April 17, 2023

Let’s talk syndications. What are they, why do you care, and how do you know if it could be a good fit for you. First, what are they?

A syndication is a fund that invests in real estate with multiple partners. General patterns run the syndication. There are typically 1-4 of these partners, while the remainder of the partners are limited partners. Limited partners contribute capital to the partnership, but are not involved in the day to day business of the syndication. 

Is this something you should invest in? Maybe, let's take a closer look.

Like most real estate deals, syndications are great investments for a specific type of investor. These partnerships are a home run for someone who wants the benefit of investing in real estate but lacks the time or experience of running rental properties. They are often high income earners who are busy with their own companies or jobs. Some of these people have a net worth of over a million dollars and are considered accredited investors. Some syndications may require this to buy in.

However, you do not need a high net worth or high earning job to invest in syndications. These partnerships also make sense to those who may not have access to conventional financing. This often includes young entrepreneurs who lack the 2 years of tax returns needed for conventional loans.

However, I’m sure you know that there's a flip side. Who is this not for? Syndications are not always the best investment for people who are new to real estate and looking for a higher cash on cash return. If you are just beginning your real estate journey, you will likely want the best return on your money. Syndications typically offer returns or around 7-8% cash on cash and 15-16% when including appreciation, equity paydown, and cashflow. These deals also tie up your money, normally five years. If your net worth is under a million, this could make you miss out on other great deals.

Now, I know why many of you are here. “Ryan, you're a CPA, tell me about the tax benefits!”

The first main benefit is that syndications provide passive income. This means that other passive losses can offset syndication income. On top of this, you get accelerated depreciation, favorable capital gains tax, tax-free refinance and return of capital from these partnerships.Often people buy short term rentals and realize it's a lot of work. Many people will take the money they earn on their properties into syndications and use the losses generated from the syndication to offset income from short term rentals.

So, what do I look out for as a limited partner? Make sure you have debt bases. A debt bases means that you carry some of the debt of the syndication. But Ryan, why would I want to carry debt - won’t that lower my DTI? If you are liable for debt you have debt bases which means you can deduct your partnership losses. If you don’t have debt bases you cannot. It is important to discuss this with the general partner so you don’t miss out. Second, you cannot deduct losses against w-2 income if you are a limited partner. Only other capital gains are applicable as mentioned above. If you are a high income earner, it is important to take this into account. Another method used with syndications is stacking. If you know you will have a huge gain in a particular year, it may be wise to invest in syndications to take losses and offset huge gains. This is seen often when someone is looking to exit a property tax efficiently. If they sell a property that they have had for many years, it often makes sense to put that money into a syndication in the same year and take advantage of those losses.

Lastly, watch out for bad operators. They could be a fast track to taking substantial losses - I’m not talking about your tax return. Do your research. Watchout for aggressive debt strategies. Some of these creative financing strategies can crash and burn if the real estate market takes a substantial swing. Review your agreement before signing. Make sure you carry debt for tax purposes. Also, know when the fund expects to liquidate. If you expect the fund to liquidate in three years and it liquidates in two, you could be left with a substantial gain and no way to offset it.

Syndications aren't for everyone but it can be a great form of diversification. It can take risk off your shoulders as well as give passive cash flow. It can offset exit strategies for people looking to eventually get out of real estate. But if you are just starting out, it is likely a better option to focus on growth. It will keep the decision making in your hands and allow for higher returns. Like most things discussed on this podcast, weigh all the options and make sure you talk to a tax professional before committing. 

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