Should Passive Investors Choose REITs Or Syndications?

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Investors looking to create passive income with real estate ask me at least twice a week, “What’s the difference between REITs and your syndications?” Both are ways to reap the benefits of passive real estate income without the headaches of being a landlord, but they’re actually very different. If you’re building your real estate investment business and wondering which one is right for you, read on.

What Is A REIT?

REIT stands for real estate investment trust. A REIT is a company that offers broad diversification through acquiring hundreds of real estate assets. As a customer, you, along with thousands of others, buy shares in that company like you would a stock. Most REITs are traded on major stock exchanges.

What Is Real Estate Syndication?

A real estate syndication is formed by a private equity firm known as “the sponsor” that pools capital from a smaller group of investors for specific real estate acquisitions. Syndications may purchase a large property like a multifamily apartment complex or several properties. When you invest in a syndication, you are a part-owner of actual real property.

If You Want Control, Syndications Are The Right Choice

Some people like to hand over their investment dollars to someone and say, “Take care of this.” But if you want to have a bit more control, a syndication may be a better choice. With a real estate syndication, you can select which acquisitions are the right fit for you based on your specific investment criteria and goals. With a REIT, your investment is blended across a portfolio without any visibility on what properties are bought, sold and where.

Which Gets Better Returns: REITs Or Syndications?

Though either type of investment has the potential to be successful, I generally see higher returns from syndications. Unlike REITs, which are under pressure to spend investors’ funds across a vast portfolio of properties, syndications must convince their investors of the merits of each acquisition. So they acquire fewer properties and tend to work harder to find discounted buys with greater upside potential.

Also, REITs with billions in holdings tend to have layers of management fees that can dilute your returns, and they do not offer the tax advantages of owning real property like syndications.

Syndications Provide Protection

There are three ways that syndications offer protection for investors that REITs do not. First, you can choose to invest only in syndications that are acquiring properties you like, in locations that are desirable and that achieve your balance of cash-flow, appreciation and, most importantly, risk.

Second, the sponsor’s track record, the investment’s business plan, financials and market fundamentals are all laid bare for your consideration. This allows you to conduct due diligence and balance the risks, cash-flow and appreciation of each investment. REITs typically offer neither choice nor information from which to conduct due diligence on the specific assets being acquired.

Third, since REITS are stocks, what you really own is paper value in that company. If the market value of a REIT falls to zero, you risk losing all of your investment. However, even if the syndication firm folds, you still own your percentage of the real property you invested in. This provides more downside protection, as there is greater likelihood you can recover your investment once the asset sells.

If Liquidity Is More Important Than Returns, REITs May Be A Better Choice

REITs are publicly traded and have a diversified portfolio that allows you to get in and out whenever you like, making it a more liquid investment than a syndication. With a syndication, you may receive monthly cash-flow, but your investment dollars are held according to each syndication’s business plan. Traditionally, these can range from three years to more than 10.

Syndications Win With Tax Advantages

Syndications win hands down when it comes to tax advantages. While some businesses can claim a slight business income deduction, REITs are similar to stocks – the only way to receive a tax advantage is if you lose money and can deduct that loss on your taxes. All dividends and payouts are considered ordinary income, which adds to your tax burden.

With syndications, investors can deduct for depreciation of their asset, which can result in a substantial reduction in tax liability. Syndications often use rapid depreciation, cost segregation and bonus depreciation, which can mean as much as a 50 to 70% depreciation paper loss passed through to investors in the first year. It’s common for syndication investors to avoid paying taxes on the first five to seven years of distributions because their dividends are offset by depreciation.

Also, if you choose a syndication with a value-add strategy, the sponsor will typically refinance the property once improvements are complete and the property’s value is higher. Investors may be able to make most of their initial investment back with a refinance, which is considered a non-taxable event, so you can reinvest your basis pre-tax into another deal and compound your returns. Typically, with your cash-flow and ownership maintained, you are now benefiting from diversification and multiple streams of income.

Lastly, REITs do not allow investors to reap the benefits of the 1031 exchange. A 1031 exchange allows you to invest the profits from a sale of an investment property into another investment property while deferring taxes. Many syndications will offer investors the opportunity to 1031 exchange into their next deal after sale of an asset.

REITs And Syndications Both Have Their Place

Andrew Carnegie once said, “Ninety percent of all millionaires become so through owning real estate. More money has been made in real estate than in all industrial investments combined. The wise young man or wage earner of today invests his money in real estate.”

Whether you choose a REIT or syndication, investing in real estate is still considered one of the best ways to build wealth today. Decide which aspects of investment are most important to you, and you’ll be on the road to a promising financial future.

The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

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