Consistent passive income is the holy grail of the investment world. In an economy with a wildly fluctuating stock market, inflation, and long-term uncertainty, this sort of income seems out of reach. But one area in the economy performs well for those with the capital to take advantage of it.
During economic downturns, industry experts turn to real estate investment opportunities. Generally, real estate is a recession-proof investment, and property values show a historically upward trend.
Over the long-run, real estate appears to have the greatest value for investors and offers diverse options outside the stock market.
The Pros of a Diversified Investment Portfolio
By now, you’re familiar with the necessity of a diversified investment portfolio. Outside of your 401k, you probably started with mutual funds because of the safety inherent in a pool of stocks. If one goes down, another will balance it out by outperforming.
A diversified portfolio also allows you to play with high-risk-high-reward investments that you might otherwise avoid.
Common sense dictates that you would make real estate investments one of the pieces of your portfolio, especially with the advantages investment properties provide.
The Advantages of Investing in Real Estate
Real estate is historically one of the best long-term investments you can choose. Even an undeveloped property can increase in value significantly if it’s in a high-growth area. A well-kept investment property will sell for much more than the price paid as developers search for more land to meet increasing demand.
Generally, a real estate investment entails purchasing a property and using it as rental income. Both commercial and residential real estate offers the potential for long-term cash flow and a large payout when you decide to sell.
With all the advantages of having a strong real estate portfolio, investing in real estate feels like the way to go. The entire system seems like a good hedge against poorly performing stocks or a weak economy. However, there are some disadvantages to real estate investments.
What Are The Disadvantages Associated With Investing Directly in Real Estate?
Real estate investing has great promise but comes with a strong, upfront disadvantage.
That disadvantage is the cost of purchasing a property. Unless you inherit property or the money to purchase land, most property purchases require the buyer to take on debt. You’ll have to go through the process of finding a loan, fronting a down payment, and managing the property before it starts to provide you with cash flow.
If you’re buying a rental property, you must be prepared to deal with lawyers, taxes, and other real estate transaction costs.
The Disadvantages of Developing a Property
One option is to buy a property to develop it yourself. In this instance, you have complete control over how the property is shaped, from the buildings to the landscaping. In essence, you have a blank palette on which to impose your creative will. Unfortunately, developing a property, especially larger properties, comes with potentially years of frustration before you see a return on your investment.
During the beginning phase, you’ll either rely on your regular income or large loans to pay for the work. You’ll also have to negotiate with local politicians over zoning laws, deal with contractors, underwrite the changing cost of materials, and face other setbacks.
If you go into the deal with a partner as a joint venture, you may experience the difficulty of navigating a professional relationship with potentially differing goals or ways of dealing with the constraints that will invariably arise.
Although the long-term potential may outweigh the short-term hassles, the introductory phase of working with undeveloped properties has many disadvantages.
The Disadvantages of Working Directly with Rental Properties
Most people think of starting and running rental properties when real estate investments are mentioned. In theory, this sounds simple, but in practice running a rental property is a full-time job!
If you plan to work your career and run rental properties, you are in for a shock. You’ll have multiple responsibilities, from interviewing tenants to fixing toilets. Even if you have a property management company to deal with the daily details, you will have to oversee the property’s marketing to ensure that you keep your buildings occupied, work with insurance, and have full legal liability for what happens on your property.
Your ROI might not be adequate in exchange for your invested sweat equity.
All this might be an advantage if you are an extrovert who loves hands-on managing and more control over your property. For most people, running a rental property and having a full-time job is a marked disadvantage, even with additional cash flow.
Suppose you want the profits generated by a strong real estate market without the struggles of active investments. In that case, you will want to consider the advantages of investing in a real estate syndication.
The Advantages of Investing in a Real Estate Syndication for Passive Investors
Real estate syndications are group investments where accredited investors pool their resources to purchase asset classes that would otherwise be out of reach.
Syndications offer you a truly passive experience with the opportunity for a 6-8% annual ROI, sometimes more.
This sounds way too good to be true! Are real estate syndications really that simple? As with direct real estate investing, syndications come with advantages and disadvantages.
Real Estate Syndications Come With Pros And Cons
Let’s start with the obvious. Real estate syndications are not perfect
Like every other investment vehicle, real estate syndications come with pros and cons, and you have to weigh each one for yourself based on your personal investment goals.
Here are a few advantages and disadvantages of real estate syndications to get you started.
Pro: As a passive investor in a real estate syndication, you don’t have any active responsibilities. That means that you don’t have to deal with tenant turnover, renovations, or middle-of-the-night emergencies.
Con: As a passive investor, you don’t have any control over the investment. Often, you don’t even get a vote. The sponsor team is responsible for the day-to-day operations and strategy behind the investment, so you have to put your trust in them.
Pro: Most real estate syndications are long-term investments, with projected hold times of 5 years or longer, so you can put your capital in and not have to think about it for a while.
Con: Because real estate syndications are long-term, you can’t pull your money out at will like you could with stocks and mutual funds.
Pro: As a passive investor in a real estate syndication, you just sit back and collect regular cash flow checks. Often, these checks get direct deposited into your bank account, making it truly low-muss, low-fuss.
Con: As one of many investors in a real estate syndication, you share the overall pot of returns. Often, you’ll see an 8% preferred return with a 70/30 split thereafter. In other words, the first 8% of all returns go 100% to you and the other passive investors, and then the rest is split 70% to the passive investors and 30% to the sponsor team. This is unlike rental property investing, when you, as the sole owner, get 100% of the returns.
Real Estate Syndications Are Not For Everyone
While passive investing might sound like an amazing investment vehicle, real estate syndications are not right for everyone.
Major Upfront Costs
Private real estate syndications start with a high minimum investment (usually $50,000 or more) and will hold your money for a long period of time (typically 5 years or more).
The one advantage to investing through a syndication over personally developing land is that you know how much capital you have to invest upfront. Rarely are you expected to invest more once you’ve signed the PPM and wired your capital.
In addition to the upfront costs, you’ll have to meet the threshold required for accredited investors.
Accredited vs. Non-Accredited
You can invest in pretty much any real estate syndication if you’re an accredited investor. To qualify as an accredited investor, you either have to have over $1 million in net worth, not counting your primary home, or make $200,000 per year (or $300,000 together with your spouse), have done so for the past two years, and intend to make the same amount this year.
This is a pretty high bar, so it’s completely understandable if you haven’t yet reached accredited status yet.
If you’re not an accredited investor, there are still some real estate syndications that are open to you, but you’ll have to dig to find them, since they cannot be publicly advertised. This means you’ll have to put in some extra work to network with people and find opportunities that are open to you.
The Trust Factor
Being a passive investor also involves a certain level of trust. If you’re the kind of investor who wants to be in control of everything and make all the decisions yourself, this is a major disadvantage, and here’s why.
As a passive investor, you’re not in the “situation room,” so to speak. You don’t need to make big decisions about budget, timelines, or renovations. You get a monthly update about the project’s progress, along with a cash flow distribution check, and that’s about the extent of your ongoing involvement. If you’ve never done that type of backseat investing, it might take some getting used to.
Some People Have Lost Money Investing In Real Estate Syndications
Okay, let’s talk about the elephant in the room, losing money.
You want to know, if you could lose money if you were to invest in a real estate syndication. And the answer is yes. You absolutely could. Is it likely? Not if you invest right. But it’s always a possibility.
Real estate syndications, just like stocks and mutual funds, are an investment, and no investment comes with a full guarantee. There’s always a chance that things could go awry. And yes, that includes the additional risk of losing your investment.
There, I said it. You could lose some or all of your original investment.
As a passive investor, that’s something that you will need to get comfortable with. So if you’re starting to sweat just reading these words, then maybe real estate syndications aren’t the right fit for you, at least not yet.
Because here’s the honest truth. There are people who have lost money investing passively in real estate syndications.
It hasn’t yet happened to any of our investors in any of the deals we’ve done (knocking on all the wood I can find right now), but I do know of people who have invested with less experienced operators or in less savory submarkets who have lost money.
So are real estate syndications too good to be true? Absolutely not. Are the projected returns guaranteed? Definitely not.
Similar to direct real estate investing, you could absolutely lose money. But it’s extremely unlikely if you invest right.
Despite the disadvantages, real estate is still a strong investment.
Active investors and passive investors face similar disadvantages when it comes to real estate.
For example, both have to provide upfront capital before seeing positive cash flow. Both have to research and perform due diligence before investing. And both have the possibility of losing money.
None of these potential downsides can eclipse the fact that real estate investors who do the right research and proceed with wise caution have generated billions in revenue even during recessions and depressions.
I hope that by now, you see for yourself that real estate syndications, while totally awesome, are not perfect, and they’re not for everyone.
Just like any other investment vehicle, real estate syndications come with pros and cons, potential downsides, and a good amount of time investment up front.
But, if you make it through…if you put in the work and you have those conversations and you ask your questions and you do your research…I believe that you’ll find passive investing to be a truly one-of-a-kind type of investment experience, one that you’ll be raving about to your friends as you show off your latest cash flow checks.
And when they ask you whether it’s too good to be true, you’ll laugh quietly to yourself as you send them the link to this article.