In prior articles we discussed the benefits of investing passively in syndications. In an effort to present a more balanced view, in today’s quick snippet we will discuss reasons why syndications might not be a great fit for you.

1) Lack of control. When one invests passively in syndications, one joins as a Limited Partner (“LP”). As an LP you are not involved in the day to day operations and do not have voting power on major decisions. In exchange, you are also shielded from business liability associated with operating the property. As such, it is important that you know and have confidence in the operator, his/her team, and their ability to execute on the business plan.

2) Large upfront investment. For most syndications, the min investment amount starts at $50,000 (some require as large as $100,000). There are strategies to work around that by investing via a self-directed IRA or eQRP (i.e. leveraging liquidity from your retirement account vs. dipping into excess liquidity sitting in your bank account or having to find additional liquidity). Nevertheless, that is not a small amount of money for many people and may preclude some from investing.

3) Long term horizon and illiquid investment. While the market environment in the past two years was somewhat unusual, with many syndications selling the property within 1-3 years, the typical hold is 3-7 years. As noted above, as an LP, you do not control when the investment is sold and cannot freely sell your share. You need to be comfortable with not being able to access the invested liquidity for a period of time.

4) Complexity and administrative burden. As discussed in a prior articles, buying apartments entails not only making a real estate investment, but also running a business. As you do your diligence on the investment, you need to ensure you understand the market, the sub-market, the business plan and have confidence in the operator’s ability to execute on such business plan by vetting such operator. The administrative burden can also be a nuisance to some – both when submitting your commitment (especially for accredited investors who go through a third party accreditation verification), reviewing a number of documents (e.g. Private Placement Memorandum, Investment Summary, etc.), as well as working through the annual tax reporting (e.g. annual K1 reporting for taxes).

5) Small ownership share. While typical ownership share splits grant approximately 70% ownership share to the passive investors (LPs), that 70% share is distributed among several individuals/entities. In addition, the deal sponsors (managing partners) will often establish caps on the maximum permissible investment amount. This in turn, limits your ownership share and ability to control the deal. While a small share of a big pie can still be quite meaningful to an investor, it caps the share of profits you capture.

Other: In the current market environment, particularly in the first year of operations while the sponsors are stabilizing the property, cash flow is limited. While as an LP you mostly benefit from the ongoing preferred return (think of it as interest paid on the principal amount you invested in the deal, though it is not exactly the same especially for tax purposes), the preferred return is not guaranteed. Thus, the biggest gain for both LPs and the GPs (deal sponsors) is generated at the time of sale, timing of which depends on the hold period (i.e. is not immediate). If you invest a small principal amount, that might equate in a relatively small amount of monthly income (though as shared in a prior article, that can stack up over time in a meaningful way).

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Disclaimer: The information presented does not constitute legal, accounting, tax, or individually tailored investment advice. Past results do not represent or guarantee future performance.