When I started out in real estate, I invested in single-family homes and duplexes. It didn’t take long for me to realize that being a landlord wasn’t very appealing. I wasn’t fond of receiving emergency calls in the middle of the night because of a broken furnace or toilet, but I did enjoy the extra income even though it came with more work and unexpected situations.
The next step most inventors make is in Real Estate Investment Trusts (REITs). Like stocks, REITs are easy to access, and many investors turn to REITs in an effort to diversify their investment portfolio.
So, What is a REIT?
Many aspiring investors commonly assume that investing in a multi-family REIT means they’re investing directly into the actual apartment complex, yet, that isn’t the case. They’re actually purchasing stock in a company that invests in commercial real estate.
Let’s look at the 7 biggest differences between real estate syndications and REITs:
Difference #1: Number of Assets
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.
On the flip side, with real estate funds, you invest in a group of hand-selected properties across multiple markets. You know the exact location, the number of units, the financials specific to that property, and the business plan for your investment.
Difference #2: Ownership
When investing in a REIT, you purchase shares in the company that owns the real estate assets.
When you invest in a real estate syndication, you and others 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.
Real estate funds, on the other hand, are often 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.
Even once you have obtained a connection, become accredited, and found a deal, you should allow several weeks to review the investment opportunity, sign the legal documents, and send in your funds.
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, funds have higher minimum investments, often $50,000 or more. Though they can range from $10,000 up to $100,000 or more, real estate fund 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.
Real estate funds, 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 is locked in.
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 investment into a fund 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.
So Which Option (REIT or Syndication) Is Better?
We already know there isn’t one magical, perfect investment strategy that works for everyone across the board- that doesn’t exist.
It all depends on how much control you want to have over your investment capital, how much you can invest, and the type of tax benefits you desire.
If you want to invest smaller amounts, have your capital easily accessible, and be able to monitor the daily ups and downs, REITs might be a good option for you.
If you want to invest larger amounts of capital in large pieces of real estate, receive quarterly updates from sponsors, and benefit from significant tax breaks, then a real estate fund could be more aligned with your goals.
And truthfully, you don’t have to pick just one option. You may start with REITs and decide to switch to commercial real estate funds down the road. You might even try both and further diversify your portfolio.
The biggest thing to remember is that whichever you choose, you’re making progress towards your investment goals.