REITs vs. Real Estate Syndication: A Comparison Guide by FNRP
One of the exciting aspects of a commercial real estate investment is that there are many vehicles through which an individual can gain exposure to this asset class. Two such options are a Real Estate Investment Trust (REIT) and an individually syndicated deal. While both of these options are in pursuit of the same objective (a high return), the structure and method used to achieve it is very different.
In this article, the key differences between REITs and syndications are discussed. By the end, readers will be able to identify which option is a more suitable fit for their individual investment objectives.
At First National Realty Partners, we offer individually syndicated investment opportunities. To learn more about them. click here.
Let’s start with the key definitions.
What is a Real Estate Investment Trust?
A Real Estate Investment Trust (REIT) is a company that buys, sells, operates, or finances commercial real estate. REITs can be privately traded, which means that they are only available to accredited investors who meet certain income and net worth requirements. Or, they can be publicly traded, which means that their shares can be bought and sold on major stock exchanges by anyone with a brokerage account.
Because each of the major commercial real estate asset classes have their own operational quicks, REITs tend to specialize in specific property types like office buildings, multifamily apartments, or retail shopping centers. For example, Prologis is a large publicly traded REIT that owns and operates industrial/warehouse properties. Or, Kimco Realty is a large REIT that focuses on the acquisition and operation of grocery store anchored retail shopping centers.
Commercial real estate investors like publicly traded REITs for their liquidity, opportunities for diversification, and steady dividend income. But, the downside is that REIT share prices can be subject to periods of significant volatility and investors have no say in which properties their capital is used to purchase. On this second point, an individually syndicated deal may be a suitable alternative for investors who prefer more control over the property selection process.
What is a Real Estate Syndication?
“Syndication” is the real estate term used to describe a temporary alliance of individuals who invest in a large transaction that would be difficult or impossible for any one of them to handle individually. Because commercial real estate assets are so expensive, it is common for them to be purchased using a “syndicate” of investors.
In the syndicate, there are two groups of participants. The General Partner is the deal “manager” and they are responsible for finding the property, arranging the financing, and managing the asset once it is purchased. When arranging the financing, the General Partner puts together a group of Limited Partners (LPs), each of whom invest some amount of capital in the deal. LPs are passive investors and they have no say in the day to day management of the property.
The capital raised from the Limited Partners (plus some of the GP’s own capital) is combined with debt and used to purchase the property.
Is a REIT the Same Things as a Syndication?
Even after reading up on REITs and syndications, many investors are left asking if a REIT and a syndication are the same thing. While they are both vehicles that allow investors to gain exposure to commercial properties, they are not the same thing. Regardless of which option investors choose, they will own real estate through the vehicle. As we will see in the sections below, there are differences between these investment strategies that investors need to know about in order to decide which is the best option for them.
REITs vs Real Estate Syndication Differences
Again, the goal of both a syndication and REIT investment is the same, to earn a high return. But, there are some significant differences between the two that investors should be aware of before deciding how to deploy their capital.
One of the basic differences between REITs and syndications is the way they are structured from a legal perspective.
A REIT is an investment vehicle that allows individual investors to purchase a fractional share of a portfolio of commercial real estate assets. REITs can be privately held or publicly traded and often specialize in a particular asset class.
Syndications are typically structured as a Limited Liability Company (LLC) or a Limited Partnership (LP). If it’s an LP, the Sponsor is the General Partner and the Investors are LP’s or passive investors.
A syndication will provide investors with either an Operating Agreements (LLC) or a Partnership Agreement (LP). These documents are very important, and investors should spend ample time reading and understanding them before committing capital. The documents outline how distributions are paid out, how voting rights are established, and any fees due to the Sponsor prior to distributions being paid out to investors.
Number of Properties
From the description above, it should be obvious that a REIT investment portfolio could contain hundreds or even thousands of different properties. For example, according to Kimco Realty’s website, they own 422 properties across the United States. This type of portfolio provides investors with a high level of diversification. If one property is underperforming, there are hundreds of others that can offset the impact.
By definition, an individually syndicated deal is just for a single property. So, there is some amount of diversification risk because there are no other properties to offset underperformance. However, the upside to this is that syndication real estate investors know exactly where their money is going. As a result, they can perform their own due diligence on the property, the real estate market, the tenants, and the leases to ensure they are comfortable with every aspect of the transaction.
REIT investors own shares in a company that owns real estate. They do not own the underlying real estate directly.
The situation is similar for syndication investors, but with one slight difference. The “syndicate” (all of the investors combined) has direct ownership of a single property. Individual investors (the GP and LPs) own shares in the syndicate, which entitles them to a portion of the underlying investment property’s positive cash flow.
Publicly traded REITs are accessible to anyone with a brokerage account and enough capital to buy at least one share.
Privately traded REITs and individually syndicated deals are only accessible to investors who qualify as “accredited” under SEC regulations. This means that they meet certain income and/or net worth requirements or they are “sophisticated” enough to understand the risks involved in a real estate investment.
For a publicly traded REIT, the only minimum is the amount of capital that it takes to purchase at least one share. This could be $100 or less.
Private REITs and syndications often require a minimum investment amount that is much higher. The exact amount varies by deal, but can often range from $25,000 – $100,000.
Publicly traded REITs can be bought and sold at will on major stock exchanges, which makes them very liquid. Depending on the broker and the demand, shares can be converted to cash in a matter of minutes.
Private REITs and syndications are not as liquid. It can take years to properly implement a business plan for a property. As such, managers may require minimum commitments of five years to ten years, during which time an investor’s capital cannot be accessed. If there is an emergency and an investor needs to sell their shares for some reason, they may have to do so at a significant discount.
Under IRS rules, REITs must pay out at least 90% of their taxable income to avoid being taxed at the entity level. This rule provides tax breaks for investors and results in a high dividend yield.
Syndication investors also benefit from a number of tax breaks. First, they can take a tax deduction for the property’s operating expenses, including one for depreciation, which decreases the amount of taxable income that is passed on to investors. Second, Investors have the ability to defer taxes on a profitable sale by reinvesting proceeds into another property that is “like kind.” This sort of transaction is known as a 1031 Exchange and can provide investors with a chance to defer taxes indefinitely.
Total returns for both a REIT and syndication are highly dependent on the property, the manager, and a number of other factors. Both types of investments have the potential to deliver a very high return or to deliver a mediocre return. However, there is one key point to remember.
Returns for publicly traded REITs can be volatile because they are subject to factors that go beyond the performance of the underlying properties. For example, broader economic factors like unemployment, interest rates, or monetary policy can cause dramatic stock market swings and REIT prices can get caught up in this.
Returns for private REITs and syndications tend to be less volatile for two reasons. First, their shares do not trade hands nearly as often so the price is not constantly changing. Second, the valuation of the underlying properties may only be evaluated once or twice per year.
Despite the many differences between the two commercial real estate investment options, the risks are fundamentally the same. They include the market risk that rental rates could change, vacancy risk that space will go unoccupied, credit risk that tenants will default on their payments, and the liquidity risk that the property cannot be sold at the end of the investment period.
Given the differences between the two options, it is only logical for real estate investors to ask, which is the better investment?
Investing in a Syndication vs a REIT
The most important thing to know when deciding whether to invest in a syndication or a REIT is that investors in syndications or private REITs are required to meet certain IRS rules. Specifically, these investments are only accessible to investors who qualify as “accredited” under SEC regulations. These are typically illiquid investments that carry higher investment minimums.
Publicly traded REITs are open to the investing public and can be bought or sold anytime.
Investors who meet the accreditation requirements, typically invest in syndications because of the management team’s track record for finding profitable investments. Syndication investors will also know upfront which property the management team is offering to them, so many investors appreciate this level of transparency.
It’s always difficult to say whether a REIT or a syndication will perform better or worse over the course of a holding period. That said, REIT performance tends to be influenced by macro forces, including stock market swings.
The performance of a syndication is mostly tied to the particular property that the management team selects for investment. The ROI is also dependent on the management team’s ability to negotiate a good price on the asset and manage it well over time. Investors who opt for syndications may do so because they have confidence in the management team’s ability to generate strong returns.
Which is the Better Investment?
Commercial real estate investing is not a zero sum game. Investors have the option to buy both equity REITs and individually syndicated deals. But, if they are only going to choose one, neither option is objectively “better.” But, one may be more suitable. Potential investors should take the time to understand the key differences and to compare them to their own individual preferences and investment objectives. Then, they should choose the one that is the best fit for their needs.
Summary and Conclusion
For individual commercial real estate investors seeking passive income from a commercial real estate investment, there are two common options, REITs and individually syndicated deals.
REITs are companies that own, operate, or finance commercial real estate assets. They tend to specialize in specific property types, like apartment buildings or shopping malls.
Individually syndicated deals are single transactions offered by private equity firms (like ours) and they involve two groups of participants. The General Partner is the deal leader and they are responsible for finding the property, arranging the financing, and managing the asset once the transaction is complete. The Limited Partners offer their passive investment in return for a share of the cash flow and profits from the property.
While the goal of each option is the same – to earn a return – there are fundamental differences between them on several fronts including: ownership, access, liquidity, tax benefits, and the number of properties involved.
Neither option is objectively better than the other. Instead, individuals should focus on their characteristics and choose the one that is most suitable for their own needs.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you are an Accredited Real Estate Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or email@example.com for more information.