Real Estate Syndication vs REIT: Which is Right for You?

New Passive Investor Circle members often think that a REIT is the same as a real estate syndication.

If you want to check out my video breakdown on the two, take a look here: 

Both investments offer unique opportunities to invest in real estate, but key differences exist.

In this article, we’ll compare the differences between a REIT and a real estate syndication so you can make the best financial decision.

What is a Real Estate Syndication?

Real estate syndication allows investors to pool their resources and collectively invest in specific properties. This investment structure offers you the opportunity to participate in larger real estate deals, which might be out of your reach as an individual investor.

Syndications involve a general partner (GP) who manages the investment and multiple passive investors.

Related article: GP vs LP In Real Estate Syndications: What’s The Difference?

How Do Real Estate Syndications Work?

The process begins when the GP identifies and secures a real estate opportunity. They present the deal to potential passive investors (LPs), providing detailed information about the property, expected returns, and investment terms.

Once enough passive investors commit to the project, legal documents, such as a limited partnership or a limited liability company agreement, are created to establish the investment structure.

Here are the steps involved in real estate syndication:

#1. General partner identifies a suitable property.

#2. General partner recruits passive investors for the project.

#3. Legal documents are drafted to define the investment structure.

#4. Passive investors contribute capital to the deal.

#5. GP manages and operates the property on behalf of the investors.

#6. Passive investors and the general partner share profits based on the agreed structure.

Role of General Partner and Passive Investors

Real Estate Syndication Deals and Structure

Real estate syndication deals typically involve a specific property, such as an apartment building, office complex, or retail center.

The investment structure can be set up as a limited partnership or a limited liability company (LLC), providing liability protection for passive investors.

Preferred Return

The investment returns are distributed according to a predetermined deal structure. This usually includes a preferred return, a preset percentage of annual profits paid to passive investors before the general partner receives any profits.

After preferred returns are distributed, the remaining profits are typically split between the passive investors and the general partner based on an agreed ratio.

For example, a common real estate syndication structure might offer passive investors an 8% preferred return, followed by a 70/30 profit split between them and the general partner.

What are Real Estate Investment Trusts (REITs)?

A Real Estate Investment Trust (REIT) is a company that owns, manages, and finances income-producing real estate properties. As an investor, you can purchase shares in a REIT, which allows you to receive a portion of the income generated by the properties without directly owning or managing them.

REITs distribute at least 90% of their taxable income to shareholders as dividends, providing a steady income stream while also allowing for capital appreciation over time.

Types of REITs

There are two main types of REITs: Equity REITs and Mortgage REITs.

Equity REITs

Equity REITs primarily own and manage income-producing properties, such as residential buildings, office spaces, hotels, and shopping centers.

As an investor, your returns come from these properties’ rental income and appreciation.

Mortgage REITs

Mortgage REITs, on the other hand, invest in mortgages or mortgage-backed securities and generate revenue from the interest earned on these loans.

This type of REIT offers more exposure to the financial aspects of real estate rather than the physical properties.

REITs on Major Stock Exchanges

Most publicly-traded REITs are listed on major stock exchanges, such as the New York Stock Exchange (NYSE), NASDAQ, and London Stock Exchange. These REITs must comply with the regulations and reporting requirements of the Securities and Exchange Commission (SEC), providing transparency and security for investors.

Here are some well-known REITs listed on major stock exchanges:

Public vs. Private REITs

REITs can be classified as either public or private, depending on their structure and accessibility.

Public REITs

These are listed on stock exchanges and can be bought and sold like any other publicly-traded stock.

These REITs offer more liquidity, transparency, and are subject to stricter regulatory oversight.

Private REITs

Private REITs are not traded on public exchanges and are usually available only to accredited investors.

While potentially offering higher returns, private REITs are less liquid, may have higher fees, and may lack transparency compared to their public counterparts.

Minimum Investment Requirements

In real estate syndication, the minimum investment requirement is generally higher, often ranging from $25,000 up to $100,000 or more.

Most of the offerings for our investors have a $50,000 minimum.

This can be limiting for some investors who might not have that much capital readily available.

On the other hand, investing in a publicly traded REIT is more accessible, as the only minimum requirement is to purchase at least one share, which could cost as little as $100 or sometimes even less.

What About Profit Distributions?

Real estate syndications and REITs both offer the potential for positive cash flow and returns on your investment.

REITs

REITs typically pay dividend payouts regularly, providing a consistent stream of income. The average annual return for REITs can vary, but historically, they have performed well compared to other investment options.

Syndications

In the case of real estate syndications, returns are generally generated through rental income and property value appreciation.

These returns can then be distributed to investors, although the frequency and structure may differ from syndication to syndication.

Liquidity and Time Horizon

Tax Implications of Syndication

In real estate syndications, investors have numerous tax advantages.

When you invest directly in a property, you can receive various tax deductions. One of the main benefits is depreciation, which allows investors to write off the value of an asset over time.

Depreciation helps offset the income generated from the property, potentially reducing your taxable income.

Other deductions can include:

    
• Mortgage interest
    
• Property taxes
    
• Operating expenses

REIT Taxation Benefits

The IRS regulates Real Estate Investment Trusts (REITs). These trusts must distribute at least 90% of their taxable income to avoid being taxed at the entity level. This rule provides tax breaks for investors and results in a high dividend yield.

However, it’s important to note that REIT income is categorized as ordinary dividend income, which may lead to a higher tax bill compared to syndications.

Impact on Personal Tax Bill

To understand the impact on your personal tax bill, consider the following comparison: