Investing in real estate is a great way to build your wealth and your portfolio, but taking on a landlord role isn’t for everyone. If real estate investing seems interesting to you, but you’d rather avoid becoming a landlord, you’re not alone. Most people don’t welcome the unexpected issues and expenses that come along with active real estate investments.
Many investors considering real estate as an investment vehicle take their first step by investing in a real estate trust, or a REIT, which are easily accessible, similar to stocks.
How Does a REIT Work?
When you choose to invest in a REIT, you’re buying stock in a company that invests in commercial real estate. Most people assume that if you’re investing in an apartment REIT, you must be investing directly in an apartment building.
That’s actually not the case at all.
In this article, I’m taking a deep dive into the differences between a REIT and a real estate syndication.
7 Biggest Differences Between a REIT and a Real Estate Syndication
#1 – Number of Assets Being Held
When you invest in a REIT, you’re putting your capital into a company that holds a portfolio of properties across multiple markets in a particular asset class. For example, individual REITs are available for apartment complexes, shopping malls, office buildings, elderly care, etc.
This creates an amazing opportunity for diversification for investors.
On the other hand, with real estate syndications, you’re investing in a single property in a single market. So you know the asset’s exact location, the number of units, the financial details specific to that property, and the business plan for your real estate investment.
#2 – Who Owns the Asset
As an investor in a REIT, you invest by purchasing shares in the company that owns the real estate properties.
Investing in a real estate syndication means you and your fellow investors contribute directly to purchasing a specific property through the entity that holds the asset. For these investment deals, the entity is typically an LLC or LP.
#3 – Investment Accessibility
You can find most REITs listed on major stock exchanges. When you find a REIT that interests you, you can invest in it directly through mutual funds or exchange-traded funds. The process of investing in a REIT is quick and easily completed online.
However, real estate syndications are often under an SEC regulation that disallows public advertising. As a result, real estate syndication deals can be quite difficult to find without knowing the sponsor or other passive investors. Another hurdle for would-be investors is that many syndications are only open to accredited investors.
Once you have a solid connection, become an accredited investor, and find a deal, you should still allow several weeks to review the investment opportunity, sign the legal documents, and send in your funds.
#4 – Minimum Investment Required
The monetary barrier for entry into a REIT is quite low. Given that you’re purchasing shares on the public exchange, you can start investing in a REIT for as little as a few dollars.
Real estate syndications have higher minimum investments, often $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.
#5 – Liquidity of Your Capital
When investing in a REIT, your money is liquid. At any time, you can choose to buy or sell your investment.
Real estate syndications, however, are accompanied by a business plan. This plan typically outlines holding the property for a certain amount of time, often five years or more. Your money is locked in and unavailable to you during the holding period.
#6 – Tax Benefits
One of the most significant benefits of investing in real estate syndications over REITs is the taxes. When you invest directly in a property, whether a home or a real estate syndication, you receive several standard tax deductions.
The main tax benefit in a real estate syndication is depreciation. To put it simply, when investing in a syndication deal, you’re able to write off the asset’s value over time.
As a passive investor in a real estate syndication, it’s not uncommon for the depreciation benefits to surpass the cash flow. So even though you may show a loss on paper, you can still have positive cash flow. Those paper losses can offset your other income, like that from a W-2 employer.
On the other hand, when you invest in a REIT, you’re investing in the company and not directly in the real estate property itself. As a REIT investor, you do get depreciation benefits, but those are factored in before dividend payouts. There are no other tax breaks on top of that, and you, unfortunately, can’t use that depreciation to offset any of your other income.
Another negative in terms of taxes for a REIT investment is that dividends are taxed as ordinary income, which unfortunately contributes to a larger tax bill rather than a smaller one.
#7 – Projected Returns
As you probably know, returns for real estate investments can vary wildly. For example, according to historical data compiled over the last forty years, exchange-traded U.S. equity REITs have an average of 12.87 percent per year in total returns. In comparison, stocks averaged 11.64 percent per year over that same period.
On average, this means if you invested $100,000 in a REIT, you could expect to earn around $12,870 per year in dividends, which is decent ROI.
That being said, when cash flow and the profits from the sale of the asset are figured in, real estate syndications can offer around 20 percent average annual returns.
For 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 five years, or $100,000, taking into account both cash flow and profits from the sale, which means your money doubles over those five years. Real estate syndications offer phenomenal ROI.
Which is the Best Fit for You?
Now that you better understand the difference between a REIT and a real estate syndication, you’re likely wondering which one you should invest in.
As you know, there’s no one best investment for everyone.
If you have limited capital to invest and want to access that money freely, you may consider investing in REITs. On the other hand, if you have more money available to invest and want direct ownership, want to talk to the sponsors directly, and want more tax benefits, a real estate syndication may be the best fit for you.
It’s essential to keep in mind that it doesn’t have to be one or the other. Many new investors start with REITs and later migrate toward real estate syndications. Regardless of how you choose to start, investing in real estate is the first step in building your wealth and portfolio.