What is a Real Estate Syndication?
A commercial real estate syndication is a group of investors who pool their resources (i.e. time, knowledge, and money) to buy a large asset and share the profits. There are two types of investors in a syndication:
- General Partners (GPs) provide the capital, time, experience and network needed to identify, buy, stabilize, and manage the property
- Limited Partners (LPs) provide the capital required to purchase the property
GPs are active investors, meanwhile, LPs are passive investors. Commercial real estate has moved into the mainstream. Investors, whether they are large institutions like BlackRock and small independent operators alike, have been in a race to add this stabilized asset class to their portfolio.
One of the challenges, of course, is that commercial real estate is typically expensive and has high barriers to entry. Few people can access high-caliber deals on their own. That is why passiveinvestorpro.com can provide you with opportunities to fractionally invest in real estate alongside our experienced partners who manage a portfolio of properties.
Below is an illustrative example comparing a syndication to how a company is run:
What are LPs required to do?
After depositing your investment amounts, you become a passive investor and obtain pro rata share of ownership in the asset (LLC). LPs receive ongoing updates on the progress of the asset and any cash flow payouts. GPs are available to answer any and all questions.
Four different sources of returns for Passive Investors
Cash Flow
Cash returns, often referred to as “mailbox money”, are the money you receive on a monthly or quarterly basis from your commercial real estate investment. In a multifamily investment, free cash flow available for distribution are calculated as follows:
Gross Income (rents, self-storage, pet fee, etc)
– Operating expenses (repairs and maintenance, property management, taxes, insurance, etc)
– Replacement reserves
= Net Operating Income (NOI)
– Debt service (principal and/or interest)
– Asset management fee
= Free Cash Flow Available for Distribution
Appreciation
The biggest way to create long-term wealth is through appreciation of your investment. In commercial real estate, appreciation can take the form of two ways: forced or market.
Forced appreciation happens when the owners take action to improve the NOI, such as increasing rents and/or lowering expenses. Market appreciation is a result of factors external to the asset, such as population growth, number of jobs moving into the market, demand versus supply for multifamily etc.
Principal Paydown
Income generated from rental payments are used to pay the monthly mortgage on a multifamily asset. This helps increase equity and lower the outstanding balance on the loan.
Tax Benefits
Commercial real estate offers many tax benefits to investors.
IRS tax codes allow owners to depreciate commercial real estate asset over 27.5 years. Depreciation is considered a “paper loss” and not true loss, thus reducing taxable income by 1/27.5th of the value each year. In many instances, depreciation would be sufficient to wipe out current income, especially in the early years of ownership.
Accelerated depreciation is another strategy used by owners to increase the depreciation expense. This strategy is often performed by a professional third-party cost segregation firm that studies certain items such as cabinets, appliances, fixtures and applies an expedited depreciation schedule on these items, thereby increasing the depreciation allowed for by the IRS.
The cash income (or “paper loss”) and/or any capital gains earned from the sale of the asset are treated as “passive” and therefore taxed at a capital gains tax. Capital gains tax is lower than income tax rates. This is possible as long as you are not treated as a “real estate professional”; and therefore, your tax status is treated as passive investment.
If you have “real estate professional” tax status, your investment in multifamily would be considered “non-passive”, which can be used to shelter against your earned income from your or your spouse’s job (think W-2 or 1099).
It is important to understand the tax implications of your investment by consulting with a CPA, tax expert or tax accountant.