For anyone who is serious about building wealth through passive income, diversifying is key. Owning 20 single-family homes might provide enough rental income to suit your purposes. But if that is the entirety of your portfolio, a single economic event can destroy your income.
Perhaps you want to expand into apartment buildings or storage unit complexes but don’t have the cash to do so. If that’s the case, consider a real estate syndication. A syndication can grant you access to higher-value assets without you having to carry the entire financial burden. Here is how a syndication can be beneficial and allow you to amplify your passive income.
Basics of a syndication
A syndication isn’t just something that occurs with classic television. With real estate, it’s a way for multiple people to lend financing toward a high-quality asset. Typically, there are two types of participants: sponsors and investors.
The sponsor is the person or entity that organizes a real estate deal and manages the asset afterward. Sponsors are usually expected to invest some capital themselves, but the majority of financing will come from investors. Sponsors receive a management fee for their services.
If the property becomes profitable, investors will receive the preferred return rate stipulated in their investor deal. So if they invested $100,000 and have a return rate of 8%, they would receive $8,000 per year. Any profit remaining after the sponsor fee and the preferred returns would be distributed based on the contracted split structure.
Rental income
Rentals can provide the sponsor and investors with long-term income. Through a syndication, it’s easier to acquire a multi-unit apartment, retirement community or larger commercial property. Commercial properties are usually more stable earners than residential properties.
There are important considerations before choosing a property to sponsor or invest in for the purposes of rental income. If the property has been in existence for some time, what are its historical returns? Just because a property receives an influx of cash doesn’t mean profitability will necessarily increase. Also, consider the economic trajectory of the area around the property. If large employers have been slowly leaving the area, rental increases over time might not be justifiable.
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Property appreciation
Property appreciation is an increase in a property’s value over time. This can be due to ordinary economic growth or actively increasing the asset’s value through renovation.
Selling a property during a high economic point can be very profitable. Because the timing must be right, it requires keeping a careful eye on economic projections, which usually is a task for the sponsor.
Buying an asset for the purpose of flipping it tends to have a much quicker turnaround. The sponsor will need to find a property, estimate the cost of improvements and renovations and present the plan to investors.
A benefit of flipping properties rather than keeping them long term as rentals is pricing confidence. An area’s local economy is unlikely to collapse between the time a property is purchased and when it is upgraded and sold.
Keeping a property long term allows for appreciation over time, but it poses risks of an economic downturn or site damage. While rare, it’s possible a surge of apartments could be put on the market, leaving owners to compete for a limited number of renters.
A word of caution
Syndication isn’t for everyone. Investors have limited flexibility on the commitment, compared to solo investing, and the ROI could take years. Investors also have limited control — especially since the syndicator/sponsor manages the assets for them. And then there’s the large initial investment that’s required for many syndication deals.
Higher-value properties with less personal risk
“Don’t invest with your own money” is an interesting concept. While sponsors are usually expected to contribute some capital, a syndication allows access to real estate tiers that were formerly off-limits to many. With the right management and investors, it can be a powerful way to round out a passive income portfolio.
