus, investing in a REIT can be done with a minimal amount of money, making it quite appealing to newer investors.
On the contrary, syndications typically have higher minimum investments. Typically, the minimum investment amount can be as low as $10,000 and as high as $100,000+.
However, while it is true that you need more capital to invest in real estate syndications, the returns are significantly higher with real estate syndications.
One of the major disadvantages of investing in REITs is how owners receive their passive income. Specifically, REITs distribute income via dividends to their owners, and this is not tax-deductible.
Additionally, the REIT distributes from net income rather than earnings, resulting in a lower payout. Lastly, REITs typically come with a lot of fees, some of which are not transparent.
On the other hand, real estate syndications distribute income to their limited partners (investors) before depreciation. This allows the investors to substantially reduce their tax liability by claiming asset depreciation (more on that below).
One of the key reasons people invest in real estate is due to the number of tax benefits. In other words, the IRS is very friendly to real estate investors allowing them to take there are tax deductions.
One of the most beneficial tax deductions has to do with depreciation. In act, the benefit of deducting depreciation is a big enough reason for most investors to purchase real estate. Essentially, depreciation allows you to take a paper loss while at the same time enjoying positive cash flow.
Moreover, if you qualify, you can offset your other income by taking these paper losses.
However, when you invest in REITs, since you‘re not investing in a property, the tax benefits are not as great. While you still receive the benefits of depreciation, which is taken out before you receive your dividends, you can‘t use depreciation to offset your other income.
Lastly, any dividends you receive from your REITs are taxed as ordinary income, which in most cases creates a bigger tax bill.
1031 exchanges are a power tax deferral tool for real estate investors. It allows investors to avoid paying capital gain tax of property when they swap it out and acquire a like–kind real estate property of equal or greater value.
However, since most REITs are treated dividend income like stocks, REITs can‘t be used in a 1031 tax-deferred like-kind exchange.
Investors who are serious about growing their real estate portfolio should seriously consider whether they are ok with forgoing this benefit by investing in REITs.
Should You Choose a REIT or a Real Estate Syndication?
In a well–balanced portfolio, there is a place for both REITs and syndications.
While REITs may be better for more passive income, they do not provide the same level of returns that investors can receive when investing in a real estate syndication. Furthermore, real estate syndications provide a more reliable stream of income. Not to mention that you actually own the property you are investing in.
Typically, Much Less Risk By Investing in Real Estate Syndications
Due to the fact that you do not know exactly what properties you are investing in when you choose a REIT, it is kind of tough to make a complete risk assessment.
Remember, within REIT, you only own a share of the company that owns the property and not: directly the property. On the contrary, will stay syndication investors know precisely what property they are investing in to thoroughly evaluate the investment and its risk associated with it. Who knew`?
If direct ownership is essential to you and you want a little bit more control over the property that you invest in, coupled with want more tax benefits, real estate syndications probably are your best bet. On the other hand, if you have a couple hundred or even thousands of dollars free to invest, and you value liquidity, REITs may be better for you.
Now that you understand the pros and cons of both REITs and real estate syndications, you can decide which is best for your investment goals and your real estate portfolio.
If you‘re genuinely on the fence about which form of real estate you want to invest in, in general, you really do not have to choose.
Instead, you can choose to diversify by having a little bit of both in your portfolio.
In other words, there is room for both REITs and real estate syndications in your real estate portfolio. As such, no matter how you choose to invest in real estate, whether that be directly or indirectly, you will still receive a fair amount of benefits from your investment.