For most people, getting into real estate means buying an extra home or two and renting them out to tenants. Theoretically, you get some solid tenants in the homes, have minimal maintenance and repairs, and rake in the cash flow. Unfortunately, the reality of landlord-life is not that easy.
If real estate investing seems interesting to you, but you’d rather avoid becoming a landlord, you’re not alone. Fixing toilet emergencies at 3am isn’t appealing to most people, myself included.
The next logical step that many investors take when looking at real estate options in the US economy is toward a real estate investment trust (REIT), which is easy to access, just like stocks.
What is a REIT, anyway?
When investing in a REIT, you’re buying stock in a company that invests in commercial real estate. So, most people naturally figure, if you invest in an apartment REIT, it’s the same as investing directly in an apartment building.
That couldn’t be further from the truth.
Let’s explore the 7 biggest differences between REITs and real estate syndications:
Difference #1: Number of Assets
A REIT is a company that holds a portfolio of properties across multiple markets in an asset class, which could mean great diversification for investors. Separate REITs are available for apartment buildings, shopping malls, office buildings, elderly care, etc.
On the flip side, with real estate syndications, you invest in a single property in a single market. You know the exact location, the number of units, the financials specific to that property, and the business plan for your investment.
Difference #2: Ownership
When investing in a REIT, you purchase shares in the company that owns the real estate assets. You’re relying on that company’s positive position in the stock market to generate income.
When you invest in a real estate syndication, you and others contribute directly to the purchase of a specific property through the entity (usually an LLC) that holds the asset. In this case, your investment is directly reliant on the asset’s value, not the value of the company holding the asset.
Difference #3: Access to Invest
Most REITs are listed on major stock exchanges, and you may invest in them directly, through mutual funds, or via exchange-traded funds, quickly and easily online.
Real estate syndications, on the other hand, are often under an SEC regulation that disallows public advertising, which makes them difficult to find without knowing the sponsor or other passive investors. An additional existing hurdle is that many syndications are only open to accredited investors.
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.
Difference #4: Investment Minimums
When you invest in a REIT, you are purchasing 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 higher minimum investments, often $50,000 or more. Though they can range from $10,000 up to $100,000 or more, real estate syndication investments require significantly higher capital than REITs.
Difference #5: Liquidity
At any time, you can buy or sell shares of your REIT and your money is liquid.
Real estate syndications, however, are accompanied by a business plan that often defines holding the asset for a certain amount of time (often 5 years or more), during which your money is locked in.
Difference #6: Tax Benefits
One of the biggest benefits of investing in real estate syndications versus REITs is tax savings. When you invest directly in a property (real estate syndications included), you receive a variety of tax deductions, the main benefit being depreciation (i.e., writing off the value of an asset over time).
Oftentimes, 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.
When you invest in a REIT, because you’re investing in the company and not directly in the real estate, you do get depreciation benefits, but those are factored in prior to dividend payouts. There are no tax breaks on top of that, and you can’t use that depreciation to offset any of your other income.
Unfortunately, dividends are taxed as ordinary income, which can contribute to a larger, rather than smaller, tax bill.
Difference #7: 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.
This means, on average, if you invested $100,000 in a REIT, you could expect somewhere around $12,870 per year in dividends, which is great ROI.
Between the cash flow and the 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 5 years, or $100,000 (this takes into account both cash flow and profits from the sale), which means your money doubles over the course of those five years.
So, which one should you invest in? What’s the best way to build a legacy?
All in all, there’s no one best investment for everyone (but you knew that, right?).
If you have $1,000 to invest and want to access that money freely, you may look into REITs. If you have a bit more capital available and want secure, direct ownership of a tangible asset, want to be able to talk to the sponsors directly, and want more tax benefits, a real estate syndication may be a better fit.
And remember, it doesn’t have to be one or the other. You might begin with REITs (like I began with single-family rentals) and then migrate toward real estate syndications later. Or you might dabble in both to diversify. Either way, investing in real estate, whether directly or indirectly, is stable, forward progress toward wealth preservation and financial freedom so you can live a vibrant life.