As you know, I’m a big fan of real estate investing.
Several years ago I purchased 14 units in Grand Rapids, Michigan and they have done very well through the years.
Then a year or so ago I added private real estate lending to my list of investments. That has been going well too (who can argue with 10% returns?)
That said, I have been looking for even more ways to generate passive income. You could probably tell this since I’ve written recently on five categories of passive income, 28 passive income ideas, and my list of the 10 best ways to create extra income. After all, while I have multiple streams of income, more is better, right? š
This is why I started investing in dividend stocks as well as started the Millionaire Money Mentors forums. I also have a couple extra ideas up my sleeve for 2021 which you’ll hear about in due time — assuming my video game playing doesn’t get in the way. Haha!
Over a few posts, this series is the story of how I added another real estate, passive income stream to my finances. Yes, I have invested in a couple real estate syndications and am looking for some more.
I’ll cover the topic of real estate syndications from top to bottom as well as give the details on what I’ve done.
I am far from an expert in this area of investing, so I’ve asked my buddy, Jeff, from Debt Free Doctor to share his expertise.
So with that said, take it away, Jeff…
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It seems that “passive income” is the hot topic these days especially among the FIRE community. Everybody is searching for it yet few know how to obtain it on a regular basis.
Our search began about five years ago after a minor snow skiing accident in Beaver Creek, Colorado. While getting off a ski lift, I had to quickly swerve to avoid colliding with a kid and landed on my wrist.
As a periodontist, I make my livelihood using my hands treating patients. Up until that moment, I’d never given thought about what would happen if I couldn’t use them. I guess that’s human nature. We don’t think about getting sick or injured until we get sick or injured. Maybe that’s why we avoid thinking about death as well?
Up until that point of my career, I had only one income stream (dental practice) coming in providing for the family. I’d once heard that the worst number in business was “one” and now I was realizing how much that was true.
Warren Buffet once stated, “Never depend on a single income. Make investments to create a second source.”
Relying on only one income stream is NOT good, especially when you have teenagers to feed! This minor accident was the catalyst that eventually led me down the path to investing in passive real estate syndications.
But before we discuss those investments, let me fill you in on the back story.
My Path To Real Estate
Typically doctors and other high-income earners fall prey to those pitching financial services, insurance plans, “get rich quick” deals, etc. It seems as if we’re walking around with a big “S” on our shirt. No, not for “Superman”, but for “Sucker” instead.
During dental school, I fell for one of these scams from a guy pitching disability insurance. I was led to believe that if I didn’t purchase the policy while still in school, then rates could more than double when I graduated. Locking the rates in during school would help avoid this from happening. So he said.
After paying two months of premiums, I realized not only could I not afford it (was using student loan money) but that I had been duped.
Looking back, I’m actually glad this happened so early in my career. This incident made me realize that I should question every financial decision more closely.
The Financial Advisor Dilemma
I’ve always been interested in investing so when it came time to start, several financial advisors wanted to “feed me” to discuss what they could do for me. I quickly realized that what they could do for me and what I wanted were two different things.
At that time (16 years ago), it was common to pay an advisor 2% of the assets under management( AUM). This was before we saw an increase in the amount of competition among online services which caused that fee to decrease to around 1%.
The other issue I had was that they were insistent on putting my money in actively managed funds versus index funds.
Again, this was more for their benefit than mine as the advisors received a kickback whether I made money in the market or not. As you can imagine, this didn’t sit too well with a young periodontist just out of training that had recently been “burned” by an insurance sales man.
It was at that point in my investing career to take matters into my own hands and handle it myself via Vanguard. One of the other things I want to mention is that I was never educated on any other way to invest for retirement. I’d only learned about the “traditional” financial model. This is where we invest in a retirement account (401k, IRA, etc.) for 35+ years and hope that we have enough to last us until we move on from this Earth.
This was the only option I knew about so that’s where we began until my snow skiing accident.
More than likely you’re quite familiar with the “traditional” retirement approach.
So today, ESI Money has asked me to share with you a different method for those that want to focus on acquiring income now rather than the future. We’ve had experience investing in passive real estate via syndications with great success.
Let’s get started to see if they’re a good fit for you too.
What is a Real Estate Syndication?
A real estate syndication is simply the pooling of funds from a group of investors in order to purchase a property thatās more expensive than any of them could have afforded on their own.
Not unlike private equity firms which source the purchase of companies for a portfolio, they can be structured in LLCs or limited partnerships both of which have benefits and downsides.
Typically the principal or sponsor is given āsweat equityā to place a deal together in the form of shares or ownership in the property.
Normally a sponsor would be given a āpromoteā of 15-20% of the asset (i.e. apartment complex), however would still be placing capital in the deal as well. For constructing the deal, the participant investors place 80-90% of the capital needed to fund the acquisition.
As you can tell, real estate investing is a team sport. Everyone involved contribute to the project and share in the risks and returns by combining their knowledge, experience, time and capital.
Without pooling these resources together, it would be next to impossible to complete the transaction on an individual basis.
Why Syndications?
One of the first questions I ask new members of our Passive Investors Circle group is, “What financial goals are you trying to accomplish?”
The majority of the answers are vague such as, “I want some passive income” or “I’d like to retire early”.
Which of the people below do you think would have the better opportunity of reaching their weight loss goal?
- Mr. Vague: I want to lose some weight this year. I think 25 pounds would be good.
- Ms. Specific: I want to lose 17 pounds in three months before I take our girl’s trip to the beach. I’m focusing on losing 5-6 pounds a month by working with a trainer and dietician.
If you guessed Ms. Specific then you won the prize!
The more detailed you can get when setting both short and long term financial goals, the better you’ll be focused on accomplishing them.
Our initial goal we set after realizing we needed other income streams was to replace our monthly expenses with passive income within seven years while avoiding a second job. Our main focus was on cash flow.
Basically we wanted to get our money working for us and not working longer hours (or jobs) in the process. Our kids are now teenagers and we realize our time with them is limited. Being there during their school functions, sporting events and travel is very important to us for the next 5-7 years.
By setting these specific goals, we’re able to rule out active real estate investing. I have several friends that are active investors that spend all hours of the day and night taking calls from tenants. These calls deal with anything from maintenance issues (clogged toilets) to meeting the local sheriff to investigate burglaries.
It’s a never ending cycle that I didn’t want any part of.
Once we ruled out active investing, we were able to focus on passive real estate opportunities. At that time, I knew very little about it but was excited to learn something that not too many of my other doctor friends knew about.
“90% of millionaires become so through owning real estate.” – Andrew Carnegie
The ESI Money site has a section dedicated exclusively to Millionaires. This is where those that have reached millionaire status are highlighted and many have done so with using real estate.
He also recently started a cool program (which I’m a part of) featuring Millionaire Mentors. I would have loved to have access to something like this early on in my career.
Most of the high-income earners that I associate with have limited time which what makes investing in passive real estate syndications so attractive.
4 Benefits to Invest Passively In a Syndication
#1 Time
This is more than likely the #1 reason why busy professionals choose to invest in syndications. Myself included. As a passive investor, the sponsor (general partner) of the deal rather than you (limited partner), is responsible for evaluating, acquiring and managing the property.
#2 Knowledge
If you choose the active route, you’re the one that must dedicate a large amount of time learning about the market, neighborhood and property. On the other hand, passive investors enjoy leaving that responsibility up to the sponsor for performing market research, evaluating, acquiring and managing the properties.
#3 Capital
Active real estate investors are responsible for obtaining funding and also to make sure there are reserves on hand for repairs, maintenance and operations of the property. Also, they’re the ones signing the loan. As a passive investor, your capital is limited to only the equity you choose to invest into the project. Also, you do NOT sign the loan thus reducing your risk should the property not perform as projected.
#4 Risk
Many new active investors start off purchasing single family homes (SFH) due to the simplicity and familiarity of them (most people can relate more to a single home vs larger properties). What they don’t realize is that they’re assuming sole responsibility of the loan thus increasing their risk exposure.
Also, with single family homes, it’s difficult to have the same economies of scale versus commercial real estate. These homes are either 100% occupied or 0% occupied.
When passively investing, the sponsor is doing the funding and signing the loan. There’s LESS risk with economies of scale of several units in an apartment complex versus a SFH. For instance, if you own a SFH and you’re tenant moves out, there’s nobody paying the rent until you get a new tenant. If you own a ten unit apartment complex and one tenant moves out, it’s still 90% occupied thus lowering your risk.
The older I get, the LESS risk I consider taking on.
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For more on this series, check out part 2 where we dive deep into real estate syndications including who the main players generally are and the seven steps to investing in a syndication.
Another excellent article about making money – especially in the passive real estate format. I’ve read about real estate syndications before – but only very vaguely and did not commit too much research into this subject area – yet.
However, this article provides me with some great content and I’m beginning to think that this could be a path for me in a few years. Hearing that we have a general partner to basically take care of the minutia while the limited partners “only” invest a certain portion of the capital and passively see their investment grow makes me feel much more at ease. I’ve been in the real estate business before and working directly with tenants is not a high point of mine.
Thank you very much for sharing and I look forward to part 2!
The Millennial Money Woman
Iām interested to read the other parts of this series. I am a physician and, too, was looking for ways to invest in real estate as a second income stream. I also ruled out direct ownership for the reasons you mentioned. I spent the past six months doing a lot of research on real estate syndication investing to gauge my comfort level. For me, there are not enough benefits over Vanguard REIT index fund investing to make the jump and justify the extra risk. My concerns included:
1. Unless you have the knowledge to vet the real estate markets and overall plan and you can also follow the commercial real estate cycle, you are putting a lot of trust in the sponsor. Picking a deal where the sponsor has > 10% equity in the deal themselves seemed like a way to make sure they had a high level of confidence in the deal, but still seemed risky to me for a non-real estate professional.
2. For individual deals and private non-traded REITs, you are never really sure of the valuation until the end of the deal when you actually get your payout and see what it is worth. I am much more comfortable with a publicly traded REIT with a set market price, like Vanguardās product.
3. Non-liquid asset. It can be difficult to get your money back out of these deals, although you have the same issue with direct real estate ownership. Not an issue with REIT index investing.
4. The fee structures seem very complicated with some of these desks a d I found it difficult to calculate the actual amount of fees I would be charged.
For these reasons, I stuck with the Vanguard REIT index fundātruly passive real estate investing. Long-term returns have been been good enough for me. This is an area of investing that I will continue to keep an eye on.
I think you will want to stay tuned.
Yes, the VG REIT has some advantages, but looking at both the return and the yield, it underperforms (by a good amount) what you can get with these.
It’s a risk/reward issue and depends on your goals, so the VG fund may be better for you…
TimR:
Here’s a few differences between syndications and REITS:
https://www.debtfreedr.com/why-not-to-invest-in-reits/
One of the main reasons we invest in syndications is #6.
[PUBLIC SERVICE ANNOUNCEMENT]
*** REITs are not real estate investing any more than Exxon Mobile stock is oil investing. ***
I wish there was a way to make this knowledge readily available and easily understandable to most people, but it is a hard nut to crack. I have stated this until I was blue in the face, but it is a hard sell for most people to accept. I’m basically a smurf from repeating it so often.
I think people must believe REITs are a safer more passive path to the same kinds of benefits of real estate investing that they hear so many people talk about.
Direct ownership of real estate has increased risk and increased work that makes it not entirely passive. As a result direct ownership of real estate does outperform stocks over long periods. You cannot buy a REIT and remove those increased risks and increased work and think you are still getting some of the benefits that come from them. I assure you, you are not getting those benefits in a REIT.
Don’t believe me? Look at the long term performance of REITs. They do not outperform stocks. There is nothing wrong with REITS per se, but there is nothing special about them either. If you want diversification, you get that in a broad index fund which includes REITs.
A REIT is just a stock. The only difference between a REIT and other stocks is that you will get high dividends that are not even given the special capital gains tax rates that normal dividends get.
I cannot honestly think of a single reason to directly own a REIT or a REIT ETF as a long term growth investment.
I realize that REIT index investing is stock investing and not a direct real estate investment. I think it does help offer some diversification within a stock portfolio. Compared with other index funds, Vanguardās REIT index has performed well. Starting around 2000, it has returned around 9.7% average annually whereas the Total US Stock Market and S&P 500 index funds have returned around 7.6%.
I wish I had the research time and real estate knowledge to feel more comfortable investing in real estate syndications. I understand that the returns and tax benefits can be superior, but for me, I like to be able to understand anything I am investing in 100%. For me, I will give up potentially higher returns for less risk and a truly passive option. I believe a lot of investors are jumping into real estate syndication deals without fully vetting the deals or understanding all of the risks. I am interested to see the rest of this series to learn more on the subject.
OK. Sounds like you know what you are getting. Many people think they are getting an easy path to real estate returns.
What is it about them that you don’t understand? they are actually pretty simple in concept.
And if you need any specific questions answered, most good syndicators require you to have a conversation with them where they qualify you and you can ask them whatever you like.
Learning how to assess the local real estate market where a deal is located is a bit nebulous to me. And I think this is difficult to do remotely when a property is located on the other side of the country. As a non-real estate professional, it is hard for me to know what information I need to see if a business plan is viable or even makes sense in that individual location. Other than looking at a sponsorās track record on individual crowdfunding websites, I donāt really know how to tell a good sponsor from a questionable one. Iāve also read that the commercial real estate market is cyclical and timing your investment can be very important.
All of them include a market analysis in their offerings. Then they usually have a webinar follow-up where people can ask questions about anything. And if you miss the webinar, they record it so you can watch later.
Agree about cyclical nature, that’s why I’m diversifying these investments by syndicator, type of RE, and market. I’m also laddering them like CDs so they impact different time frames.
Not trying to see this, just explaining it. I was where you are now until I had some of the millionaire mentors take me through it.
Also, we’re working on getting a syndicator to work with us through the forums, show us a deal, then we all chat through the pros, cons, etc. Learning like this is perfect for the mentors membership.
I can think of one reason to own REITs.
My US large cap stock fund excludes REITs.
One of the major things to look out for in these deals –
As noted here in the article, the sponsor or “GP” will often times get a promote on the back end of the deal (meaning they get a bigger piece of the upside as an incentive int he deal).
However, this also means that from day 1, they are motivated to sell the deal so that they can earn this upside.
In my opinion, the greatest way to truly earn wealth in RE is to hold for a very long time.
There are sponsors out there that have indefinite time horizons for holding the assets. I would advise people to look for those type of deals, and also make sure the asset is the type that you would want to hold for a very long time (multi family, high quality office, industrial, etc.).
I actually want them to sell in 5-7 years. This is where I’m expecting my biggest gains.
In part 3, I’ll tell what I’m doing and you can see for yourself.
Great topic! I am working my way through Brian Burke’s book “The Hands-off Investor” which goes into detail on all of the topics included in syndication investing. It talks about how important it is in choosing the right sponsor to invest with as it is in assessing the syndication offering. It teaches a little bit about reading financial statements as well as exactly what questions to ask.
Can’t wait to check out part 2!
Daniel: If you learn everything in that book (it’s great by the way), then you’ll be well on your way to becoming VERY proficient in syndication investing.
Thanks Dr. Jeff! I am curious on what your thoughts are and experiences in finding and interviewing different sponsors. Where did you look to find new ones? What were some of the most important questions you asked them?
Thanks for the great information!
I got mine suggested by experienced investors in the MMM forums. I’ll be listing the ones I went forward with in part 3 of this series.
My husband and I were part of a real estate syndication years ago and it did not turn out well. The real estate market dropped and the property became worth less than the mortgage on the property and the majority of the shareholders of the syndication bailed out so we lost the property and all money invested. We only had one share worth about $15,000 but at that time we were a young family with a mortgage so this was a big loss to us. We were at the mercy of the group. After that experience, I decided to learn about personal finance and investing in stocks. Today, I am 60 yrs old, I retired at 52 yrs old with a stock portfolio that gave me that freedom. I never borrowed money to make my investments, I invested steadily over all my working years, reinvested the dividends and never made withdrawals. I now take the dividends in cash for a passive monthly income. I am a buy and hold type of investor. I feel real estate is too risky for me because of the leverage needed to buy the properties.
A few thoughts:
1. As you’ll see in part 3, I say I would never have invested in these early in my wealth journey. I agree that they are risky, illiquid, and lack control, which are things I could not afford to give up in the early days.
Now things are different. I can afford to take more risk for more reward, and that’s where these fall.
2. The MMM forums have made a HUGE difference for me. In there are people who have a ton of experience with these investments. They have saved me a large amount of time and (probably) money with their advice. They have also pointed me in the right direction of who to deal with based on their many deals which has given me a big head start in the process.
3. I think the syndicator makes a BIG difference. You really are trusting a person with your money which is why you want to get to know them, do some reference checks, etc. IMO you can’t do this with companies like RealtyShares et al, so those are a no-go for me. I want to connect directly with the person I’m making a deal with.
4. I look at these investments as similar to the private lending I’ve done which I wrote about here:
https://esimoney.com/how-to-invest-in-private-real-estate-lending/
It’s the same in that I’m giving someone my money to invest in real estate and he/she is paying me back a return for it.
A few differences:
1. The private loan pays a higher yield (10% versus 8%).
2. The private loan doesn’t come with tax write-off benefits whereas the syndication does.
3. The private loan doesn’t allow me to participate in the upside when the property sells whereas the syndication does.
Pretty much everything else is the same.
Donna: I agree with you. REI is RISKY if you don’t know what you’re doing. If you’re investing passively, it’s VERY important to really get to know who you’re investing your money with (sponsor).
I lost $50K(https://www.debtfreedr.com/realtyshares-2/0 with Realty Shares with crowdfunding early on in my investing career. I didn’t have a clue what I was doing so it was no fault other than my own.
I used that as a catalyst to begin educating myself which then led me to start my blog to help others NOT make the same mistakes I had made.
Situations like that $50K loss are exactly what I want to avoid and why these deals leave me with so many questions! Hopefully you can go into detail on how you now vet deals and try to avoid similar situations.
TimR and Daniel: It took ALOT of trial and error (and effort) to find only a handful of syndicators to invest with. There are hundreds of them out there and it’s amazing that MOST don’t manage any property, they’re just marketers.
It’s like my dental school class, I would ONLY let maybe 4-5 work on me even though all of them are dentists.
It took me years of networking, reading, interviewing, etc to find those to invest with.
Luckily I found a great group that I’ve since partnered with (as I trust them that much) and working with them mainly because of how they treat their investors and their morals align with ours.
Can you tell us who they are and why you like them?
I can tell but you have to join the Passive Investors Circle to find out!!
Haha. I already have my own list that the millionaire mentors gave me. š
Jeff, I consider this experience as lucky because it led me to learn about personal finance and investing while I was young so I had lots of time to build my portfolio for retirement. I am not against real estate investing for others… we all choose what we are comfortable with. The key is to INVEST IN SOMETHING, and not leave your money languishing in a savings account. Iām always interested in reading about others paths to retirement. Thx ESI for interesting posts.
I am curious what target returns have the OP realized over the past couple of years? Are there specific sectors he stays away from? Are there sectors that achieve better returns? How has communication been between the syndication funds and the limited partners?
Glad this investment arrangement was openly discussed.
I have spoken to so many sponsors trying to find a fair syndication.
Unfortunately I have not been able to find a good one yet.
The biggest hurdles I keep finding are:
-LOW preferred returns around 8%
-The promote. The most common outcome is the sponsor wants 30%. (They increase NOI to increase the value then sell to take 30% of all the gains)
Owning dozens of units myself as well as running an 140 unit apartment complex for the last year I know that much higher returns are common.
I offered to be a GP to some smaller ones (because I know that’s it’s not terribly difficult with the right team) but they only want more LP’s.
Saying its “completely passive and hands off” shouldnt justify the fee structure that’s generally offered.
IMO there is a big market out there for syndications that offer better returns to LPs without a huge promote on the backend.
Instead, hold, refinance the property, get all invested capital back out and find another property to do it again.
Agree entirely.
Iām not saying that thereās not a place for passive investing in syndications but best be aware of the fees. What is the net return. The tax advantages of passive investments arenāt there either vs. buy and hold.
So many options to buy/ hold / reposition loan etc.
Iām open to these passive syndications but I havenāt found one that I couldnāt beat with own I get property outright.
The returns you get are net of fees. There are no extra expenses.
As far as tax advantages, what do you mean? Are you talking about depreciation? If so, as an investor, you get your portion of the depreciation write-offs. This post from BP says it pretty well:
https://www.biggerpockets.com/member-blogs/10928/75498-8-reasons-to-invest-in-real-estate-syndications
“Unlike other investments such as stocks and bonds, income from real estate is considered tax advantaged income.
This is because of a non-cash expense called depreciation. Depreciation combined other operating expenses can easily cause a property to show a loss for tax purposes, even though it is producing positive cash flow.
Since syndications are set up as partnerships, these losses are passed down to you as a limited partner. These losses can offset other passive income, and depending on your income level these losses can potentially offset your ordinary income. If not, they are carried forward into future and can offset future passive income.”
See above for my thoughts on comparing one investment type to another. There’s never one right answer for every person in every situation.
Direct ownership in RE might be the best option for YOU, but is it for everyone? Not even close. We both know there are pros and cons with direct ownership and most people will not want to put up with the cons to get the pros.
I’m not saying that syndications are better or worse than anything (including direct RE ownership). But they certainly are a viable investment option just like dividend stocks, private loans, index funds, real estate ownership, etc. are.
Let’s say you have two investments with equal risk and other factors.
In the first, you invest $50k and earn 15% per year on your money. The guy who brought you the deal earns 30%.
In the second, you invest $50k and earn 10% per year on your money. The guy who brought you the deal earns 10% as well.
Which is the better deal? I think it’s pretty obvious.
I like to concentrate on what I invest, what I risk, and what I make. If that’s a great return, do I care what someone else is making? Not really.
For instance, with my private loans, I make 10% per year. The owner of the property will likely make much more, but he might not. We are assuming that the places will always appreciate and we know that is not true. So he has a chance to make more but he could also make less. he’s taking more risk and thus has the opportunity for more reward. That’s how it works with most investments.
In addition, investing is never a one shot game. People invest in multiple things for multiple reasons. There’s real estate (in many forms), index funds, dividend stocks, private loans, and on and on. None of them is always better than any other all the time. People have different preferences, goals, etc. that make all of these right based on how they want to run their lives.
For instance, how many people do you think “own dozens of units as well as run an 140 unit apartment complex”? I’m betting not very many. In fact, most people don’t even want to rent out a single family home because of everything else that goes along with direct ownership.
So real estate syndication deals are an option for them. Or for people who want truly passive income (we both know owning real estate directly is not completely passive even if you have a property manager) at very good returns.
I’d ask that you’d open your mind to possibilities and see how this can work for people versus taking an extreme example and then saying it doesn’t work compared to that.