More and more, people are becoming aware of the benefits that passive real estate investing can provide.
The volatility in the stock market has lead a lot of people on to the real estate path.
Let’s say you’ve become interested in multifamily investing.
Not too long ago, you might have thought that your only way into this field was to purchase your own multifamily properties, which can be pretty intimidating and unrealistic for the average investor.
Today, the situation is a bit different.
What is syndication?
Real estate syndications are, in a certain sense, crowdfunding real estate investments where a group of investors pool their capital into a single entity called a syndicate to invest in more expensive real estate assets than any individual investor in the syndicate could likely have purchased on their own.
In most cases, you need to be what is called an accredited investor in order to participate in these opportunities.
In this article we will first give a very brief overview of passive investing, as well as explain how you can qualify to get involved in this increasingly popular form of investment.
You Don't Have to Do It Alone
Without the real estate syndication option, perhaps the individual members would have been restricted to buying a duplex or another small rental property.
That involves sourcing the deals, finding a lender, asset management, and in all likelihood conducting the rental property management on your own due to the lack of scale in your rental portfolio.
Now, don’t get me wrong – some people enjoy this process and like being an active investor.
The main benefit to being an active investor is that you are in control.
Who you hire to work on the property, who you rent to, and when you sell, among the myriad of other small decisions involved with real estate asset management are all on you to decide.
A Full Time Job
You should keep in mind, however, that being an active real estate investor is basically its own full time job and that’s not what most people think they’re signing up for when they decide to invest in real estate.
Most people are looking for cash flow and other neat benefits to owning real estate like depreciation. We discussed depreciation in more detail in our Benefits of Depreciation & Cost Segregation Studies for Real Estate Investors Explained article.
Benefitting from Depreciation
Luckily, you don’t need to be an active investor to benefit from depreciation, for example.
Most syndications are structured as limited liability companies (LLCs), which allow all of the tax benefits to pass along to the passive investors. You should ask yourself if complete control is even something you want for your real estate investments.
If your schedule is already full, or you’re trying to make your money work for itself and reduce your workload, that control might seem like more of a burden than a benefit.
Passive investors receive regular cash flow distributions just as you would if you were to be an active investor, and also get their portion of the sale price when the asset is sold at the end of the hold period (anywhere from 2-10 years, depending on the business plan and type of asset).
Diversify Your Investments
That’s why passive real estate investing is such an attractive option to the average person looking to put some of their capital in real estate.
You can even invest funds from your self directed IRA into a real estate syndication.
When you invest in a real estate syndication as a passive investor, you don’t have any of the daily responsibilities that come with being an active investor. The sponsor and general partners will take care of all of that work for you.
The general partner is compensated for their efforts through fees and a share in the cash flow distributions, depending on how the syndication is structured.
The thing is, the general partner team will have experience in real estate asset management and systems that are extremely difficult to replicate when you’re trying to do it on your own.
They have access to better deals, relationships with top operating property management companies, and robust systems for asset management.
Go Big or Go Home
Due to economies of scale, when you purchase large real estate assets through a syndication, there is enough cash flow to go around for everyone.
Passive investors, who are called the limited partners in a real estate syndication, can receive attractive returns without doing any of the work and the active general partners can gain some additional sweat equity for pulling the deal together and managing the asset.
Where do I start?
You might be thinking this all sounds pretty good, where do I sign up?
Well, first we have to make sure that you qualify to become a passive real estate investor, as only certain people are allowed to invest in these offerings.
Rules and Regulations
First, we need to briefly review the SEC’s rules and regulations.
You might be curious why you haven’t heard more about this form of real estate investing.
The Securities and Exchange Commission oversees any activities in the United States that involve the selling of securities.
The SEC has a number of regulations that must be followed when selling securities, including regulation D, which describes the rules and parameters for forming a syndication.
Prior to 2012, you were unable to advertise real estate syndications and needed to have a documented pre-existing relationship with your investors.
With the passage of the JOBS Act in 2012, a new option became available for syndication: the rule 506c offering.
The previous model, which required the pre-existing relationship between the sponsor(s) and investors and allowed no advertising, was now classified as a rule 506b offering.
Under those rules, you were allowed to accept up to 35 “sophisticated” investors and an unlimited number of accredited investors per offering.
Due to the need for the pre-existing relationship, syndications used to be a pretty unknown investment vehicle. It was an insiders-only club and you had to know someone who was involved in this world in order to get the benefits of passive real estate investing.
The Game Has Changed
That all began to change with the introduction of rule 506c.
The new rule 506c offering allows advertising, but only if your investors are verified by a third party to be accredited investors.
Today, the majority of regulation D offerings are still 506b, but with the ability to advertise, the concept of real estate syndication slowly began to seep into the public consciousness and has become increasingly mainstream.
We have worked with our investors to raise capital for real estate in this manner for several years and have seen increasing interest with each passing year.
Do I Qualify?
So who qualifies as an accredited investor and who qualifies as a sophisticated investor? What do you have to do in order to be recognized as accredited?
Accredited investors: Accredited investors are any individuals who meet either a net worth requirement of $1 million (not including their primary residence) OR they have an annual income of $200,000 for a single individual or $300,000 for a married couple.
If you meet these criteria, you are automatically labeled as an accredited investor. The term “accredited” sometimes trips people up and makes them think they need to be registered or certified by some board, but that’s not the case. You simply meet these requirements and you already are an accredited investor!
Sophisticated investor: A sophisticated investor is a non-accredited investor that is capable of weighing the risks involved with investments because they possess a sufficient amount of financial knowledge.
This is obviously a loose definition, but the purpose is to protect those with little or no experience from getting in over their heads. If you are raising money from sophisticated investors, be sure to confirm they have some experience with investing and would qualify as sophisticated.
Remember that sophisticated investors are only eligible to participate in 506b offerings and that the majority of passive real estate investors are accredited investors.
The important thing to keep in mind here is that there’s nothing you need to do to “become” an accredited investor. By fitting the requirements, you are by definition an accredited investor.
The only real task that is required of you as an accredited investor is to submit your information to a third-party verification company in the event that you are investing in a 506c offering.
These companies simply confirm that you do in fact meet the net worth or annual income requirements.
Advantages and Requirements
There are no hoops to jump through or tests you have to take. For a 506b offering, there is no verification required and it is basically up to the individual investors to be honest about their accredited status.
After reviewing the requirements, do you think you qualify as an accredited investor?
If you’re interested in real estate investments, it’s worth considering if the passive investing option is right for you.
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