Which Makes More Money, Investing In Rental Properties, or Real Estate Syndications?
You have made the decision: I am going to be a real estate investor. You then start to ponder, should I be an active investor, or should I be a passive investor? Should I invest in single-family or multifamily? A question that comes up most often is, which investment provides a better return, a rental property or investing in syndications?
People want to know if investing in real estate properties is more lucrative or if real
estate syndications are genuinely the best choice. I suspect investors are thinking they are cutting out the middle man by investing in their own rental property instead of joining in with a group of investors, but are they? When you total up the brokers, lenders, property managers, and contractors, you are paying the piper, only you have to work harder to do it.
Real estate syndications' significant benefit of being an actual hands-off investment saves
investors stress of maintenance issues, tenant complaints, and dipping cashflow. That right there can make you feel like syndications are a better deal. Other positives are not having to try getting the loan – furnishing docs for your lender can be a harrowing experience. One majorly overlooked benefit of investing in syndications is that you leverage that operators’ connections and abilities to buy "off-market," and thus, buy at a discount.
On the other hand, with rental properties, you have to do all the legwork and establish those connections yourself. That includes finding a broker, property manager, contractors, and coordinating with lenders and insurance reps. So, in exchange for all that hard work, you better be earning higher returns; otherwise, what would be the point? What is an hour of your time worth? Do you even have the time?
I have invested in both rental properties and syndications, so I can run a comparison. So, let's get started.
Real Estate Syndication
First, let's review what a $50,000 real estate syndication deal would look like cashflow-wise just so we have a comparable reference.
If I were to invest $50,000 into a real estate syndication with an 8% return, that equates to about $333 per month in cash flow.
$50,000 x 8%= $4,000 / 12 months = $333
If I could make $333 per month with a 50K investment in a real estate syndication, then a real estate rental that requires sweat equity would need to provide me more than $333 each month to be worth it overall.
Obviously, a large omission here is the other 8-12% annualized return you earn when the property is sold, but we compare monthly cash flow for now.
$1,375 sounds great, right? If I owned the property free and clear, it would be great to pocket $1,375, but I have to pay the mortgage. Remember the mortgage plus taxes and insurance is $1,731?
Now, let’s have a look at an actual rental property that I own.
A great example is a four-plex in Indianapolis that cost $240,000 at the time of purchase. Each of the four units rent for between $600 - $700 a month (basically the 1% rule). It is not a home run, but a decent buy in this neighborhood. I put $50,000 down and wound up with mortgage payments of around $1,350 a month. If you add up taxes and insurance, our monthly obligation comes out to $1,731 a month.
The whole point of owning rental property is that the rent you earn is greater than the mortgage and expenses you owe on the property.
On a month where all four units were occupied, except one didn't pay, we had 3 rent payments come in for a total of $2,035 before expenses. Expenses for this example included management fees, HVAC service fees, and utility fees, which total $660.
$2,035 - $660 = $1,375
$1,375 sounds great, right? If I owned the property free and clear, it would be great to
pocket $1,375, but I have to pay the mortgage. Remember the mortgage plus taxes and insurance is $1,731?
This means for December of 2018, I actually lost money on this rental property.
Almost nothing’s the same month-to-month, and there are good months. We need to examine a few more windows of time to really gain a clear picture.
This was yet another month where there were four occupying tenants but only 3 rents
being paid. November's expenses included the regular management fees, utility fees,
plus an electrical repair.
The total income minus expenses came out to $1,270, which, again, didn't
cover the mortgage payment. I was in the hole of $461 that month.
Fortunately, in October, all four tenants paid rent, which brought in $2,590. The expenses were about the same as November's (above), which brings our net operating income for October to $1,966.
After paying our mortgage, taxes, and insurance of $1,731 on that property, the cash flow was $235.
If we go back one more month to September, we see another month where all tenants paid. This month, we had minimal maintenance issues, so the $2,688 resulted in $586 positive cashflow after all expenses and the mortgage payment. $586 is fantastic, but remember, this is only one of four months that shows this much in profit.
Rental Property Review
My investment of $50,000 on a rental property yielded cashflow (rents paid minus property expenses, mortgage, taxes, and insurance) of $586 in September, $235 in October -$461 in November, and -$356 in December. The overall result of those four months, 2 positive and 2 negatives, was a cash flow of just $4. Yeesh.
I realize this is just one example, but I will tell you that I was cruising along earning 12% COC on another fourplex, but we had to evict one of the tenants. By the time I added up the lost rents, the costs of the eviction, the costs of the make-ready repairs, and the leasing fee paid to the property manager. I was down to 7% on the year. When one out of four tenants puts you in this bind, the costs are relatively high. This is a prime example of the diversification of risk that you enjoy with syndications. When you need to evict one tenant out of 200, it is barely a blip on the radar, whereas the pain is definitely felt on your 4-unit. Even worse, on our single-family rental.
Rental properties require ebbs and flows. Tenants come and go, and maintenance expenses are unpredictable. If you're really interested in inconsistent cash flow in exchange for minimal work, rental properties aren't going to be a good fit. Rental properties might be for you if you really want a hands-on investment and if you're okay with having some tough months in exchange for those with positive cashflow. You'll just have to do everything in your power to ensure most of the months are positive to make it "worth it" long term.
Getting into capital appreciation requires another article, but we can quickly sketch a few numbers. Syndications average about an extra 8-12% annualized return with profit at the sale, so let's call it 10% a year.
Based on our $50,000 investment and a 5-yr hold, that is $5k/year for a total of $25,000. This is a 50% ROI, excluding the annual cashflow (another 40% ROI – 8% COC per year).
Remember, I paid $240,000 for the fourplex and put down $50k, so it will require me to sell for $265,000. Actually, when you consider the cost of sale (commissions, closing costs, repairs), it will be more like $275,000 - $280,000. After 5 years, it is not inconceivable to average a 3% appreciation in this market. It is a stable market – not a booming market.
It is also an excellent time to point out the difference between how these investments are evaluated. Option A – the syndication is assessed on it's net operating income (NOI). Thus, we divide the NOI by the prevailing market cap rate and out spits our value. We have all the control.
Option B – the rental property, is based on comparable properties – the comps. So, you are more reliant upon the whims of the market. This can be very opportunistic in a rising market. It can be regrettable in a falling market. We do not have the same control.
So, Which is Better?
There’s no right answer for everyone. As you can see, I invested in both types of properties.
There’s value in both.
Rental properties do have the potential for higher income - if the stars align and you have a fully occupied property with low maintenance costs and tenants that pay rent. There's no such thing as a maintenance-free property, though, and to boost rental rates, you'll want to do some improvements here and there, and then still, you are limited by the comps.
For a no-fuss investment with consistent cash flow, then a real estate syndication might be your
I had a good discussion with a fellow investor who was interested in how I quickly ran numbers. It was a small multifamily property, but I ran them using the commercial method of using NOI and cap rate and then analyzed as a single-family, using comps. This was not some uncovered gem; it was merely taken off the MLS to use as an exercise, but the lesson should be the same. It was located in central California, so not cash flowing market, and the numbers held true, as it yielded a .036% COC return –basically zero cash flow. Could there be some appreciation? Maybe, but then we are speculating and not investing.
My thought was, why wouldn't you invest in syndications and earn 15-20% annualized return, rather than take on all that work, risk, and speculation and maybe break even? I suspect that people don’t like losing that control. They don’t like handing over their hard-earned money to an operator rather than operating the investment themselves. But maybe, just maybe, that operator is more qualified to handle your investment - fall in love with the numbers, not the property or the pride of ownership. Sure, you can say, by God, I did this myself! But will you be bragging to your friends if you are losing money every month? Just make sure to ask yourself the tough questions so as to have the best investment vehicle to grow your net worth.