If real estate investing seems like an interesting alternative to your stock market investments, but becoming a landlord is not your cup of tea, you’re not alone. Fixing toilet emergencies at 3am isn’t appealing to most people, myself included. Been there, done that, and had a property management firm do that too, but there is a more hands-off way to be a successful real estate investor.
With a quick Google search for “easy real estate investments,” you’ll stumble upon real estate investment trusts (REITs), which are easy to access online, just like stocks. At first glance, you might assume you’ve solved your dilemma and found a great way to diversify your investments, but I strongly encourage you to explore further.
What is a REIT, anyway?
When you invest in a REIT, you’re buying stock in a company that invests in commercial real estate. So, most people naturally figure, if you invest in an apartment REIT, it’s the same as investing directly in an apartment building.
That couldn’t be further from the truth. With REITs, you’re investing in the company, not the real estate assets you were after, which is confusing, for one, and, for two, just as risky as buying stocks of other companies.
Let’s explore the 7 biggest differences between REITs and real estate syndications:
Difference #1: Asset Quantity
A REIT is a company that holds a portfolio of properties across multiple markets in an asset class, which could mean great diversification for investors. Separate REITs are available for apartment buildings, shopping malls, office buildings, elderly care, etc.
Alternatively, when you invest in a real estate syndication, you have invested in a portion of a single property in a single market. You know the exact location, the number of units, the financials specific to that property, and the business plan for your investment.
Difference #2: Clear Ownership
I mentioned this above, but it’s worth stating again – when you invest in a REIT, you purchase shares in the company that owns the real estate assets. You have no access to the real estate investment property itself.
However, when you invest in a real estate syndication, you and others pool your capital together to contribute directly to the purchase of a specific property through the entity (usually an LLC) that holds the asset.
Difference #3: Access to Invest
Most REITs are listed on major stock exchanges, and you may invest in them directly, through mutual funds, or via exchange-traded funds, quickly and easily online through any of the big brokerages like Fidelity and Vanguard. Depending on your allocation arrangement, you may already own some inside your 401K. REITs are widely available to anyone with a brokerage account and investors can complete transactions immediately online.
Real estate syndications, on the other hand, are usually under an SEC regulation that disallows public advertising, which makes them difficult to find without knowing the sponsor or other passive investors. An additional existing hurdle is that many syndications are only open to accredited investors. So, syndications are not widely available, require a connection, and you have to qualify to invest in one. Furthermore, it could take a few weeks to attend the webinar, complete your due diligence, and wire your capital before your transaction is totally complete. We will share more about how to evaluate syndications in the future posts!
Difference #4: Investment Minimums
When you invest in a REIT, you are purchasing shares on the public exchange, some of which can be just a few bucks. Thus, the monetary barrier to entry is low.
Alternatively, syndications have higher minimum investments, often $ 25,000 or $50,000 or more. Though they can range from $10,000 up to $100,000 or more, real estate syndication investments require significantly higher capital than REITs.
Difference #5: Liquidity
At any time, you can buy or sell shares of your REIT and your money is liquid. It may take 3 days for your brokerage or bank to complete a transfer, but generally, your cash is highly accessible at any time.
Real estate syndications, however, are accompanied by a business plan that often defines holding the asset for a certain amount of time (often 5 years or more), during which your money may not be withdrawn.
Difference #6: Tax Benefits
One of the biggest benefits of investing in real estate syndications versus REITs is tax savings. When you invest directly in a property (real estate syndications included), you receive a variety of tax deductions, the main benefit being depreciation (i.e., writing off the value of an asset over time).
Oftentimes, the depreciation benefits surpass the cash flow. So, you may show a loss on paper but have positive cash flow. Those paper losses can offset your other income, like that from an employer.
When you invest in a REIT, because you’re investing in the company and not directly in the real estate, you do get depreciation benefits, but those are factored in prior to dividend payouts. There are no tax breaks on top of that, and you can’t use that depreciation to offset any of your other income.
Unfortunately, dividends are taxed as ordinary income, which can contribute to a larger, rather than smaller, tax bill.
Difference #7: Returns
While returns for any real estate investment can vary wildly, the historical data over the last forty years reflects an average of 12.87 percent per year total returns for exchange-traded U.S. equity REITs. By comparison, stocks averaged 11.64 percent per year over that same period.
This means, on average, if you invested $100,000 in a REIT, you could expect somewhere around $12,870 per year in dividends, which is great ROI.
Between the cash flow and the profits from the sale of the asset, real estate syndications can offer around 20 percent average annual returns.
As an example, a $100,000 syndication deal with a 5-year hold period and a 20 percent average annual return may make $20,000 per year for 5 years, or $100,000 (this takes into account both cash flow and profits from the sale), which means your money doubles over the course of those five years.
Which Is The Better Investment: REITs or Real Estate Syndications?
All in all, there’s no one best investment for everyone (but you knew that, right?).
If you have $1,000 to invest and want to access that money freely, you may look into REITs. If you have a bit more investment capital available and desire direct ownership, the ability and access to speak with sponsors directly, and are in pursuit of tax benefits, becoming a limited partner in a real estate syndication may be a better fit.
And remember, it doesn’t have to be one or the other. You might already own some REITs and begin migrating toward real estate syndications as you continue your online education about passive investing in real estate. Or you might purposely invest capital in syndications for the long term and invest in REITs with money you want to remain liquid.
Consider your personal and financial goals, your desires for diversification, any large upcoming expenses, and your tax situation to help you make a choice that’s right for you. Investing in real estate, whether directly or indirectly, is forward progress.