Let’s get straight to the point: most of us would like to retire at some point (preferably sooner rather than later). To be clear, in our opinion retirement should not mean idleness, but rather financial independence: the state in which your time belongs to no one but you.
Robert Kiyosaki has spent a great deal of time and money promoting financial independence (or “financial freedom”) and the mindset it takes to pursue this state successfully. We have followed his methods and philosophy for years through his literature, podcasts, and famous Cashflow board game. If you’re familiar with his work, you’ll know that he is strong on real estate investment as one of the best means to the end of financial independence.
Yet, there are so many ways to invest in real estate. One can buy single-family houses or duplexes and rent or flip them for a quick profit. One can purchase notes (mortgages) that are performing or not performing. One can buy real estate investment trust (REIT) shares through his brokerage account. One can even flip raw parcels of land. Or, if he already has some solid net worth, he can purchase commercial real estate assets like self-storage facilities, apartment buildings, office buildings, or retail.
But if you have a more modest net worth and/or prefer to keep your hands clean and your time free, invest the way Robert Kiyosaki invests: passively through private real estate syndication or fund. This type of private equity investment vehicle that used to be restricted to the frequenters of country clubs has slowly become accessible to the masses. Yet, it has not quite reached mainstream awareness.
What is syndication? Essentially, it’s the process of pooling capital contributions from several investors to raise equity to purchase commercial real estate. The money raised from investors usually covers the downpayment, closing costs, reserves, and capital improvements to the asset. The rest of the purchase price is usually paid via a mortgage.
Syndication allows passive investors to purchase equity shares in commercial real estate and achieve rates of return in the range of 15% annually and pay little or no tax on these returns if they structure things properly. They can even use equity from their residence or retirement accounts to invest passively in funds or syndications.
Typically, a fund or syndication is arranged by one or more sponsor(s) (general or managing partners). The sponsors are like the board of directors and executives rolled into a team. They take care of all of the high-level work, like finding the property to purchase, putting it under contract, hiring the legal and accounting teams to take care of the paperwork, hiring management for the property, managing the asset, and raising funds from passive investors.
These passive investors are called limited partners because they are silent partners in the deal with no management responsibilities. They often have voting rights if there is a significant decision to be made, but generally, they will have no say in the everyday operations of the syndication management, nor will they be legally liable if there is a lawsuit.
While not having control may seem scary to some (and we can all relate to this), there is one enormous advantage: with more power comes more responsibility. While the weight of responsibility lies upon the shoulders of the sponsor(s), the limited partners can focus their free time on their careers, hobbies, and relationships. Furthermore, it limits the risk for the other investors since control is left in the hands of the operators.
It’s similar to purchasing stock in a company. How much control do you have when your money is in the stock market? You can buy and sell, but unless you work for the company you own stock in or on the board of directors, you don’t have a lot of influence over whether it rises or falls. You make your best bet on a company and hope it pays off.
But why put your hard-earned wealth at the mercy of Wall Street for an average return that might only net 7% annually when you can achieve double that return and own equity in a hard asset by investing in a real estate syndication? And how many stocks come to mind that yield a dividend of 7-8% per year? Many syndications offer the equivalent of a dividend, called a preferred return. This is a minimum distribution to the limited partners of the cash flow from the rental income produced by the property.
The bulk of the return will be distributed when the property sells or does a substantial cash-out refinance after two to five years or more. When the gain from appreciation is added to the preferred return of 7-8%, the total annual internal rate of return will generally be projected in the range of 15% or thereabouts. There may not be a preferred return for a ground-up development or heavy value-add syndication, but the total profit share can amount to a 25%+ annual average rate of return. These deals carry significantly more risk than a value-added deal, but the returns can be worth it for those with significant cash to invest.
What is value-add syndication? This refers to a property with some problem(s) to be fixed that, when amended, will raise the property’s net operating income (NOI). The NOI is the remaining cash flow after the property’s expenses are paid (before debt service). Simply put, it’s the profit margin. When the NOI is increased, the property’s value on the market is increased proportionally based on the submarket’s prevailing capitalization rate (cap rate). For instance, if the NOI from a two million dollar facility in a 5% capitalization rate market is raised by 30% over two years because the rents were 30% below market, then the property’s value rises to $2,600,000. That’s what we call forced appreciation.
Problems can be as simple as rents below the market rent in the area or expenses that can be lowered by managing the property more efficiently. Most often, a value-add business plan will include tackling deferred maintenance, exterior cosmetic repairs like landscaping and paint, and interior renovations. These types of capital expenditures will help to justify rent increases. Another important activity is to fill vacant units and replace any nonpaying tenants. There is plenty of room for creativity in finding ways to boost NOI.
Downsides of Syndication Investment
One objection might be that syndications are not liquid. You cannot typically sell your shares. Your money (principal) will be tied up for several years until the property is sold. However, it is usual for a value-add syndication to cash-out refinance or add a supplemental loan to the property and return a large chunk of principal to the limited partners in the first two to three years so that they can reinvest it (perhaps into another syndication).
This is extremely powerful. The investors maintain their equity shares in the deal but get their principal back. How much is the cash-on-cash return if 100% of the principal is returned? Answer: it’s infinite!
Think about it: how liquid is your retirement account anyway? If the plan is to keep it growing and not take any distributions until actual retirement, it should not matter too much if it is invested into illiquid real estate for five to ten years.
Another challenge for the passive investor is that he or she must vet the deal and the sponsor. It’s essential to have a basic understanding of underwriting to be sure that the deal itself is a good deal with a plan of action that can realistically be executed. Even more importantly, the investor must have enough trust and confidence in the sponsor and his or her ability to succeed with the project.
Of course, this is also true for those handing money to a financial planner or investing in individual company stocks. If the planner is untrustworthy or incompetent, the investor may lose money. If the stocks purchased by an investor are in a company that is poorly managed or falls upon bad luck, the investor is also likely to lose money.
How does one properly assess a syndication investment opportunity? We believe that it’s imperative to make a wise decision when it comes to your hard-earned money. Read this article to get started.
Conclusion
With all of these things in mind, we conclude that for most people with at least a moderate nest egg, we are confident that passive real estate investment will produce the very best risk-adjusted return. Real estate will often provide double the returns of an index fund with more stability (not to mention the tax advantages).
With the proper due diligence, you can turbocharge your savings and even do so within your 401(K) or IRA. Yes, your retirement account CAN be used to invest in syndications. There’s no reason to continue settling for average returns and the hefty (often hidden) fees and commissions your financial advisor collects.
What’s the best time to plant a tree? Ten years ago.
What’s the second-best time? Now.
The same goes for your financial future. Now is the time to take control.
Would you be interested in learning more about how our investment opportunities work? Schedule a call with us today for a 30-minute consultation to see how we can help you. This won’t be a high-pressure sales call. We want to get to know you to see if we are a good fit for one another. If not, we will try to point you in the right direction.
Disclaimer: The opinions conveyed in this article are provided for educational purposes only and should not be interpreted as an offer to buy or sell any securities or to make or contemplate any investment.
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