You Want to Invest in Real Estate: Is a Syndication or Private Fund the Way to Go?

You Want to Invest in Real Estate: Is a Syndication or Private Fund the Way to Go?

 

Does this sound familiar? You’ve decided to invest in the real estate market, but you’re unclear about whether syndications or private equity funds are the best choice for your portfolio. In order to make an informed decision, you first need a clear understanding of each investment model.

1) Syndication — The pooling of money to purchase a single common asset

Why would an investor want to be a part of a syndication? Great question. It’s because a syndication allows you to buy into a larger asset for a nominal amount compared to the total purchase. In order to purchase the asset, an operator (otherwise known as a general partner) pools together funds from various investors (otherwise known as limited partners[1]), and then secures a loan for the remaining balance.  

In most of the deals I have seen, the minimum investment in a syndication was set to $50,000. This might seem like a lot of money, but the $50,000 allows you to buy into an asset that is worth millions and receive all of the benefits that a larger business provides, such as professional property and asset management, consistent profit distributions, and better terms on the mortgage of the asset.

My alternative option to investing in a syndication would have been purchasing another single-family rental, which would have given me 100% share of the $50,000 rental but with zero of the upsides that comes from investing in an institutional-quality asset.

 

The Advantages of a Single Property Syndication

 

  • Allows the investor to do their due diligence (homework) on the specific deal to be purchased
  • Can produce outsized returns if the single deal performs well
  • Offers limited liability and credit protection to the limited partners in the syndication
  • The investor is only waiting on one property to report for taxes

 

The Disadvantages of a Single Property Syndication

 

  • Your investment performance is tied to one property in one market
  • Lack of control over when the property sells can cause an unexpected tax event

 

2) Private Equity Real Estate Fund — The pooling of investor capital by an operator in order to acquire and manage multiple real estate assets, as opposed to just one

Operators can raise capital for both current assets or for future prospective property acquisitions—the latter of which is called a “blind pool fund.” In this case, the operator explains their criteria for purchasing deals usually in terms of the returns, geographic locations, market fundamentals, and previous track record they have doing deals that meet those criteria.

As an investor, you would then need to make a decision on whether the fund’s vision aligns with what you’re looking for in an investment.

In a blind pool fund, the investor invests in the operator on a deeper level than in a single syndication deal because all of the fund’s assets usually have not yet been identified at that point.

From an operator’s perspective, funds simplify the capital-raising process and make them a more serious buyer in the seller’s eyes because they can provide proof that the investors’ funds are already in place. Also, they allow larger operators to compete for multiple properties at the same time vs. being constricted to one deal at a time. In a market where it’s difficult to acquire properties (like the one we find ourselves in today), this gives the operator more leeway. Lastly, raising capital is an extensive and exhausting process—from investor calls to subscription documents, and attorney and accounting reviews. One large fund can replace multiple smaller raises and save a good amount of repetitive work in the process.

 

The Advantages of a Real Estate Fund

 

  • Helps the investor diversify into multiple equities with one investment
  • Helps reduce the risk of a single property underperforming
  • Potential tax benefits as the capital gains that are received from sold properties are offset by the properties still in the fund
  • Access to a larger pool of assets, as funds usually raise a higher dollar amount than single deals
  • Offers limited liability and credit protection to the limited partners
  • Helps the investor get access to better deals in a competitive market
  • Ability to diversify into multiple business plans in one investment

 

The Disadvantages of a Real Estate Fund

 

  • Not being able to perform thorough due diligence, as you might not know which specific future assets will be in the fund
  • Taxes may be delayed since all properties within the fund must first complete their accounting documentation

 

How Do I Know Which Choice Is Right for Me?

 

While there are no hard-and-fast rules, the answer depends on your goals and your individual risk/reward profile.

If you’re a newer accredited investor in this space, you may want to take a closer look at funds for your first few deals because they provide maximum diversification. And if you only have money for one or two deals, this approach decreases the risk of one single property performing poorly.

Also, depending on how the fund operator reports their performance, you can ramp up your knowledge more quickly. Let’s say a fund has six deals; the operator should be providing quarterly reports on the performance of each one of those deals. This allows you as an investor to learn more quickly why one deal was more successful than another deal, which is knowledge you can apply to your next deal.

If you’re an investor with a larger existing portfolio, you may have no preference in investing in a fund versus a single syndication. The major factor is simply who the operator is and what your existing relationship is with that operator. In other words, if you’ve had multiple successful dealings with one specific operator, you probably wouldn’t give much thought to whether they’re offering a fund or a single syndication.

Either way, there are definitely merits to both investment options, and it’s not an either-or scenario: You may decide that both options are right for you for different reasons. If you’d like to learn more about alternative investing options that match your specific goals, please reach out to start a conversation.

[1] Limited partners also get the benefits of limited liability and practically no recourse if the investment goes bad. The common saying is a limited partner can only lose their entire investment but no more.

 

If you liked this article and wish to continue on your path in learning about alternative investments, please make sure to check out my other educational articles as well as my bookThe Alternative Investment Almanac: Expert Insights on Building Personal Wealth in Non-Traditional Ways

Disclaimer: The information presented in this article is for informational purposes only and does not constitute professional financial or investment advice. The author does not make any guarantees or promises as to the results that may be obtained from it. You should never make any investment decision without first consulting with your own financial advisor and conducting your own research and due diligence. Even though, the author has made reasonable efforts to ensure that the contents of this article were correct at press time. The author disclaims all liability in the event that any information, commentary, analysis, opinions, advice and/or recommendations contained in this article results in any investment or other losses. Your use of the information in this article is at your own risk.

 

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