A high level overview, with 8 specific talking points, as to why apartment syndication is an appealing investment vehicle.
Real estate has been a staple in many successful investment portfolio for decades, and for good reason. It is a limited commodity that has a proven track record of lucrative returns, the offer of diversification, and resilience to economic recessions. One may hold a number of real estate assets from land to single family homes, and even small multifamily homes. One piece of real estate that is often overlooked, however, is large multifamily units, or apartments. The reason behind this may be one of many; limited access, high cost of entry, or the lack of “know how” to name a few. Continue reading to find out why apartment syndication is, in my opinion, and appealing investment vehicle that should be considered by all qualifying investors for their portfolio.
1. Diversification. Many portfolios today include some type of real estate holding, commonly land or SFHs. Often overlooked, however, MFHs (apartments) can offer to strengthen a key portfolio characteristic – diversification. There are plenty of studies out there that support the fact that MFHs are typically more resilient to market downturns than land or SFHs, and can still offer returns to investors in such times. When considering an investment with an apartment syndicator, make sure to check for the presence of a sensitivity analysis; what you’ll want to see here is conservative underwriting that shows what the returns or losses will be given certain market or asset variables, namely a down market.
2. Performing asset. I’ll preface this section by saying that this does not hold true for ALL apartment deals, nor is it necessarily always the play for apartment syndicators. That being said, it is not uncommon for syndicators to target assets that have a proven history of performance prior to acquisition. What this means is that, without putting a single dollar into renovations, re-branding, etc., the asset already provides positive cash flow. This of course in turn mitigates risk to investors. Proof of such is commonly found in the deal presentation.
3. Truly passive income. An apartment syndication partnership will typically follow a general/limited partner(s) structure. The general partner, often an LLC formed specifically for the deal, is responsible for finding the deal, securing financing, overseeing the day to day operations, etc. Meanwhile, the limited partners, or the investors, have very little involvement in the major decision making and daily operations of the partnership. While this less active role is not ideal for everybody, it is the perfect opportunity for those investors looking for a passive investment. Just sit back, relax, and collect payments in the form of quarterly or monthly cash flow distributions and lump sum payouts at disposition (and sometimes refinancing).
4. Forced appreciation. One of the first things you will want to look at when considering an investment with an apartment syndicator is the general partners plan to reposition, or force appreciation on, the asset. There are three ways to force appreciation; increase income, decrease expenses, or a combination of both. Regardless of which approach is used, the result will be the same – an increase in NOI (net operating income). Let’s look at how an increase in NOI will affect 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. As you can imagine, a decrease in expenses will affect the numbers in the same way by increasing the NOI. For some ideas on how to increase revenue or decreases expenses, check out the insightful articles written by my mentor at links (1) & (2) at the bottom of this page.
5. Economies of scale. This one is simple - the more units under management, the higher your ability will be to lower expenses (think cost per unit), thus driving up NOI. This is particularly true when using a property management company or undertaking renovations. Property managers will lower their cost of onsite management the more units that you have, even better if they’re in a more condensed area (as opposed to 100 SFHs spread throughout town). When thinking of renovations, contractors price per unit will be lower the higher the number of units, and providers of renovation materials – flooring, appliances, doors, siding, paint, etc. – often offer deals or discounts for ordering in bulk.
6. Access to large commercial deals. Commercial properties, in this case apartment complexes, offer the potential for very high returns, but at the same time not many individuals have the monetary means to purchase such properties. Realtyshares defines a syndicate as “an effective way for investors to pool their financial and intellectual resources to invest in properties and projects much bigger than they could afford or manage on their own.” By it’s definition, apartments syndicates allow you to pool your money with other investors and provide you with the opportunity to invest in an asset class that you’d be priced out of on your own. A syndicator’s PPM (private placement memorandum) or operating agreement will often be aimed at investors looking to contribute funds in the $50,000+ range, but it’s not out of the question to see minimum investment requirements as low as $10,000.
7. Tax advantages. There are several tax advantages to an investment in any type of real estate; for brevity, I will name a few of the top ways that MFHs are a tax efficient investment. We can look at this in two ways, (1) advantages during the life of the investment and (2) advantages at the time of sale. For the former, regular distributions to investors can often be filed as a loss on your K-1 tax statement since depreciation, property tax, loan interest and other expenses can be used as deductions that offset those gains. (Quick note: a K-1 is the tax form that allows a partnership to pass on tax liabilities to each entity that has an interest in the partnership; in this case, the investors/limited partners) Further, any refinancing that results in a return of capital to investors is not a taxable event in the eyes of the IRS. When thinking of the sale of the asset, both depreciation recapture and the fact that the IRS considers this a long-term capital gain – which is treated at a lower tax rate – will help you keep as much of your returns as possible. If this all seems a bit too complicated, don’t worry, typically the general partner of the deal has CPAs, attorneys, etc. to find all tax benefits possible.
8. Less liability exposure. With any real estate investment, one should look to limit their exposure to liability as much as possible. Often this is done through the formation of an LLC which “owns” an individual’s rental properties. Apartment syndications are similar, but different; they add another layer of protection, via the LLC formed by the sponsor to acquire the asset. Since most syndications have investors as limited or passive investors, which generally means minimal involvement in management decisions, this LLC protects them from any incidents arising from daily operations of the property as well as any debt obligations.
I’ve now listed what I believe to be the top eight reasons that apartment syndication is an attractive investment niche. This is by no means an all-inclusive list, so I encourage you to go out and do some research yourself; if you find any interesting points that you think I missed, please comment! By SEC rules, most apartment syndication opportunities will require that an investor is accredited. If you fulfill this requirement, I believe that you should consider this highly lucrative investment vehicle as a way to diversify your portfolio.