We have often received the question “What’s the difference between investing in a real estate syndication vs investing in a fund?” In this article we break down some of the differences and high light the similarities.
What is a real estate syndication?
Put simply, a syndication is a group of investors pooling money together to make a purchase of an item (in this case real estate) that they would not have the resources (time, money, skills etc.) to purchase and manage on their own. (For the purpose of this article, when we use the term syndication, we are referring to single entity Limited Liability Company purchases of a real estate asset.)
An easy way to think about this is an airplane ride; you purchase one seat on the airplane and other passengers purchase the remaining seats. Due to the funds provided by all the passengers and skills by the pilot there is enough financial support and technical knowledge to take that plane from departure to final destination. In the case of a multifamily real estate syndication the pilot can be compared to the operator or sponsor – the person/team that puts the deal together. The passengers can be compared to the passive investors – the individuals that provide capital resources to help complete the deal but are not responsible for the active work necessary to make it a success.
What is a real estate fund?
Real estate equity funds operate as “blind pools” meaning that investors will invest a set amount of capital into the fund and then the operator will subsequently go out and make purchases of multiple properties until all the capital is deployed.
Liquidity refers to how easily you can move capital from one asset to the next with cash being the most liquid and a security that can’t be resold being the least liquid. There is often a misconception that there is no liquidity in real estate investments during the hold period (the time that your deal is expected to last). Investors should read the Private Placement Memorandum (PPM) however to see what the true liquidity for the deal is.
Often in real estate syndications there are hardship clauses that allow you to pull out your capital and also the PPM may allow for resale of shares after a set period of time (usually 1-2 years). Typically in this scenario the syndicate will have right of first refusal to purchase your shares prior to you attempting to find an external buyer.
Closed end real estate funds operate in a similar manner however open ended funds provide the most liquidity. Open ended funds will have “redemption periods” which line out at what point you can request your money and how long it will take to receive the money after initial request.
Control over investment selection
In real estate syndications you get to see the specific property you will invest in, have access to the financials and other pertinent data prior to investing and have an opportunity to inquire with the sponsor about the deal. If you do not like the deal at the end of the day you can choose not to invest in that deal or with that sponsor.
When you invest in a fund you are purely going off trust of that sponsor. The sponsors will typically provide a set of investment criteria that gives the investors an idea of what type of property the fund will look to acquire. Often these properties are not even identified until after the fund is established.
Once the properties are identified the investors will not have an individual veto power of the purchase or ability to accept only the properties they like into the fund. The investor will not have control over the investment selection so they will need to do proper due diligence on their sponsor selection and do what they need to get comfortable with the sponsor that is managing the fund.
The payment structures are usually similar for both syndications and funds
Syndications are often available to non-accredited or sophisticated investors and have minimums that may range from $10,000 - $100,000. Funds on the other hand due to the legal hurdles required to start a fund and the typical size of the fund, they are usually only open to accredited investors and have higher minimums. As such, those that have access to real estate equity funds, make up a smaller demographic than those that can invest in syndications.
Syndications have a plethora of tax deferral and tax deductions. One of the greatest being paper losses that come from depreciation – an accounting term for recording decrease in value of an asset due to aging over time. This depreciation creates an artificial loss on paper that prevents you from paying taxes on your income.
For funds it is possible that you may lose some of the tax benefits based on the way the fund is set up. You should carefully read the PPM and speak with the sponsor and your tax accountant to understand the tax implications of the fund you plan to invest in.
When investing in a syndication you are only invested with that syndicator and in that deal. To obtain true diversification you would need to invest in multiple deals with multiple syndicators in multiple markets. This will take more capital to accomplish diversification.
Funds, while they offer diversification because of the number of different properties in the fund, are all with the same sponsor. Diversification should be viewed on several levels; if you have a significant amount of money invested in the fund of one sponsor, you should consider whether that amount makes up a large portion of your investment portfolio and if there is need to diversify. If there is a problem with that one sponsor it may impact your portfolio significantly as the investment in funds relies heavily on trust of the sponsor.
“So, should I invest in a syndication or in a fund?”
So, should you invest in a syndication or in a fund? At the end of the day the answer is "it depends." You should consider the big picture of your financial and personal wants, needs and goals and see which investment vehicle most aligns with those criteria. Once you can answer that question you will know what to invest in.
So, what are you going to decide?