The idea of investing in real estate has been very appealing to passive investors for many decades now. Like many investors out there you want the benefits but not the 2AM phone calls from a tenant inquiring about fixing an issue. Not enticing at all to say the least. Investors seek alternatives to investing in real estate other than just purchasing real estate and now creating a new job and managing the asset as well as tenants. So what is the next layer down to be a passive investor in real estate? REITS are publiclty traded so that’s appealing. Multifamily syndications allow you to invest directly into the asset being purchase and share in the benefits, that sounds pretty passive right? A fund of funds does exactly what the syndication does but spreads it throughout multiple assets spreading your investment out sounds real juicy to investors.
We’ll walk through these investment options and help you uncover what the best vehicle is for you as a passive investor. Before we do that, lets explore what each investment vehicle is.
What are REITs?
Real estate investment trust’s (REIT) method of operation is like that of a mutual fund in which investors invest their capital to purchase certain asset classes like apatments, office buildings, shopping malls, mobile home parks, assisted living, ect and afterward acquire pay from their shares. Could be a good way to diversify your investment portfolio.
What is a Syndication?
A multifamily syndication involves investors who invest capital to purchase an existing property or build a new property. It provides investment opportunities to passive investors and contributes to creating passive income. To really dive into what a multifamily syndication looks like, we went into full details on our blog post titled, what is a syndication.
What is a Fund of Funds?
A fund of funds operate similar to syndications in structure but offer a more hands off approach when it comes to investing. The difference is the general partner/sponsor of the fund of funds will passively invest those funds that their firm thoroughly vets, has relationships with top level sponsors, diversifies your investment by spreading your risk through many investments instead of just a single investment like a syndication. A fund of funds takes removes investors from having to review one off deals similar to the process of a syndication and repeating the process over and over again when you receive a new investment opportunity. The fund of fund is the best of both worlds of a syndication and a REIT where the fund of funds you participate in will be similar to your investment criteria. Hands off but more alignment of your real estate focus.
The five major differences between syndications vs REITs vs Fund of Funds:
- Ownership
- Access and Opportunities to Invest
- Minimum Investments
- Liquidity & Returns
- Tax Advantages
Syndication vs REIT vs Fund of Funds
These two are different from each other in numerous ways. Some of them are listed below:
1. Ownership
When investing ina REIT you are investing in a copany that holds a portfolio of properties across multiple markets with specific focus on different asset classes that we noted earlier. The REIT will likely own and manage these assets. You don’t get a say in which investments they choose to purchase and as the investor, you just know they are investing in real estate. Just a way to diversify your investment portfolio.
With multifamily syndications, you are investing in a single property in a single market. You know exactly where the property is, nearest economic driving resources, unit count and provided all the financials specific to that property at your request. Also, you know the business plan associated with the asset.
A fund of funds acts similar to the syndication as far as ownership but also allows the same process to be spread out into different opportunities. For instance, if the fund of fund is invested in 4 different investments, your risk is spread out between those 4 investments and in 4 different markets.
2. Access and Opportunities to Invest
Have $1000 (and probably less) to invest? Great, you can invest in a REIT as fast as you can find a computer with internet and a brokerage site. All it takes is setting up your account and done.
Multifamily syndications have a higher cost of entry. Also, the process is also requires a bit more effort. Syndications follow SEC regulations that regulate between existing relationships and being able to advertise a deal. Most syndications are private and build relationships with their investors prior to offering investment opportunities. Essentially, you need to know someone who has the investment opportunities to be able to participate unless you meet the accreditation status required to participate in publicly advertised opportunities. This happens over and over again with each offering.
Fund of funds operate the same as syndications once you meet the criteria and align it with your real estate investing criteria. Once you pass these and invested into the fund, the rest is left to the sponsor. You leverage the firms connections, underwriting and deal review for them to invest passively on your behalf. One and done.
3. Minimum Investments
Similar to stocks you purchase shares when you invest in a REIT. As we detailed earlier in the article, the entry to investing is low so the amount of capital needed doesn’t take much. This might be appealing to investors seeking to test the waters or just getting started with real estate investing.
With multifamily syndications the minimum with most firms, as is the common practice here at The Fortes Company, is $50,000 for first time investors and with repeat investors can be as low as $25,000 from deal to deal. In some instances in the industry, investment minimums might be as low as $10,000 to as high as $500,000 depending on the opportunity.
Fund of funds practice the same as syndication but in most instances, private investors seeking a hands off approach will find that investment minimums will not be less than $25,000 but as high as $250,000 per fund. It’s good to have an idea that the fund of fund size for private investors similar to what we partner with at The Fortes Company can be capped at $1,000,000 to as high as $25,000,000. With fund of funds that work with instituational investors, the investment minimum can be as high as $25,000,000 due to the fund size being in the hundred of millions.
4. Liquidity & Returns
Before we dive into the returns on this portion, its good to understand that investments can vary exponetionally depending on the asset type, people overseeing the investment (sponsors) and timing.
What makes REITs so appealing is that you can divest out of a REIT by selling shares and freeing your capital which almost feels instant these days, give or take. It’s basically the same if you choose to buy more at any given moment. Data shows that over the last forty years total returns for exchange-traded U.S. equity REITs averaged 12% per year. Basically if you invested $100,000 in a REIT expect around $12,000 a year over the same period.
When you invest in a multifamily syndication, you invest directly in a real piece of property. Similar to when you purchase a home, you can’t buy or sell without going through the proper channels of doing so. Same thing with multifamily syndications, as the business plan includes a holding period for the asset which your investment would be illiquid during that time. The returns from a multifamily syndication can average upwards of 20% average annual returns. Let’s say you invested $100,000 on an investment with a holding period of 5 years. Upon disposition (sale of the asset) your investment could essentionally make $20,000 a year over that holding period. Of course factor in the cash from and profits from the sale of the asset. If you banked that capital or even invested with an IRA, you would see that $100,000 turn into $200,000.
With a fund of funds, it’s the same as a syndication when it comes to the illiquid aspect of it. The kicker is the diversification which I’ll explain shortly. You’re investing for the long term when you invest in a fund of funds. Most of our investors use their self-directed IRA’s or whole life insurance policies with our funds due to the long term strategy. The fund then invests in multiple opportunities spreading the risk and not having to rely on just one investment. If one doesn’t produce you still have others that can. With our underwriting process and relationships in the industry, we know what deals produce because of operators and markets so we trust our analysis process when selecting opportunities but also have a strong network to choose from.
5. Tax Advantages
A known benefit of investing in real estate is the tax advantages. Take for instances investing in real estate directly, you have a variety of tax advantages already in your favor through tax deductions as well as depreciation.
When investing in a REIT you are investing in a company and not directly in the real estate itself. The tax benefits are essentially non-existant. However you do benefit from depreciation but its factored in before you get your dividends. You don’t get any tax breaks and you can’t use that depreciation to offset any of your other income. Dividends are taxed as ordinary income which can add to your tax bill.
With multifamily syndications you’re exposed to more tax benefits than REITs. You receive the depreciation which also exceeds the cash flow which essentially shows a paper loss while you’re actually getting positive cash flow. Using those losses to further offset your other income, per say your income producing W2.
With a fund of funds approach, it works the same as the syndication which the fund is used to invest in mutiple multifamily assets and cascades it down to the investor through depreciation and paper losses with the positive cash flow. Yes, you just read something similar with multifamily syndications because that’s what the fund of fund will be investing in. Just provides the working professional with a hands off approach and less overall exposure to risk.
Which Investment Appeals to You?
REITs, syndications and fund of funds have some similarities as they both invest in real estate but as we have discussed there are some differences. With many options of investment vehicles that invest in real estate, but between the three, REITs seem easy to get into but syndications and fund of funds offer more benefits.
There isn’t a best overall fit for investing in real estate. We wish we could pick one option and say, “this is the best real estate investing approach” for every individual passive investor. We wish it were that easy. Instead we lay down the differences, because we understand that each passive investor has their own individual situation to consider. Though we do not offer REIT investing here at The Fortes Company, we do offer multifamily syndications and fund of fund investing for our investors so that essentionally tells you which direction we lean as a private investment firm.
In the event you had $1,000 ready to invest but wanted access to it, then a REIT would be your best appealing to you. Say you had more that you are looking to preserve value and hedge against inflation, you might be exploring multifamily syndications and fund of funds. Considering your investment goals, decided the between the pros and cons of each is a healthy and great start. Just understand that as a passive investor, you don’t need to make one decision and select just one option. As a passive investor, its great to have options and you might want to explore all three options and invest the minimum as well as weigh the returns against one another. As far as we see it, investing in real estate is a win/win probability in our book.
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