Real Estate Syndication 101: What to Know Before You Invest

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1:46Elizabeth Ayoola:Katie wants to diversify into real estate and is considering real estate syndication. Today, we break down what it is, what it costs, and also what's at stake. Welcome to NerdWallet's Smart Money Podcast, where you send us your money questions and we answer them with the help of our genius nerds. I'm Sean Piles. I was going to serenade myself, but I won't. And I'm Elizabeth Ayola. This episode, we're talking about something that we have not touched on in some time, and that is real estate investing. Thanks to you, Katie. Hopefully you're listening and watching. They want us to weigh in on the pros and cons.

2:22Elizabeth Ayoola:So here is their question. I hear I should think about diversifying my investments into real estate. I don't need to learn another profession, so I don't want to manage rental houses or STR, short-term rental. Can you tell me about getting into real estate syndication? Pros and cons. Minimum investment for most places. Questions I should ask as I talk to a sponsor. How long will the capital be tied up? as well as everything I don't know. Thanks, Katie. Well, Katie, we can't teach you everything that you don't know because that is a long list that extends well beyond real estate investing. But we'll give you some tips today and we're joined by NerdWallet investing writer Sam Taub to help out.

2:59Sam, welcome back to Smart Money. Long time no see. Sam, let's start by outlining what real estate syndication is. So real estate syndication is a group investment where a bunch of investors pool their money together to buy or build something, typically something big, like an apartment complex or a shopping center. Big, expensive things that you need a lot of money for.

3:19Elizabeth Ayoola:Well, you can get involved with real estate syndication in different ways, Sam. I know because I was researching the topic. And one is by joining a real estate crowdfunding platform. Can you explain to me how this works? Real estate crowdfunding platforms organize these kinds of syndications online, which gives investors some of the ease of use of like an online brokerage account, although you can't necessarily buy and sell whenever you like, as if you're trading stocks online. But it does kind of give you some of that easy user experience. NerdWallet has a roundup, actually, of online real estate crowdfunding platforms that we can put in the show notes of this episode.

3:56Okay, that sounds like it's almost somewhere between a Kickstarter account and a Fidelity or another kind of taxable brokerage account. Is that about right? Yes, definitely. Yeah, those are other types of crowdfunding accounts, your Kickstarter and your Indiegogo and whatnot. But there are other points of entry into syndicate investing. Can you talk about those two? Old school real estate syndication is generally just about knowing a guy. It's about networking. But nowadays, there are also online networks you can join. Angel Investors Network and Grid Investor Network are two of the bigger ones that can facilitate access to private deals, not on these platforms.

4:34On the other end of things, one investment vehicle that's open to pretty much everyone is real estate investment trusts. These are publicly traded funds. They're kind of like exchange traded funds, but they're structured a little differently. But basically, they invest in real estate on behalf of shareholders, and they're available in pretty much all brokerage accounts. Now, granted, these aren't quite the same thing as real estate syndication deals, but they're another kind of pooled investment in real estate. And for that matter, they're actually significantly easier to buy and sell than an investment in a private syndication deal.

5:11Elizabeth Ayoola:Yeah, someone who is lazy with her money, as soon as I heard about REITs, I was like, yes, please, that's for me. Okay, so for the people out there who are maybe like, hey, I don't want to go the crowdfunding platform way, and also I don't want to go the REIT way, Sam, they could also start their own syndication, right? For the ambitious folks? For the ambitious folks, sure. You'd probably need to be a real estate lawyer or have the money to hire a bunch of real estate lawyers. But you could theoretically do it on your own. Starting up your own syndication would mean incorporating a company and then drafting a bunch of complex legal documents like a private placement memorandum, which is basically an investment prospectus for your partners that outlines objectives, risks, and so on.

5:56So it also means, you know, potentially exposing yourself to a lot of legal risks. If you don't want to deal with all that lawyering, you're probably better off just joining someone else's syndication. Sounds like our listener Katie will be more in that ladder camp because they don't want to take up a whole new profession or go to school or anything. They just want to invest in real estate, and this is one way they're considering doing that. There are different members of a syndication, but two key ones are the syndicator or sponsor who leads strategy and financing initiatives, and the passive investor, which it seems like Katie would hope to be.

6:27What are some questions that Katie or anyone else in this situation should be asking to ensure they're choosing the right real estate syndication or sponsor, as Katie mentioned? I'm thinking here about, you know, communication agreements, profit sharing, voting. Those are good things to ask about. And then I think another thing I'd add is track record. Has the person ever completed a deal? Did it make money or did it lose money? Do they have people who come back and invest with them again after previous deals? This is probably something to ask them and see what information they give you. And for these sorts of deals, sponsors are typically required to file forms with the Securities and Exchange Commission.

7:04And so you could use the SEC Edgar database to kind of verify what they tell you by looking for their name. I think you'd really want to do your due diligence and make sure they have done all those filings before you give anyone any money so that you don't end up giving it to some sort of scammer who's promising a bunch of returns on some kind of real estate project. For sure.

7:22Elizabeth Ayoola:Katie, if you love Reddit as much as I do, go on there. Of course, do your research and ask all these questions. But some people in the Reddit apparently lost money doing this. So you definitely want to be aware of scammers and you don't want to lose your hard earned money. Now, speaking of money, what about the cost, Sam? As we know, you can buy stocks for pennies. Now, is it the same for real estate syndications? Do they have a low point of entry or is it on the higher side? It depends what you define as a low point of entry. Some online syndication platforms advertise a pretty low point of entry.

7:56Like Fundrise's minimum investment is technically only$10, although a lot of the specific investments on Fundrise have multi-thousand dollar minimums. Equity multiples minimum is$5 ,000. Now, having said that, that's still on the low end compared to what you're looking at for like a traditional private offline syndication. In that case, you might be looking at$25 ,000,$50 ,000, maybe even$100 ,000 or more. And if you think about what you're actually investing in, those numbers make a lot of sense because it costs a lot of money to build something like an apartment complex or a mall or some sort of event arena.

8:35so you're going to have to pony up a lot of cash if you want any kind of sizable return, I imagine. Definitely. So Sam, let's talk a little bit about how long folks' money might be tied up and what kind of return they might expect for putting money into something like this. What should people know? So when it comes to duration, it's probably good to expect your money to be tied up for at least five years. That's what Fundrise advertises on its website, and that's generally the same as what you'll kind of expect from a lot of private syndication deals. Now, some of the online platforms that we're talking about offer shorter-term options, but they may not be as profitable as long-term deals, and they may even have an explicit penalty attached to them.

9:15Fundrise, for example, offers early liquidation with a penalty on some investments, and Equity Multiple issues short-term debt securities that finances projects that mature in just a few weeks or months in addition to offering long-term deals. But those aren't the same and don't pay quite as much. According to Equity Multiple, actually, debt securities tend to target an annualized rate of 8 to 12 percent, whereas the rate of return can be as high as 15 percent for investing directly in deals. But a caveat that we have to attach to that is that real estate investing deals like this can be risky.

9:54And there is a risk that projects completely fall apart and investors can take a total loss.

9:59Elizabeth Ayoola:Sam, how much more risky in terms of the losses? I know we can't probably do it for dollar for dollar. Would this be compared to an REIT, for example? The amount of money at stake is going to be significantly higher. As we talked about, a lot of these, even the kind of easy to access online platforms, a lot of them have multi-thousand dollar investment minimums for both deals. So, you know, you're wagering a lot more than you would if you were just buying a few shares of an REIT in a brokerage account. And then on top of that, private investments of all kinds, including real estate syndication deals, are not necessarily vetted and regulated as strictly as publicly traded investment companies and funds are.

10:42And so there is a lot more of a risk that the apartment building never gets built or, you know, just the project completely goes to zero and the investors lose everything. And we'll talk a little later about how some of these online platforms have come under fire in recent years for kind of underplaying that risk to investors. So it seems like there's a much greater onus on the investor to really understand the specific project and how viable or risky it might be compared to something like investing in an ETF or some sort of index fund. Absolutely.

11:17Elizabeth Ayoola:I was just envisioning myself sliding down a wall if that ever happened to me and my$50 ,000 just went down the drain. Lots of drama. Yeah, I'd be really kicking myself. We'll be back in a minute. Stay with us.

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13:42Elizabeth Ayoola:For those who expect more from every moment, there's a vehicle designed to meet it. The Range Rover Sport. Exclusive offers available now. Explore further at RangeRover.com. Sam, let's get into the requirements in order to participate in a real estate syndication. What do you need except for thousands of dollars in some cases? Well, you actually need millions of dollars in some cases. Typically, real estate syndication is only open to accredited investors. And that's someone who has a net worth of at least$1 million, not counting their primary residence, or an annual income of at least$200 ,000 for a single taxpayer or$300 ,000 for a married taxpayer.

14:25I really want to underscore that because that's such a frustrating part of the investing world that's so biased toward the wealthiest of the wealthy. I want to underline, too, that just because you have a million dollars, that doesn't mean that you're financially savvy. You could have just inherited that money. Yet other people who actually might know more about investing and don't have access to that kind of capital are excluded from investing. And that's just because of these rules, which I find really frustrating. I think that defenders of those rules would say that, you know, it's supposed to be kind of protecting people who don't have as much from losing their shirt on this.

15:02But it does definitely lock us normal folks out of a lot of different types of investment opportunities. Yeah, it's patronizing, but that's not the focus of this conversation. Yeah, just had to give my two cents on that. One of the platforms we review, Fundrise, has some options that are open to non-accredited investors. But if you're looking at a private deal, you need to meet those thresholds. Well, let's talk a little more about how investments are managed and maintained, because this is a sort of passive investment, right? Yeah. The online platforms kind of simplify the process of keeping track of your investment and keeping the paperwork together.

15:38That's one of the main benefits of going through these online platforms. But otherwise, that's pretty much all the responsibility of the sponsor, which is part of the reason why it's so important to ask the sponsor about how things are going to work, what their track record is. They don't just have your money in their hands. They also kind of are wholly responsible for keeping the process organized and keeping you informed.

16:01Elizabeth Ayoola:I'm thinking about how this type of investment fits into your broader portfolio. I know one of the appeals of real estate investing is that you can get returns that aren't necessarily correlated with the market. In other words, it's a way to diversify your portfolio, which we're always harping on about. So should everybody consider diversifying their portfolio into real estate? Wait, yes, this is a trick question because I know we don't give financial advice. But what do you think, Sam? The caveat that we have to give is, you know, it's a good idea to talk to an advisor about real estate decisions like this.

16:31What I can talk about is kind of the statistics here. So, yes, the diversification you get from real estate can be good for an investment portfolio. And that's one reason why even a lot of like lazy portfolios that are just made out of ETFs and mutual funds and things, they often include a small allocation to REITs or real estate focused mutual funds or something else, because real estate returns aren't necessarily correlated with the stock market. But having said that, it's also worth noting that when it comes to long-term average returns, real estate actually tends to trail the stock market for the most part.

17:07Over a period of decades, you're looking at average annualized returns of 4 % to 6 % in real estate versus 10 % in the case of the stock market.

17:16Elizabeth Ayoola:All right, Sam, well, now that we understand the basics, let's look at the pros and cons, which Katie wanted to know. What are some pros? Let's start with that. I know tax benefits are a big one. For sure. As we talked about, these are generally long-term multi-year investments. And because of that, their profits are usually taxed at long-term capital gains rates, which are lower than income rates. And then on top of that, there are a lot of deductions available in real estate investing, which reduce those taxable gains even further. There's depreciation, building wear and tear, maintenance expenses, mortgage interest.

17:51All of those can potentially be deducted from the profits that you have to actually pay taxes on. All right, let's talk about some cons and thinking here, like we touched on before, that risk is a big one. Yeah, these sorts of real estate partnerships, as we talked about earlier, are not regulated like publicly traded companies are. They're not regulated as closely, I should say. And if you go into the private route, there's a very real risk of putting quite a lot of money into a project that just never gets realized and completely falls apart. As I touched on earlier, a couple of these online real estate platforms, Yieldstreet was one that had a big scandal a couple years back.

18:31Realty Mogul also has come under fire for just misrepresenting the risks to investors, and they've kind of been accused of duping people into losing a lot of money on failed projects. Our roundup of real estate crowdfunding platforms, we keep it updated in light of these kinds of stories. We pay pretty close attention to this and we kind of prune it to only include platforms that haven't had a big scandal like this and have a decent reputation when it comes to curating investments, managing risks and communicating the risks with investors. But something we keep coming back to again and again is it's buyer beware when it comes to these kinds of investments.

19:10Total losses can happen. So you really got to do your due diligence on every project.

19:15Elizabeth Ayoola:And have a high appetite for risk. Good luck. Now, for people who do not want to get involved in real estate syndications, broadening out here, and are considering REITs, how do they go about buying those, Sam, or investing in them? It's a lot easier than what we've been talking about here. REITs are available in pretty much any brokerage account. I mean, pretty much all the major ones offer exchange-traded funds and similar things. REITs are technically a little different, but they tend to be available wherever ETFs are available. Now, you still have to do some investment research if you're investing in REITs.

19:51We actually have a page on the best-performing REITs that folks can check out in the show notes. But if you really want to kind of play it safe and take the diversified approach, you can also buy into real estate index ETFs that invest in a whole bunch of REITs for you. The three biggest of those by assets under management are the Vanguard real estate ETF, the Schwab US REIT ETF, and the State Street real estate select sector SPDR ETF. There are a number of easier ways that people can get some real estate exposure in their portfolio than doing these private deals. I do wonder how Katie came across real estate syndications that seems so niche in the world of real estate investing.