Is Investing in a Real Estate Syndication Truly Passive?

Oftentimes syndicators say that investing in a real estate syndication is passive. In a sense, that is true, however, there is more to it than one might think. In this post I want to cover how investing in a syndication is passive and in what ways it’s not.

As a limited partner, someone can invest in a real estate syndication in exchange for equity in a property. As a result, they receive the benefits of owning real estate without doing much of the work. The benefits I mention include receiving cash flow, tax benefits in the form of depreciation, and principal pay-down amongst other things. These benefits and more, in addition to not having to put in much work, are what is so alluring about being a limited partner in a syndication. While this sounds great, nothing in this world is for free and there are a multitude of things that limited partners must do in order for things to go smoothly.

Why investing in syndications is passive

There are a few ways that investing in a real estate syndication is passive. For starters, limited partners will not be getting any phone calls regarding what some people call the three T’s: tenants, toilets, and termites. In other words, they won’t be bugged or have to worry about the day-to-day activities of running a property. It would be the managing team (i.e. the general partners) that makes sure the operations of a property run smoothly. More often than not, the managing team will hire a third-party property management company (PM) to run the day-to-day operations. For syndicators that are large enough, they may be able to bring the PM in-house (i.e. the company is vertically integrated) which then makes operating a property more efficient, but also more complex due to the systems associated with being a PM. Regardless, investors have the benefit of not having to think about the day-to-day operations of a property.

Another way that investing in a syndication is passive is that investors don’t have to manage renovations at a property or keep an eye on contractors who may not be doing a sufficient job. While syndicators would love if every property they bought was completely renovated and provided great returns, that is not the case. All properties at some point in time need to be repaired. Also, syndicators may choose to buy a property with the idea of implementing a value-add business plan which essentially means that they want to renovate the property to achieve a higher rent. Whether a syndicator is renovating a property or simply repairing something, there will be contractors involved. In a perfect world, all contractors would be efficient and do their job will zero error. As we know, that is not the case and from time to time there will be contractors that simply don’t do a good job. It is the responsibility of the managing partners to either get those contractors to step up or simply exchange them for another group that can get the job done if they are not performing well.

Finally, investors don’t have to look through and underwrite hundreds of deals in order to find one that actually pencils out. Believe it or not, finding a good property to invest in takes a ton of time. During a time with rising interest rates, such as the one we’re in right now, finding deals is even harder because sellers don’t want to budge on pricing and buyers can’t afford to pay the price sellers are asking for. The truth of the matter is that syndicators (including our team at JP Acquisitions) are continuously contacting brokers, underwriting deals, and touring properties. This process is very time intensive and for those of you that know, when you’re looking to purchase from a mom-and-pop operator the financials often look like their kid wrote them with a crayon (the red hopefully) which makes life a bit more challenging for the operator. Fortunately, investors are spared from having to constantly look for strong investment opportunities because that is the job of the managing partners.

What Makes Investing in Syndications Not Passive

After reading the previous section, you may be thinking to yourself what work do passive investors have to do in a real estate syndication? In short, the answer to that question is that there is a lot of upfront education that has to be done. Lucky for passive investors, that education is free via the internet. However, it could take months to get comfortable with how syndications and commercial properties work. For those who have a finance or real estate background, the process is quicker. Nonetheless, investors should be educated on three things.

Firstly, investors should be up-to-date as to what is going on in the world of real estate and their target markets. In terms of staying up to date on the world of real estate, that can be done by following various publications (e.g. CBRE or rejournals.com) or professionals on social media. By simply reading up on real estate each day, over time a general picture begins to emerge and trends can be spotted. In terms of staying up to date on various target markets, that is slightly more difficult as having local knowledge trumps reading up on markets. Nevertheless, investors should not only read up on the markets they’re interested in, but also visit them. There is nothing like talking to locals or brokers in an area to get a good understanding of what is going on there. For example, our team was interested in a market five hours from where we are located. We figured the best way to understand the area of interest was to tour a couple of deals and meet with a capital markets professional as well as brokers while there. The insights we gained were extremely valuable and provided a prospective that would not have been gained by simply reading up on the market. Anyhow, investors should be educated on the world of real estate as well as their target markets.

Secondly, investors should vet the operators (i.e. syndicators) that function in their markets of interest. I think we can all agree that no one should invest blindly into a syndication without understanding who it is that is managing their money. No two Syndicators are exactly the same and they have varying levels of sophistication and experience. That is why investors should meet and have multiple conversations with various syndicators in order to pick the one that is right for them. Some investors may like to work with large firms and feel comfortable considering their level of expertise and resources. Other investors may have little experience or be skeptical of large firms and prefer to invest with a syndication group that is smaller knowing they could get in contact with them easily when needed. More so, regardless of firm size, different syndicators invest in different asset classes. Not all operators invest in multifamily, there are other assets within real estate to invest in such as hotels, ground-up developments, self-storage, etc. The point is that limited partners should feel comfortable investing with a certain group and build a sufficient level of trust before handing over their money.

Thirdly, investors should be familiar with underwriting. That does not mean that investors need to have a model handy and re-underwrite every deal that their preferred syndicator(s) sends them, although that certainly would not hurt. What I mean by “familiar” is that investors need to be able to comprehend an underwriting model and make a judgment decision as to whether invest or not based on the numbers presented. If an investor can’t make sense of a model, then more likely than not they should not be investing in a real estate syndication. The model lays out the business plan associated with a property using numbers. The underwriting will not tell the full story, but rather provides the assumptions regarding a deal. It is the job of the operator to further explain the business plan to the investor in one form or another. The bottom line is that if an investor cannot read an underwriting model, they cannot make a judgment regarding a deal and therefore should not be investing in a syndication.

Conclusion

To recap, investing in syndications is passive however it requires some upfront work. Investors need to educate themselves on potential syndicators to invest with, the real estate market in general, their target markets, and underwriting. The good news is that the upfront work investors do can create income streams that will serve them for years into the future. Something I did not dive into is the work that needs to be done during the holding period of an investment. What I’ll note here is that during a holding period, investors should read the updates their syndicator sends out and if they happen to not send those out, consider working with a different operator. If something happens to go wrong during the holding period, communication is critical and should be a priority for the syndicator. Nevertheless, I digressed and will finish by saying I trust this post flushed out the question as to if investing in a real estate syndications is truly passive.

If you have any questions regarding the terms and concepts in this post or previous ones, don’t hesitate to reach out to either me (tedi.nati@jpacq.com) or someone on our team so we can help explain what is causing the confusion. If you’re interested in investing with us at JP Acquisitions, you can contact us via email (contact@jpacq.com), LinkedIn, Instagram, or our investor portal to set up a meeting.

As always, I hope you enjoyed reading this post as much as I have writing it. Best of luck!