While real estate's returns and tax benefits attract individual investors, not everyone wants to spend their time finding, acquiring, and managing a property. The "hands-off investor" is more interested in receiving an investment opportunity that earns passive income than a phone call from a disgruntled tenant complaining of a backed-up drain. Plenty of investors dip their toe into the stock market by way of a mutual fund, but what investment vehicles deliver the benefits of real estate with the ease and passivity of a mutual fund? Enter the REIT, which has the accessibility of stocks. In comparison, the returns may not quite match apartment syndications or the individual real estate deal, but the ease and accessibility make them attractive to some real estate investors.
What exactly is a REIT?
When investing in a REIT, you're buying stock in a company that invests in commercial real estate. If you invest in a REIT that invests in apartments, you may think you are joining just a larger real estate syndicate that invests in apartments. REITs pool money together from several investors, and the individual investors are compensated through regular dividends earnings from the REIT without purchasing or managing properties themselves. It sounds like apartment syndication, right? Not really.
Let's explore the 8 Biggest Differences Between REITs and Real Estate Syndications:
1) The Number of Assets
A REIT is a company that holds a portfolio of properties across multiple markets in an asset class, which could mean significant diversification for investors. Individual REITs are available for apartment buildings, shopping malls, office buildings, elderly care, etc.
On the flip side, you invest in a single property in a single market with real estate syndications. You know the exact location, the number of units, the financials specific to that property, and the business plan for your investment, so you better understand how your investment can succeed.
2) Ownership Structure
When investing in a REIT, you purchase shares in the company that owns the real estate assets.
When you invest in a real estate syndication, you and a group of investors contribute directly to purchasing a specific property through the entity (usually an LLC) that holds the asset.
3) Barriers to Entry
Most REITs are listed on major stock exchanges, and you may invest in them directly, through mutual funds, or via exchange-traded funds (ETFs), quickly and easily online.
On the other hand, real estate syndications are often under an SEC regulation that disallows public advertising, making them difficult to find without knowing the sponsor or other passive investors. You most likely will not be hearing about these private investments from your financial advisor, as the offering comes directly from the sponsor.
An additional existing hurdle is that many syndications are only open to the accredited investor.
Even once you have obtained a connection, become accredited, and found a deal, you should allow several weeks to review the investment opportunity, sign the legal documents, and send in your funds.
4) The Investment Minimums
When you invest in a REIT, you purchase shares on the public exchange, some of which can be just a few bucks. Thus, the monetary barrier to entry is low.
Alternatively, syndications have a higher initial investment, often $50,000 or more. Though they can range from $25,000 to $100,000 or more, real estate syndication investments require significantly higher capital than REITs.
5) Liquidity
At any time, you can buy or sell shares of your REIT, and your money is liquid.
However, real estate syndications are accompanied by a business plan that often requires holding the asset for a certain amount of time (usually five years or more). During this time, the syndication has your principal.
6) The Tax Benefits
One of the more significant advantages of investing in syndications over a REIT is the tax savings. When you invest directly in a property (real estate syndications), you receive a variety of tax deductions, the main benefit being depreciation (i.e., writing off the value of an asset over time).
Often, the depreciation benefits surpass the cash flow. So, you may show a loss on paper but have positive cash flow. Those paper losses can offset your other income, like that from an employer.
You get depreciation benefits when you invest in a REIT because you're investing in the company and not directly in the real estate. Still, those are factored in before dividend payouts. There are no tax breaks on top of that, and you can't use that depreciation to offset any of your income, and therefore reduce your taxable income.
Unfortunately, dividends get taxed as ordinary income, contributing to a larger, rather than smaller, tax bill.
7) The Ability to 1031 Exchange
1031 exchanges are a power tax deferral tool for real estate investors. It allows investors to avoid paying capital gain tax of property when they swap it out and acquire a like-kind real estate property of equal or greater value.
However, since most REITs are treated dividend income like stocks, they cannot be used in a 1031 tax-deferred like-kind exchange. Investors who are serious about growing their real estate portfolio should seriously consider whether they are ok with forgoing this benefit by investing in REITs.
While not all syndications offer the ability to 1031 exchange (via a TIC structure), many do and can be quite a lucrative option when searching for like-kind property.
8) The Overall Returns
While returns for any real estate investment can vary wildly, the historical data over the last forty years reflects an average of 12.87 percent per year total returns for exchange-traded U.S. equity REITs. By comparison, stocks averaged 11.64 percent per year over that same period.
Therefore, if you invested $100,000 in a REIT, you could expect somewhere around $12,870 per year in dividends, which is a good ROI.
Between the cash flow and profits from the sale of the asset, real estate syndications can offer around 20 percent average annual returns.
As an example, a $100,000 syndication deal with a 5-year hold period and a 20 percent average annual return may make $20,000 per year for five years, or $100,000 (this takes into account both cash flow and profits from the sale), which means your money doubles over those five years. A portion of this, say 8% to 10%, comes in cash flow distributions (paid either monthly or quarterly), and the balance comes from the investor's share of the profits at the sale.
Conclusion
For new investors looking for direct access into the real estate market, having the capital required for the minimum investment into syndications may not be viable. If you only have $1,000 to $5000 to invest and prefer to remain liquid, you may consider REITs. If it is a high return on your investment you seek and do have the capital, syndication investment opportunities may better benefit you. You then have more direct ownership and thus also enjoy tax benefits.
Remember, it doesn't have to be one or the other. You might begin with REITs and then migrate toward real estate syndications later. If it is the diversity you seek, then combine both into your investment portfolio. You will be building your equity, all while being a hands-off investor, without receiving any of those surprise tenant phone calls.