To build and maintain wealth, some families rely on their businesses while others turn to stocks or simple savings accounts. For many who succeed in building true generational wealth, real estate is a crucial pillar of their strategy. Here we cover several key advantages real estate offers to help families create and preserve wealth that can be passed from one generation to the next.
For investors looking to capture the benefits of real estate investments, there are multiple ways to build exposure, including real estate syndication and direct ownership. Here we’ll discuss how real estate syndication works, the potential pros and cons, and how it compares to direct ownership.
Syndication is a traditional way to raise money for large-scale investments. Investors form a syndicate by combining their capital to purchase a single asset, then share in the profits.
A real estate syndication is created when investors pool their capital to purchase a real estate asset, typically a single property. A wide range of real estate assets can be purchased through syndications, including single-family homes, multifamily apartment complexes, hotels, and office buildings.
Real estate syndications earn money from rental income and property appreciation. Capital is distributed according to a tiered, sequential structure, known as a waterfall. In addition to performance-based compensation, sponsors also make money through fees, such as acquisition fees, disposition fees, and financing fees.
There are two key roles in any real estate syndication: the syndicator (commonly known as the sponsor) and the passive investors.
- Syndicator – In terms of investment strategy and execution, syndicators do the heavy lifting. They’re responsible for finding investors, structuring the deal, acquiring the asset, and managing the property. Syndicators create and implement a business plan for the asset—and they’re on the hook for delivering strong returns to investors. Syndicators are typically real estate professionals with specialized expertise in a particular niche. The syndicator often invests a portion of a deal’s total required equity to have “skin in the game.”
Once the property is purchased, the syndicator operates it on behalf of the investors. Investors receive distributions based on their ownership percentage. The syndicator receives additional fees and a carried interest bonus (“promote”) if the investment goes well.
- Passive investors – The rest of the equity capital comes from passive investors, who contribute money in exchange for ownership shares. As passive participants, these investors aren’t involved in the day-to-day operations of the property.
Syndications are usually structured as a limited partnership or limited liability company (LLC). These legal structures help shield investors from potential liability related to owning a property. The partnership or the LLC owns the asset, and the passive investors are known as limited partners or members.
“Sponsor” is broadly used to describe the entity at the helm making active decisions. It may technically refer to a general partner, managing member, or non-member manager, depending on the particular structure.
When companies want to raise money by selling securities, they typically need to comply with SEC registration requirements designed to protect investors. Real estate syndicates typically avoid the costs and burdens of registering with the SEC by using Regulation D, an exemption to the Investment Company Act of 1940.
Real estate syndications often use rules 506(b) and 506(c) of Regulation D. The choice determines which type of investors can participate in the deal.
- 506(b) offerings – Syndicates can raise an unlimited amount of money and can sell securities to an unlimited number of accredited investors—but they cannot make any general solicitation or advertise the securities. Furthermore, securities cannot be sold to more than 35 non-accredited investors. These are often known as “friends and family” offerings, as you’ll need to “know a guy” to find out about the deal.
- 506(c) offerings – Syndicates can broadly solicit and generally advertise as long as all purchasers are accredited investors. Non-accredited investors cannot participate. 506(c) syndicate offerings are usually more common than 506(b) offerings.
In general, private real estate investments offer benefits such as regular cashflow and the potential for appreciation. Specific benefits of real estate syndications include:
- Passive, hassle-free returns – Syndication investors can profit from real estate without committing their time and effort to active management. Investors can skip the typical headaches of being a landlord, like late-night calls from tenants and collecting rent checks.
- Ability to choose specific investments – When investors put money into a syndication, they know exactly what asset is involved, enabling them to make property-by-property investment decisions. Real estate funds or REITs, on the other hand, are blind pools: investors don’t know in advance what their capital is buying.
- Tax efficiency – Syndicates are usually structured as pass-through entities, which means items like depreciation and interest expense are passed through to individual investors. This can create tax benefits, allowing investors to defer taxes to later years or offset income from other investments.
- Expertise of a skilled sponsor – Passive investors in a syndication can benefit from the hard-earned experience of a professional operator.
- Opportunity to diversify – Syndication allows investors to buy just a slice of a deal, enabling them to diversify across multiple sponsors, asset types, and strategies while tapping into new opportunities that may otherwise be out of reach if they had to buy the entire asset.
Real estate syndications pose certain challenges, including:
- Choosing the right sponsor – The sponsor controls nearly every major decision related to the deal, so passive investors need to pick carefully.
- Limited liquidity – Unlike publicly traded REITs, investments in real estate syndications are long term and relatively illiquid. Investment periods range from two to 20 years. Sponsors may try to periodically provide liquidity events, but liquidity may not be guaranteed.
- Limited control over the investment – Passive investors have very little control over the investment. The day-to-day decisions (like tenant screening and paint colors) and the big decisions (like refinancing and selling) are made by the sponsor.
What is Direct Investment in Real Estate?
Direct investment in real estate means purchasing and owning physical real estate properties directly, rather than passively investing through intermediaries or financial instruments, such as syndications, REITs, mutual funds, or crowdfunding platforms. A familiar example of direct investment is an individual who purchases a condo and rents it out to tenants.
The common aspects of direct investment include:
- Direct ownership structure – The investor or their company is listed on the deed as the direct owner. The investor has direct control over property decisions, including refinancing and sale of the property.
- Direct responsibilities – The investor handles, or directly oversees, property management. The investor makes all decisions about renovations, tenants, and maintenance. The investor is also responsible for securing financing and dealing directly with insurance and tax obligations.
Who can Directly Invest in Real Estate?
Unlike some investments that require accredited investor status (like many real estate syndications), direct real estate investment has no special qualification requirements beyond being able to purchase and finance the property. The main barriers are financial rather than regulatory.
For Individual Investors, What are the Potential Benefits of Direct Real Estate Investment?
- Investment control – The investor has complete control over property appreciation value through improvements and management decisions. They can also decide when to buy, sell, or refinance, which lends more flexibility to the holding period. Investors exercise control over tenant selection, rental rates, and property manager selection. They enjoy freedom to select which markets and property types to invest in, and they may also have the option to live in the property if circumstances change.
- Potential to participate in a 1031 exchange – A 1031 exchange allows investors to swap like-kind properties and defer the capital gains tax on the first property’s sale. Not all real estate investment structures are set up to easily allow 1031 exchanges—but direct ownership usually is.
- No splitting returns with a sponsor – Active, direct owners don’t give up a portion of the asset’s returns to sponsors.
- Tax efficiency – With direct ownership, items like depreciation and interest can create tax benefits, allowing investors to defer taxes to later years or offset income from other investments.
For Individual Investors, What are the Potential Drawbacks of Direct Real Estate Investment?
- Higher capital requirements – Direct ownership usually means investors are responsible for a larger share of capital requirements, such as down payments, cash reserves, property insurance, closing costs, and maintenance expenses.
- Concentrated risk in specific properties – Thanks to the higher capital requirements associated with direct ownership, investors can accumulate concentrated exposure and find it more difficult to diversify across asset types and geographies.
- More hands-on management responsibility – Active, direct ownership involves more responsibility, even if some tasks are outsourced. Investors need to coordinate and oversee contractors and other service providers while also handling bookkeeping and financial management. Investors also need to stay current with market conditions and ensure compliance with laws and regulations.
What Client Fit Factors Should Advisors Consider?
Before jumping into real estate via a syndication or direct investment, it’s wise to (re)consider the basic foundations of each investor’s portfolio, including:
- Time availability for management
- Risk tolerance
- Investment size
- Desired level of control
- Tax situation
- Need for liquidity
- Professional real estate experience
- Portfolio diversification goals
Caliber’s Advisor Resource Hub
To learn more about real estate and how Caliber can help investors generate wealth for generations to come, visit our Advisor Resource Hub or contact our team today.
About Caliber (CaliberCos Inc.) (NASDAQ: CWD)
With more than $2.9 billion of managed assets, including estimated costs to complete assets under development, Caliber’s 16-year track record of managing and developing real estate is built on a singular goal: make money in all market conditions. Our growth is fueled by our performance and our competitive advantage: we invest in projects, strategies, and geographies that global real estate institutions do not. Integral to our competitive advantage is our in-house shared services group, which offers Caliber greater control over our real estate and visibility to future investment opportunities. There are multiple ways to participate in Caliber’s success: invest in Nasdaq-listed CaliberCos Inc. and/or invest directly in our Private Funds.
Investor Considerations
The information contained herein is general in nature and is not intended, and should not be construed, as accounting, financial, investment, legal, or tax advice, or opinion, in each instance provided by Caliber or any of its affiliates, agents, or representatives. The reader is cautioned that this material may not be applicable to, or suitable for, the reader’s specific circumstances, desires, needs, and requires consideration of all applicable facts and circumstances. The reader understands and acknowledges that, prior to taking any action relating to this material, the reader (i) has been encouraged to rely upon the advice of the reader’s accounting, financial, investment, legal, and tax advisers with respect to the accounting, financial, investment, legal, tax, and other considerations relating to this material, (ii) is not relying upon Caliber or any of its affiliates, agents, employees, managers, members, or representatives for accounting, financial, investment, legal, tax, or business advice, and (iii) has sought independent accounting, financial, investment, legal, tax, and business advice relating to this material. Caliber, and each of its affiliates, agents, employees, managers, members, and representatives assumes no obligation to inform the reader of any change in the law or other factors that could affect the information contained herein.
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