Do you want to invest in real estate but are unsure of the investment route to follow? While there are several ways you can go about strengthening your position in the real estate niche, in this article, we’ll be comparing two popular options: Real Estate Investment Trusts (REITs) or Property Syndication?
REITs function like a mutual funds firm for the real estate market and they allow you to invest in properties without owning any yourself. On the other hand, direct property syndication involves several investors pooling resources to make real estate investments that they collectively own. Each of these portfolio diversification strategies has its unique benefits and drawbacks. Let’s take an in-depth look at these investment forms.
Investing in Real Estate Investment Trusts (REITs)
Similar to mutual funds, REITs are corporations formed by pooling the capital of many investors to own, manage, or finance real estate assets. These corporations allow individual investors to make profits from real estate without owning, operating, or paying for any specific property themselves. As at the time of writing this piece, the Securities and Exchange Commission (SEC) has accredited over 225 American REITs currently trading on the leading stock exchanges.
Benefits attached to investing in REITs
- Earn profits without owning a property: This is perhaps the most appealing reason investors choose REITs since investors can get dividends from real estate and but do not have to go through the hassles of owning, operating, or financing any properties.
- Low-cost market entry: REITs lower the entry requirement of investing in the real estate market. If you want to invest directly in properties, you will need to have substantial sums of money. But with REITs, you can begin your investment journey in real estate with as little as $500. This lowers not only the entry point but investment risks new investors can use this approach to diversify their portfolio while gaining experience.
- High dividends: You can expect that a minimum of 90% of taxable income will be paid to shareholders – the law demands REITs to pay this amount. Many shareholders also get a 5% dividend yield most times (and it can even be more sometimes).
- Potential for appreciation: As long as the underlying assets increase in value, your capital will also appreciate it.
- Liquidity: You can easily buy and sell your REIT shares on several exchanges. This means your money doesn’t have to be tied up on an asset for long periods of time.
Drawbacks of REITs
- Lack of tax advantages: The majority of the REITs attract high tax rates since they are not deemed “qualified” dividends.
- Dependent on interest rate fluctuations: Generally, when interest rates go up, REIT prices go down and vice versa.
- Lack of diversity: The majority of the individual REITs focus only on a particular property type, e.g., hotels, malls, etc. This leaves you at risk of certain situations that might affect the value of those properties. For instance, an investor whose REIT focuses on offices would have been seriously affected when businesses closed down for quarantine due to Covid-19.
Investing in Direct Property (Syndication)
Property syndication is a direct investment in real estate that involves several investors pooling their capital, just like REITs. One difference is that syndicates aren’t open to public investment after creating the trust or fund. Another difference is that the profits made by the properties invested in depend largely on the outcome of the income-generating activities of the purchased property. Syndicates also have a lifespan during which your money is tied up in the business. For example, a group of investors might buy some apartments in Manhattan and renovate them. After increasing their value, they may put up these Manhattan apartments for sale. When they are sold, the syndicate winds up and distributes the capital returns among the shareholders.
Benefits of investing in Direct Property (Syndication)
- High cash flow generation potential: Direct real estate investments are known for generating massive cash flow.
- Tax benefits: With direct property investments, there are several tax breaks you can benefit from. For instance, you can make deductions for managing the property. You can also reduce your taxable income when you deduct the purchasing and renovating costs of a property from its useful life.
- Appreciation potential: Property value usually rises over time, meaning that you may make sales at a better price.
- Considerable decision making power: You have more room to make decisions over the assets than when you invest in REITs. For instance, you and your syndicate can decide on which particular properties to purchase. You also determine the amount for rent, the type of tenants you want, or how much you want to sell the property.
- Lowered market entry price: Syndicates offer you the opportunity to invest in properties at a lowered price since you are investing with other investors. Although it is not as low as REITs, syndication can still help certain investors to acquire properties that might be too expensive for them if they were to purchase the assets as individuals.
Drawbacks of Syndication
- Requires sweat equity: Having to deal with the many issues attached to owning and maintaining properties is one of the turnoffs of direct property investment. Examples include issues with your tenants, damages to the property, and others.
- Risk of loan default: Many shareholders take mortgages or loans to finance their part of the investment. If the value of properties in the selected area falls or some other adverse circumstances, a loan default might occur.
- Illiquidity: In the case of an emergency, you cannot quickly sell off the property (or even your stake in the syndicate) to get cash.
If you want to invest in the billion-dollar real estate industry without managing or owning your property, you may want to go for REITs. Also, if you’re a beginner and you want to gain experience in the property market, REITs may be a smart choice.
However, if you want positive cash flow, tax breaks, and substantial appreciation potential, then direct property syndication might be the better option for you.
There’s really no textbook to investing in real estate. Both options are great, and choosing the best comes down to personal preference.
On a final note, it is noteworthy to mention that whatever option you decide to go with, chances are that you are going to sign a contract of some sort. If this is the case, it is a good idea to be absolutely sure you understand all the terms stated in the document or contract to be signed. As such ensuring that a good real estate attorney looks through the document that you are to sign will more than likely be in your best interest.
About the Author: Kanayo Okwuraiwe is the founder of Telligent Marketing LLC, a digital marketing agency that provides local SEO for lawyers to help them grow their law practices. Connect with him on Linkedln.