If you’re dipping your toes into real estate investing, you’ll be faced with a wide swath of opportunities.
Investing in and managing commercial real estate can be prohibitively expensive, not to mention the actual maintenance and upkeep of a property that comes with it. However, a syndication is one option to still reap the benefits of investing in multifamily real estate. We’ve covered real estate syndications in a separate article; in this article we will examine how real estate syndication returns work, and what to expect if you invest in a multifamily syndication.
How does a real estate syndication work?
At a high level, a real estate syndication is where a group of individuals or companies pool their money together to purchase a property and benefit from the income that property provides and the eventual sale.
Real estate syndications are comprised of two groups:
- The syndicator(s)/general partners
- Passive investors
The syndicators are general partners in the deal, they are responsible for structuring the deal, underwriting the deal, performing due diligence, financing the deal, raising capital, making the purchase and strategically managing the property until its eventual sale. The syndicators spearhead the transaction and perform the critical overhead tasks to make a deal for the property happen and ensure the investors get paid when the property is sold.
About those investors, passive investors help by providing the capital needed to purchase the property and in return they have equity in the property and can often get a regular payout in return for their investment.
Real estate syndications are usually structured around a set time for the partners to be invested in the property. These agreements can range from 3 to 10 years, after which the property is sold, providing an added benefit to the investors from the sale’s profit.
How are real estate syndication returns projected?
Recall the groups in a real estate syndication, the syndicators and the passive investors.
It’s the syndicator’s job to raise the necessary capital to purchase the investment property, and clearly communicate to potential investors the projected returns for the investment. This way the passive investors can evaluate the property and get a sense of what their return on investment will look like on a pro forma basis.
A good general partner will provide a clear view on the expected income as compared to the operating expenses of the property, which is communicated in two metrics:
- Internal rate of return (IRR)
- Equity multiple
Internal rate of return (IRR)
IRR is a metric used by financial analysts to estimate a potential investment’s profitability, including the income stream plus the sales proceeds upon exit.
In simplest terms, IRR measures the annual growth rate of an investment (as opposed to total growth, which ROI, or Return on Investment would track). IRR is a handy way to compare a future investment’s value in today’s dollars. The higher the IRR, the more attractive the investment, making IRR a useful metric to compare properties. A simple approximation of IRR is this: If a 15% IRR is achieved, this equates to a doubling of funds invested within a five year period, or a 2X multiple.
The equity multiple is a simpler metric that calculates how many times your initial investment you can expect to get back. Based on the IRR example above, a 2.0 (2X) equity multiple means you receive back your initial investment plus a 100% profit.
How do real estate syndication returns get paid now that we understand how real estate syndication returns are estimated?
How Do Real Estate Syndications Compare with Other Investments?
Nothing in finance is guaranteed so it is hard to say that real estate syndication returns will always follow an exact multiple. Still, we can provide a rough estimate based on historical performance.
On average, keeping your money in a bank account will net around 1% while the average S&P 500 return is 11.8% per year.
At Colony Hills Capital, we’ve seen greater returns over the past 12 years, along with better tax benefits and in addition to passive income.
How are real estate syndication returns paid out?
How real estate syndication returns are paid depends on a few factors.
- Straight split: A straight split is where the cash flow and profits are distributed between the general partners and the passive investors, it could be a 50-50 split or be weighted depending on how much was invested.
- Preferred return: Sometimes partners offer a preferred return as an incentive for would-be investors, this usually means that the cash flow and profits will go to limited partners until a certain threshold is met.
- Distribution waterfall: Distribution waterfalls are more prevalent in private equity and syndication deals but worth addressing. Like the preferred return, these agreements change once a certain threshold is reached. It could follow a preferred return until a threshold is met, then a split until another threshold is reached, followed by a new equity split. These agreements can get complex and will be unique so it’s important to read the offering documents closely to understand how returns will be distributed. Pay special attention to what your investment is projected to return.
How real estate syndication returns are taxed
There are two certainties in life, one of which is taxes if you are lucky enough to have income.
The returns you make from investing in a real estate syndication will be taxed, though there are a few benefits to be aware of, which can make investing in a real estate syndication an attractive option compared to other types of real estate investments.
In fact, a real estate syndication could lower your tax burden; here’s how:
- Due to age and wear and tear of a property the IRS allows owners to depreciate (expense) a portion of the property’s value each year. Syndication depreciation flows to the investors (you), pro rata.
- Suppose the property is held for over a year. In that case, the difference between the sale and purchase price will be subject to capital gains tax, which is lower than ordinary income tax.
- Properties can be refinanced, bringing in tax implications and benefits, though this can get a bit complex. Basically, you can receive some or all of your original investment back, but retain ownership in the property.
- Mortgage interest on the property is deductible, reducing the tax income burden.
- In the event an investment is not profitable, those losses can be carried over and deducted from future taxable income.
So for passive investors, you can see there are quite a few tax implications and benefits to investing in a real estate syndication. You must consult your own tax specialist for your situation.
Ready to start investing in real estate?
Real estate syndications provide numerous benefits and advantages when investing in commercial real estate while remaining removed from managing the property yourself. While returns cannot be guaranteed, you can see that a real estate syndication could generate stable passive income and a profit for its investors.
At Colony Hills Capital we are experts in the acquisition, ownership, and management of property in growing markets around the country. While we cannot guarantee results, we always aim to provide consistent and above average passive income to our investors. Past performance is no guarantee of future results. Interested in investing? Contact us today to learn more.