Cash flow comes from either active or passive approaches. Because active strategies trade time for money, the more you can capitalize on passive stratagems, the better.
Investments work the same way.
The goal is to create a portfolio centered around high-performing passive investments while balancing risk and reward. You are always searching for more efficient ways to increase the rate of return without taking on more risk.
Real estate syndication deals hit the sweet spot. It can increase diversification while providing one of the best investments from a risk-adjusted return perspective. Syndications offer all the benefits of owning property without the time required to manage the day-to-day operations.
Below is an overview of how real estate syndications work and how they can increase your rate of return without aggregating more risk.
How Real Estate Syndications Work
The legal structure allows individual investors to pool money for commercial real estate investment deals. Each purchase involves two parties: The sponsor and the investors. The deal sponsor acts as the general partner or manager and creates an LLC or LP (Limited partnership) to hold the real estate. Investors become passive members or limited partners in the business.
The JOBS Act made raising capital cheaper, faster, and simpler than the law previously allowed. Before 2012, commercial investments were only available to the ultra-wealthy. Now hard-working Americans can invest in multi-million dollar deals to gain a piece of commercial real estate profits.
The Role of the Sponsor
The sponsor or general manager will establish a separate business structure for each commercial property. They are responsible for locating and acquiring the property, managing it during the hold period, and deciding when to sell based on the objectives in the private placement memorandum.
The sponsor acts as the general partner and profits with the investors. In most cases, the sponsor invests personal funds in every deal offered. In addition to sharing the profits, the manager receives fees for their active role in the business.
Limited Partners in the Deal
Investors become limited partners in the business and have a passive role. Once invested, you are not responsible for the property’s buying, financing, or operations. You invest in the deal and own a percentage of the property based on the amount invested.
How Investors Make Money on Real Estate Syndications
- Operations – During the period of ownership, the property generates income, typically through rents. The sponsor distributes profits to investors and can be a source of regular cash flow.
- Refinancing – One way to increase profits is to reduce the interest cost through refinancing.
- Tax efficiency – Real estate syndications are often structured to be tax-efficient, reducing taxation during the period of ownership and, in some cases, at the time of the sale. It is also possible to reinvest profits through 1031 exchanges to delay taxation. Your investment dollars continue to grow tax-deferred through additional syndication opportunities.
- Tax benefits – The sponsor can also reduce taxes by taking advantage of tax benefits such as bonus depreciation or opportunity zone credits.
- Property sale: At the end of the hold period, the syndication can sell or refinance the property. Investors then receive a return of capital plus a share in the profits from the sale or refinance.
Are Real Estate Syndications Right for You?
If you want to learn more about commercial real estate syndications and whether they can enhance your portfolio, we have prepared a video presentation that provides more details about these opportunities here.