Jaime Raskulinecz, founder/CEO of Next Generation Trust Company, specializing in custodial & administrative services for Self-Directed IRAs.
Real estate-related investments are among the most popular alternative assets in self-directed IRAs, including real estate syndications. So what are real estate syndications, and what should you know before investing in one?
What Is A Real Estate Syndication?
Real estate syndications enable investors (and self-directed IRAs) to become fractional participants in the investment. As we explain to our clients, a syndication is a partnership between a group of investors (and for our purposes, other self-directed retirement plans) to invest in various types of real estate assets by pooling their resources—real estate crowdfunding, if you will. Those resources may be capital, professional expertise and connections in the market.
Syndications have become more popular since the passage of Title III of the JOBS Act. This provision opened crowdfunding to all investors, including those without accreditation, who meet certain conditions. It provides a platform for account owners to invest in more complex or larger-scale real estate investments than one can transact as an individual, such as multifamily complexes, senior living residences, warehouse campuses, shopping centers and industrial parks.
The real estate syndication provides a stream of passive income; for our clients, it benefits the IRA that made the initial investment, with the potential for long-term gains.
Types Of Real Estate Syndications
There are two general types of real estate syndication: equity syndication, which acquires an investment, and debt syndication, in which an existing private loan is offered by an original borrower (perhaps a real estate developer) to the syndicate members (who make money from the periodic payments with interest).
The Real Estate Syndication Structure
There are several ways to structure a real estate syndication in terms of distributions and cash flow. They typically have general partners and limited partners as investors, with different investment levels, rights and levels of ROI. Each investor role has their own degree of representation depending on the syndication agreement. Syndications are commonly structured as LLCs with members comprising:
• The sponsor (who is a general partner/GP): Sponsors source the deals, analyze the property’s financials and find investors, as well as handle property management and legal matters related to the asset for the limited and general partners (syndication members). The sponsor charges a fee for these services to the syndication.
• Passive investors and limited partners (individuals or self-directed retirement accounts).
• Managing entities: They earn fees and act as liaisons between all members. They may offer guidance as well as private access to investment opportunities.
• Joint venture partners: They provide capital, but are non-syndicated investors.
As with all self-directed investments, it is incumbent upon investors to fully understand the syndication’s structure and each party’s role as well as how the cash returns will be distributed—which brings me to the matter of due diligence and self-directed investments.
Due Diligence—Know The Potential Risks
Syndications can be a good way for self-directed investors to include a variety of commercial real estate assets within their portfolios and build tax-advantaged wealth. But as with any investment, be aware of the downsides. As I always counsel self-directed investors, be sure to:
1. Understand the asset (and consult a trusted advisor if necessary). As a private real estate investment, a syndication is a relatively illiquid asset, so be prepared to hold the investment for several years.
2. Understand the business plan including projected income and expenses, appreciation and capitalization rates, current and projected occupancy rates, and other financial matters.
3. Understand the fees the IRA will pay: How much are they, and what are they for? In addition to the sponsor’s and managing entity’s fees, other fees may be charged for services such as property upgrades or disposition, tenant matters, refinancing, audits and other financial transactions.
4. Research the sponsor to assure yourself you are entering a fractional investment opportunity with someone who has the right industry experience, connections and track record. Beware of over-leveraging, poor fund or property management and potential fraud.
5. Go in with eyes open to potential market risks. Research the regional real estate market for insights into conditions or regulations that may affect rental income and property values.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
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