Real estate is the ultimate investment. It’s one of the most reliable, easiest ways to grow wealth. Real estate is a staple in investment portfolios because nothing else provides the same kind of dollar-for-dollar returns or advantages.
To better understand real estate syndications and how you can benefit from investing in them, I’ve highlighted my top 10 reasons to invest in real estate syndications…
1. Cash Flow
First things first: Price Capital always purchases properties that cash-flow. It is not always easy to find these properties, but it is well worth the time and effort. The simplest definition of cash flow on a property is one that allows you to collect more revenue, usually in the form of rent, than it takes to pay for and operate the property. A big advantage of investing in real estate versus other investments is that it can produce cash flow on a monthly basis and is usually a much larger percentage cash-on-cash return.
2. Large Investment Opportunities
Some of the best real estate investment opportunities in the world are in commercial properties, however these are pricey investments. Purchase prices for this asset class can range from $5,000,000 to over $500,000,000! However, real estate syndications give you the ability to pool funds with other investors making it possible to get exposure to this asset class without a seven-figure investment alone.
When syndicators create investment opportunities like this, they usually expect to have investors with a minimum of $50,000 - $100,000. However, if they create the PPM or operating agreement, there can be a minimum investment as low as $25,000, opening up the door for more investors with less money to invest in opportunities they otherwise would not be able to invest in.
Once you understand this pooled investment model, you can get exposure to amazing cash-flow opportunities and investments. We can show you how!
3. Appreciation
Did you know that according to the National Association of Realtors, since 1968 the historic appreciation levels for real estate has been 6 percent per year. An average of 6 percent means there are areas with lower appreciation rates and areas with higher ones and that by doing your homework you can find areas that will have appreciation levels far above the national average. These are the areas that Price Capital invests in. Areas where the job growth and employment growth are high.
Cash flow coupled with appreciation is a strong combination for real estate investment success. Take a look…
Assume you are purchasing a $200,000 property at 20 percent down ($40,000) and that rents for $1,000 per month. Where do you think that investment will be in thirty years? After thirty years, the average life of a mortgage, the property is worth $1,083,678. Not only is the property paid off and worth an incredible $883,678 more than when you purchased it, but you have rental income coming in each month with very little effort on your part. This is cash flow actively coming into your account while you are sleeping, playing, traveling and exploring. And don’t forget, while the mortgage was being paid off, the rental income was growing at 4 percent per year and is now providing you with $3,243 per month. That amounts to $38,916 in annual income from just one property!
The most beautiful thing about this example is that you only put $40,000 down when you purchased the $200,000 investment. You used the bank’s money and your money experienced a higher return than if you had invested it in stocks or bonds. This is called leverage and is the ultimate power of real estate. Appreciation grows on the “loaned” amount. So, the $160,000 at 6 percent per year over thirty years with the magic of compounding grows to a value of $918,959! And you get that money, not the bank. All they receive is the interest on the original loan. The interest expense is also a tax write off!
4. Leverage
Leverage is my favorite thing about investing in real estate because it provides investors flexibility. Leverage in real estate means using various financial instruments or borrowed capital to purchase and increase the potential return on investment. Leverage is based on the asset itself and oftentimes you can get a bank to loan you up to 80 percent, 90 and even 100 percent of the total value. Why do banks do this? Because they can repossess the physical asset itself should you default.
So how is it that an investment in real estate at 6 percent appreciation is a better investment than a stock at 10 percent? One word: leverage. When you leverage an investment, you reap the benefits of the appreciation on the total asset value, while only having a small percentage of your own money in the deal. Using the same example from earlier, I’ll show you how this works.
In any investment, the goal is to have the highest cash-on-cash return, or return on investment (ROI) possible. ROI is the percentage return of your investment to your invested dollar (ROI = Return on investment / Original investment).
Let’s take this equation and apply it to our $200,000 property. Let’s say that after thirty years the property is worth $1,083,678, that means to find our cash-on-cash return, we’ll divide that number by our $40,000 original investment to find out percentage ROI:
$1,083,678 ÷ $40,000 = 2,709% ÷ 30 years = 90.3% per year
Our ROI would be 90 percent. How unbelievable is that?
Now let’s compare the return on a $40,000 down payment on a $200,000 property at 6 percent appreciation, to a $40,000 investment in stock at 10 percent per year for the same amount of time.
If you held on to your stock for thirty years, and */the stock appreciated at 10 percent per year, your $40,000 of stock would be worth $634,524. That would mean your ROI would be:
$634,524 - $40,000 = 1,586 percent / 30 years = 52.8 percent per year
Don’t get me wrong, 1,658 percent return on your money is an awesome return. But it isn’t the best return you could have.
Additionally, that doesn’t even include the cash flow generated from the property or your tax breaks!
That is the magic of leverage, and the power of real estate.
5. Depreciation
According to the IRS, depreciation is an income tax deduction that allows a taxpayer to recover the cost or other basis of certain property. It is an annual allowance for wear and tear, deterioration, or obsolescence of the property.
In real estate investment, depreciation is a nonoperational expense that can be used to your advantage come tax time. The depreciable years for commercial real estate is 39 years.
The basic equation for figuring depreciation is:
(Total Asset Value – Land Value) / Depreciable Years = Annual Depreciation
For example, let’s consider the purchase of a $19.7 million asset by Price Capital and our investors. In order to estimate depreciation, we have to first subtract the value of land since the IRS doesn’t consider that to be a depreciable asset. Depreciation only accounts for the buildings on the land, since they will lose value as they age. Let’s say the estimated value of the land is $3 million. Now let’s calculate our yearly depreciation of 39 years.
($19,700,000 - $3,000,000) / 39 years = $428,205
Now I’ll show you why this is so important. Remember that depreciation is treated as a nonoperational expense. Therefore we can use that $428,205 per year against our cash flow when the taxes roll around.
Here is a simplified property financial to show you why depreciation is so powerful:
Rental Income $2,200,000
Other Income $500,000
Total Income $2,700,000
Operating Expenses $1,500,000
Net Operating Income $1,200,000
Debt Service $900,000
Cash Flow $300,000
Depreciation ($428,205)
Net Income After Depreciation ($128,205)
What you see reflected in the chart is what I consider tax-free cash flow. The cash flow for the property after all operational expenses is $300,000. That would warrant a pretty high tax bill come the first of the year, but depreciation allows me to prove an operating loss of $128,205. Since the depreciation is a noncash expense, I don’t owe any taxes, even though my investors and I have pocketed $300,000. And I can use the tax savings for other investments. Thanks, IRS!
6. Forced Appreciation / Control
A multifamily apartment syndication is a business that is valued primarily by its Net Operating Income (NOI), rather than by property comps (like single family homes). But, with physical and operational improvements, you can increase the value of the property by increasing NOI. Most value-add syndicators look for opportunities to capture appreciation through capital improvements or by streamlining operational and physical inefficiencies with owners and property managers.
If you are considering investing with an apartment syndicator, one of the first things to consider is the partners plan to turn the property around, or forced appreciation. This is usually attainable in three ways: by increasing income, decreasing expenses, or a combination of both. Regardless of which approach is used, if successful, the result should the same – an increase in NOI.
Let’s look at how an increase in NOI affects the value of the asset. Imagine we buy a 100-unit apartment complex for $5M that has a NOI at time of purchase of $250K, thus a CAP of 5% (NOI/Asset Value). Now say we invest $350K on improvements that garnish an average premium of $75/unit. This increases the NOI from $250K to $340K and thus brings the FMV (fair market value) from $5M to $6.8M (NOI/CAP = 340,000/.05). Investing $350K for a $1.8M FMV increase, a $1.45M return, is a very lucrative move. So, as you can imagine, a decrease in expenses will affect the numbers in the same way by increasing the NOI.
7. Refinance
Another advantage of investing in real estate verses other investments is the ability to withdraw cash through refinancing the property. This too is a tax-free transaction. When you refinance a property, you are restructuring your existing mortgage debt based on the added value of the property.
When Price Capital acquires a property and implements our Value-Add Business plan, our goal is to increase the net operating income (NOI). Net operating income for an investment property is determined by subtracting your expenses from your income and is the primary indicator for the value of the property.
Income – Expenses = Net Operating Income (NOI)
Net Operating Income – Mortgage = CASH FLOW
Once we implement our business plan and increase the NOI, we can find out the new value of the property by dividing the new NOI by the going capitalization rate. A capitalization rate, commonly referred to as a “cap rate,” is the NOI divided by the purchase price or value of the property. Capitalization rates are determined by evaluating recent statistics of similar properties in a given market.
If, for example, we’re able to increase income by an average of $50 per month per unit in a 100 unit apartment complex using a variety of value add strategies we can take that increase in NOI of $60,000 and divide that by the cap rate of 6% for example, and we have just increased the value of the building by $1,000,000.
Now, we can opt to refinance and pull this money out and return it to each investor. And best of all, the money from the refinance is tax-free.
One of the biggest advantages of multifamily investments is that by increasing net operating income with sound management principles, you can dramatically increase the value of the acquisition, quickly! You will see fast the benefits of refinancing the property and reinvesting the equity into other multifamily investments.
8. Economies of Scale
This one is simple - the more units you manage, the more likely you are to lower expenses (think cost per unit) and drive up NOI. This is particularly true when using a property management company or by undertaking renovations. The more units a property manager manages, the less cost per unit they will charge. This is even more applicable where the properties are condensed to one area (as opposed to 100 SFHs spread throughout town). And if you’re thinking of renovating several or all units, take note that contractors price per unit will be lower the higher the number of units your renovate. You’ll also save on building materials because providers of renovation materials – flooring, appliances, doors, siding, paint, etc. – often offer deals or discounts on bulk orders.
9. Principal Paydown
Isn't it great to have other people pay down your debt? Imagine several hundred people doing that. That's what happens in large multifamily apartment and self-storage investment properties. Your rental income essentially pays down the debt and builds equity in the property. Through the life cycle of the syndication, rental income from the property pays all debt service. If you sell the property, property principal reductions are returned to investors.
10. Hedge Against Inflation
As inflation levels increase and the purchasing power per unit takes a hit, investors usually wonder how they can avoid losing value on their investments. One way is to do this is through investing in hard assets such as apartment buildings. Because rent rises with inflation, investing and building wealth through apartment buildings is a great way to increase your wealth even when inflation hits. In other words, when inflation hits, you can raise the rent so you don’t lose out.
In the end, Real estate in general is always a great investment, and the benefits are even greater during rising inflation. Because of the limited amount of land in certain markets and rising population growth, demand in the real estate apartment sector is high. This limited supply and high demand means that increasing property values can offset any deterioration in wealth caused by a rise in inflation.
I hope you enjoyed and found value in this article highlighting the Top 10 reasons for investing in real estate syndications. As an asset structure and investment opportunity often overlooked, I truly enjoy getting the chance to talk with investors about the many benefits real estate syndication investment opportunities offer.
For those looking to build long-term wealth while creating a consistent passive income stream along the way, consider these types of real estate syndicated deals. I realize this may not be a fit for everyone and there are many other wealth building strategies out there, but for those who have started investing through this type of vehicle, the biggest regret I hear is, "I wish I started earlier." (That includes me too!)
