Purchasing Apartment Complexes Via Syndication vs Other Investment Strategies
Theo is back today with part two of his mini-series, Why Apartment Syndication. Theo has worked for Joe for a long time and has been a part of the many projects that Joe has done in that time, so he’s more than qualified to teach us about purchasing apartment complexes using syndications.
Tune in and learn why apartment syndications are the preferred investment method for many successful investors. Did you enjoy today’s episode of the Best Ever Show? Consider subscribing in iTunes and please leave a review.
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Before we discuss the best real estate investment strategy, let’s talk about networking and finding a loan guarantor for your deals. If you need debt or equity, we suggest Marc Belsky with Eastern Union Funding and Arbor Realty Trust.
These companies have helped me and my consulting clients to raise equity and complete deals, so call Marc at 212-897-9875, or email him at mbelsky@easterneq.com.
TRANSCRIPTION
Welcome to Episode Two of the Syndication School Series
Joe Fairless: There needed to be a resource on apartment syndication that not only talked about each aspect of the syndication process, but how to actually do each of the things, and go into it in detail… And we thought “Hey, why not make it free, too?” That’s why we launched Syndication School.
Theo Hicks will go through a particular aspect of apartment syndication on today’s episode and get into the details of how to do that particular thing. Enjoy this episode, and for more on apartment syndication and how to do things, go to apartmentsyndication.com, or to learn more about the apartment syndication school, go to syndicationschool.com, so you can listen to all the previous episodes.
Theo Hicks: Hi, Best Ever listeners. This is your host of the Syndication School, Theo Hicks. This episode is part two of the “Why apartment syndication” series.
In part one we had a discussion about what an apartment syndication is, as well as the overall process, to give you a glimpse of the information we will be going over during the Syndication School series. Then we had a discussion around the pros and cons of raising money to buy apartments, versus using your own money, as well as whether you should be active in apartment syndications, so be the general partner, or if you should be passive and be a passive investor in apartment syndications, based off of how the pros and cons of those two scenarios affect your current situation.
Is Purchasing Apartment Complexes the Best Real Estate Investment Strategy?
In part two (this episode) we’re going to go into more detail about the various investment strategies and how those compare to apartment syndications. By listening to this episode – I want you to listen to it similarly as you listened to the first part, which I mean that, when I go over these pros and cons, they’re not necessarily objective and going to sound the same to everyone.
For some people, the pros are going to outweigh the cons for certain scenarios, for certain strategies, whereas for other people the cons are gonna outweigh the pros for other strategies. So the purpose of this pros and cons list are for you to listen and apply them to your life, and ask yourself if the certain pro or certain con is important.
As an example, in the previous episode when we were doing the pros and cons of the limited partner versus general partner, one of the pros of being a general part is the control. You’ve got control over the entire apartment syndication process.
Now, for some people that control is great, because they have a lot of time, they want to actually be a full-time apartment syndicator and create their own business, whereas someone else might be listening to this and saying “Well, I like my full-time job. I don’t have time to spare to create a business from scratch, so I’d much rather have the benefits of investing in apartments without all the extra work, and I’m willing to give up control in order to do so” – well, then passive investing and being a limited partner is better for you. That’s how you should approach these pros and cons lists.
In this episode, we’re going to be comparing apartment syndications to four strategies in particular. First, we’re gonna compare it to single-family resident rentals. Next, we’re gonna compare it to smaller multifamily – these are buildings with two to fifty units, whereas apartments are gonna be 50+ units, and I’ll get into why I use that classification in that section.
Thirdly, we’re gonna compare it to REITs and other similar types of stock investments. Then, finally, we’re going to compare apartment syndications to development.
The Pros and Cons of Purchasing Apartment Complexes Compared to Single-Family Rentals
Just to review, apartment syndication in its most basic sense is you are raising money from other people to buy apartment communities and share in the profits, so how does that strategy compare to single-family rentals?
Pro: Syndications are Scalable
The first pro is going to be the scalability. Let’s say you have a goal to make $100,000/year, and you determine that you’re going to need 100 doors to accomplish that. I’m just using these as basic numbers. So what’s easier to scale up to – 100 single-family homes, or 100 apartment doors, which could be bought between multiple apartments or just one apartment?
The cashflow for 100 single-families compared to 100 apartments is not going to be the exact same, but you are able to scale up with apartments faster than you are able to scale up with single-family homes in regards to the cashflow, because it will take a lot longer to buy 100 single-family homes than it would be to buy one apartment community.
You’ve also got financing to take into account – how are you going to finance 100 single-family homes when you’re only able to get four to ten loans on your own? So you’re gonna have to get creative there… Whereas for an apartment community, they’re going to base the financing on the apartment itself, not necessarily you as a borrower. Of course, you need to have certain liquidity and net worth requirements in order to qualify for financing, but that could be partnering up with someone who has those requirements…
And also, how are you going to fund these deals? Funding 100 single-family homes using either your own money – which would take time, and let alone qualifying for financing for… But at the same time, you could technically raise money for 100 single-family homes, but would it be easier to raise money for 100 single-family homes one deal at a time, or raising it for one large apartment community where you can bring in a lot of investors, and they won’t necessarily have to fund the entire purchase price or the entire equity investment.
At the same time, if you are going to be investing in single-family homes and raising money, you’ll likely need to find multiple deals at once in order to satisfy the return requirements for your investors.
Pro: Finding Deals
Another pro of apartment syndications to single-family rentals is the ease of finding deals. Now, I’m not saying it’s easier to find an apartment than it is a single single-family home, but using our example, it’s going to be easier to find one 100-unit apartment community than it would be to find 100 single-family homes. Finding 100 single-family homes is going to take some time, generally speaking. I’m sure there’s strategies out there to buy massive packages of single-family homes, but regardless, that’s going to take some more effort, whereas for finding an apartment, you can speak with brokers to find on-market listings, or do some lead generation strategies to find an off-market deal, and all you need to do is find that one 100-unit, and compare that to how long it would take to find 100 single-family homes.
Pro: The Economics
The next pro for apartment syndications compared to single-family rentals is going to be the economies of scale. When you have these 100 single-family homes – that’s 100 roofs, that’s 100 mechanicals (HVACs), 100 driveways, lawns to take care of, and then you’re gonna have a property management company likely to oversee all of those, but they’re not all in one central location, so it’s gonna cost more to have that company to manage those 100 units compared to them managing one 100-unit building in one location.
Also, you’re going to be able to have a better offering for your residents, because in a single-family home they have to have the home to themselves, but at apartments there’s going to be shared amenities; they’re gonna have a pool, clubhouse, fitness center, washer/dryer facilities, storage, lockers, things like that… And at the same time, from your perspective, you could charge extra for that, and that would increase your revenue, whereas for the single-family homes, we’d have trouble charging extra for amenities, and we’d have trouble even having those amenities at such a small scale.
Pro: A Lower Risk Factor
Then also – and this is a big one – there’s a risk factor. When you’re investing in single-family homes, you’ve got pretty low margins for each house. You’re maybe making a couple hundred bucks per door per month, and what happens when you lose that one resident who’s there? You don’t have your revenue spread out across multiple units, you’ve got one unit. So if someone’s living there, you’re making money; if someone’s not living there, you’re losing money. Also, if you have to do an eviction or a turnover, that is going to have a greater impact on your bottom line for a single-family home investor than for a large apartment… Because if you’ve got one turnover, one eviction, it’s gonna cost you some money, but you’ve got your other units that are still occupied and paying rent.
Also, what happens if you have a bigthh-ticket repair? What happens if you replace a roof, or replace HVAC, or replace a parking lot, or replace a siding? It’s going to probably cost more for an apartment, because it’s got a bigger roof, bigger siding etc, but at the same time the margins are a lot higher on apartments; so you’re making more money and you’re able to afford those repairs more than you’re able to afford the for a single-family home.
One big-ticket repair of a couple thousand dollars on an apartment – yeah, it’s unexpected and it’s gonna be frustrating, but on a single-family home, that could wipe out profit for multiple years.
Overall, the pros for apartment syndications compared to single-family rentals are the scalability – you can scale faster with apartments, and you’ll have more cashflow and more flexibility with financing. It’s easier to find a 100-unit apartment deal compared to 100 single-family homes. You also have the benefits of economies of scale; you’re not gonna have multiple roofs, multiple HVAC systems… Property managment will be in one central location, you’ll be able to have economies of scale in regards to your expenses, as well as the ability to have shared amenities, which will result in additional revenue. And finally, apartments are actually less risky than single-family rentals, due to the low margins of single-family rentals and profits being wiped out with a turnover, a vacancy, an eviction, and a big-ticket repair it.
Con: The Dual Barriers of Education and Experience
Now, the cons of apartment syndications compared to single-family rentals – this is gonna be a con that’s mostly across the board for the majority of the strategies we’re gonna be comparing (apartment syndications, too), and that’s gonna be that barrier of entry. That educational barrier of entry – you need to have a solid education and understanding and grasp of the apartment syndication process and the terms before even considering to launch your career.
You’re going to need experience in real estate and/or business, and of course, once you have those in place, you’re gonna need to find a team, you’re gonna need to raise money… Whereas if you’re gonna buy single-family rentals, technically you could just learn about real estate yesterday and try to buy a single-family home the next day, as long as you have the money, because it’s not as complicated as an apartment syndication.
That’s gonna be something that is, again, consistent across the board, but as I mentioned in part one of this series, the next series that we do is going to be a discussion around the educational and experience requirments, which means what you need from an education and an experience perspective, and then how you actually attain and gain the education and the experience required to become an apartment syndicator. As I mentioned, all these cons we will give you a solution for.
That wraps up the comparison to single-family rentals. What about other multifamily, so smaller multifamily (2 to 50 units)?
The Pros and Cons of Purchasing Apartment Complexes vs Multifamily Properties
Pro: Property Managers are On-Site
The reason why I classify smaller multifamilies as 2 to 50 units, and then apartments as 50 or more units is because generally speaking, once you get above 50 units, you will have an on-site property managment company. That’s going to be the first pro of the apartment syndication strategy versus the smaller multifamily – you’re able to have on-site property managhment, which comes with a better experience for your residents.
Someone’s actually on the site, that they can go and talk to if they have problems; you’ve got someone on-site to address problems as they come up, you’ve got someone on-site to show the units, and for walk-ins… Essentially, you’ve got someone who’s there during the day to address any issue that comes up. And, of course, since they’re always there, they’re gonna have a better understanding of the property and be able to stay on top of things more than a property managment company who is not at the property and maybe visits it once a week, and isn’t there all the time.
Pro: The Economies of Scale
Then also, you’re still going to have the economies of scale of the apartments compared to the smaller multifamily. It’s not gonna be as beneficial as it would be compared to single-family rentals, but you still have a better economy of scale because you’re gonna have a lower managment fee the more units that you have, you’re gonna have the ability to have potentially an on-site maintenance team, which could save you some money, whereas having to contract out the maintenance every single time something happens – and just contracts in general… You’re gonna have a landscaping contract, a pool contract to make sure you’re maintaining everything.
Similarly, when compared to single-family rentals, when you’re comparing apartments to the smaller multifamily, you have the opportunity to offer these shared amenities, which will allow you to have extra income.
Pro: Better Amenities for Residents
This transitions into the third pro, which is you’re gonna have overall a better offering for your residents at these larger properties, because since it is larger, you’re able to offer better amenities that wouldn’t really make financial sense at a smaller multifamily property.
Maybe you have a pool at a 50-unit, but would it make sense to have a fitness center or a clubhouse or a dog park, a playground, a grill at the smaller properties? Whereas that’s common at these larger properties. Of course, having these extra amenities are more attractive to the residents and allow you to charge a higher rent.
Pro: Rental Comps
Another less obvious pro and something that I recently came across is that it’s going to be easier to find rental comps for the larger apartments compared to these 2 to 50-unit buildings… Because what you’re gonna find when you’re looking at rental comps is – of course, when you’re doing rental comp analysis, the properties need to be similar, so if you have something below 50 units, you’re not gonna have these better offerings, these amenities (the pools, the fitness centers, the clubhouses, the dog parks, and the sorts), whereas the properties that you’re coming across in your market are gonna be larger and are going to have those… So you can’t use these larger apartments as rental comps for smaller multifamily. You have to use the smaller multifamilies, which aren’t as prevalent as these larger buildings…
So you might have to go a little bit further out to find a rental comp, or you might have to find a rental comp that’s upgraded to a higher quality than yours, which of course you’re able to adjust down or up, depending on how those compare, but it’s much better to have a rental comp that’s very similar to the subject property, and you’re gonna have a much easier time finding that like property in regards to interior quality, operations, and amenities offered for the larger apartments than for these smaller multifamily rentals. It’s possible, but you’re gonna have a harder time.
Con: Barrier of Entry
The con of larger apartments to the smaller apartment rentals is going to be that barrier of entry. Now, the barrier of entry is going to be higher for these smaller multifamilies than they would be for single-family homes, but still, it’s not going to be as high as it would be for these larger apartments… But it’s gonna be much closer, because you’re still gonna need to find a property managment company, you’re still gonna need the experience and educational requirements, because you are dealing with multifamily even though they are smaller… But you’re gonna need to raise more money for these larger apartments, which is gonna take more time on your part… Whereas you might be able to take down a smaller multifamily unit with the money that you personally have, or by raising money from your current network.
That wraps up the comparison between apartment syndications and smaller multifamily rentals. Now, what about something that’s not necessarily you buying actual properties, but more of a passive investment, which is going to be a REIT (real estate investment trust)?
The Pros and Cons of Purchasing Apartment Complexes Compared to REITs
The textbook definition of a REIT is a company that owns, operates, or finances income-producing real estate that generates revenue which is paid out to shareholders in the form of dividends. Essentially, a company buys a ton of real estate – whether it’s apartments, commercial, retail, medical, single-family homes, whatever it happens to be, depending on the company – and together, with these packages of properties, it creates a revenue just like any other property would… And you, buying a REIT, are buying essentially shares of the company that owns all these properties, and you are paid out dividends. It’s very similar to a stock, but it’s like owning a stock in an actual real estate company.
REITs are very similar to passively investing in apartment syndications, but not as beneficial. The pros and cons of apartments versus REITs are gonna be very similar to the pros and cons of being an active syndicator versus being a passive investor in a syndication.
Pro: The Returns
So what are the pros? One of the major pros are going to be the returns of being an apartment syndicator. Based off of the previous five years, the return on a REIT, if you had invested in it five years ago, would have been about 25% overall. So it’s a little bit over 5% each year. If you invested $100,000, at the end of five years you would have $125,000, so a profit of $25,000.
Now, as an apartment syndicator, not only will you make more money than that as you investing that same amount of money in your own deal as a limited partner, assuming you’ve got an 8% preferred return each year, plus the profit split, which would be about a 20% return annualized for the five-year hold, which would be essentially doubling your money… But you will likely make more than that 25% from the REIT – you’d make more than that on your acquisition fee alone.
In a future episode, we’re gonna go over all the different ways you can make money as a general partner… One of the ways and the first way you get paid is the acquisition fee at closing, which is gonna be a percentage of the purchase price. Depending on the size of the deal, if you have a million-dollar deal and the acquisition fee is 2%, that’s going to be 20k right there. So you’ve got your 20k from the get-go, whereas if you had invested 100k into a REIT, you’re only making 25k… Whereas you’re getting 20k for not necessarily investing any of your money.
Overall, you will make a lot more money, and your ROI is gonna be a lot higher by being an apartment syndicator, even if you’re not even investing in your own deal.
Pro: The Control
Another pro is going to be the control. When you’re investing in REITs, you can only control the type of REIT you invest in, and then when you buy and sell your stock, whereas for apartment syndications, as I mentioned in the previous episode, you have control of everything – the investment strategy, where you actually buy the property, the size of the property that you buy, the return structure with your investors, the business plan, the renovations, when you sell… You have control over essentially everything. You don’t have that same level of control with REITs, because REITs are a lot more passive.
Pro: The Tax Benefits
Another pro of the apartment syndication strategy versus REITs are going to be the tax benefits. As an apartment syndicator, you’re gonna have the tax benefits that come from real estate – depreciation write-offs, you have the opportunity to do a cost segregation analysis, which we will discuss in a future episode… Essentially, an analyst comes in, breaks down the entire property into its components, and then determines which of those components can have accelerated taxes on, or the depreciation can be accelerated on, so that you can essentially have a much larger write-off when you perform this cost segregation, as opposed to having it spread out over the life of the — I think it’s 17.5 years for commercial properties.
I’m sure there’s some tax benefits for REITs, but not nearly as great as they are for investing in real estate… Which is why people like to invest in real estate.
Con: Liquidity
Now, the cons of apartment syndications compared to REITs, besides the same barrier to entry from an education, experience and a prerequisite standpoint, i.e. building your team and raising money, is going to be the liquidity. For REITs, just like stocks – you can sell whenever you want. Yeah, you’ll be taxed, but you can get your money out quickly and be liquid, and use it for whatever it is you wanna use it for, whether it be buying more real estate, going on a vacation, buying a car, or whatever it happens to be.
For apartment syndications, if you were to invest as a limited partner in your own deal, that capital is gonna be tied up until you sell the property, refinance, or get a supplemental loan. If you aren’t investing in your own deal, you’re still going to build up equity in that property, which won’t be realized until the sale of the property. But you do however get an upfront acquisition fee, and if you charge other fees to your investors, whether it be a fee for signing the loan, or if you’re gonna charge a fee once you refinance the loan… There are ways to get liquid upfront and during the business plan, but you’re not gonna get the majority of your money back, or you’re not gonna get the majority of the money that you’ve made until you actually sell the property. So that’s the comparison of syndications to REITs.
The Pros and Cons of Purchasing Apartment Complexes vs Developing New Communities
The last comparison we’re going to do is going to be apartment syndications compared to apartment development. We’re not gonna focus on this one too much, because I actually did a debate with a developer whose name is Evan Holladay; if you want to listen to about 45 minutes a back and forth between the pros and cons of apartment syndication versus developments, check out that episode. That is episode number 1423. A debate between me and Evan Holladay.
Pro: Less Risk
Just very quickly, the pros of apartment syndications to development are going to be less risk, of course… Now, apartment syndications come with risk, but compared to development, there’s much less, because as you will learn in the episode with Evan Holladay, you could be analyzing a deal for years, spending money in the process, and never even closing on the deal. So the process of identifying an opportunity to closing is way longer, which means the opportunity of losing the deal goes up, and losing the money that was spent in the meantime.
At the same time, even once you actually have the deal under contract and then you close, and then you start the development process, it’s still gonna be a multi-year process, and whatever capital was invested is gonna be tied up until then, and is not going to be returned. Of course, since you are building something from the ground-up, there are a lot more variables involved in that, and a lot more things could go wrong. If something were to go wrong, you would end up losing all of your money, whereas for apartment syndications – a lot less risky, and yes, your capital is going to be tied up, but you’re going to see an ongoing return, and as long as the syndicator follows the three immutable laws of real estate investing (buy for cashflow and not appreciation, secure long-term debt and have cash reserves), then you are mitigating the risk and are preserving the capital, whereas that’s not necessarily true for development.
At the same time, you’re building something that is completely brand new, which also comes with risks, whereas for apartments it’s already there – you know that at the very least you’re gonna be making the same money that the current owner was making, whereas for development, you can make a ton of money, but at the same time the project could completely flop and you don’t make any money.
Pro: Faster Returns
Basically, there’s gonna be a lot more variables for development, which brings more risk. Also, apartments – you can close on the faster; the closing period is 60 to 90 days after you put the deal under contract, but it could be about 60 to 90 days, maybe even less, from identifying the opportunity to putting it under contract, depending on whether it’s on-market or off-market… Whereas as I mentioned before, developments could take years to close, if ever.
You’ll also get faster returns for apartment syndications. You as a syndicator are going to make your money upfront; once the deal is closed, you’ll make money on an ongoing basis and then at sale… Whereas for development you’re really not gonna make any money until the project is completed.
Pro: Lower Barrier of Entry
Then there’s also gonna be a lower barrier of entry. The developer is gonna need the same background as someone investing in apartments, because that’s what they’re doing, but on top of that, they’re going to need a stronger construction understanding, they’re gonna have to build up relationships with local government for zoning permits and design approval, so there’s a political aspect to it… They have to work with people in the community to figure it out what it is they actually want out of the building, they have to work with architects to design the building… And those are all things that an apartment syndicator does not necessarily need to do… Or if they do need to do that, not to such a high degree.
Con: Overall Returns
Then, of course, really the only con of apartment syndication compared to development is the overall return. If everything is built according to plan for the development, you’re gonna make a lot more money than you would for the apartment syndication… But you won’t make that money for a longer period of time, and the risk of not making any money at all and losing your investors’ money is a lot higher. That concludes the comparison of apartment syndications to development.
Finding the Best Real Estate Investment Strategy for You
Now, as I mentioned in the beginning of this episode, what you wanna do is you wanna listen to the pros of apartment syndications and the cons, and determine how those relate to you. For example, when you are comparing apartment syndications to single-family rentals, how important is scalability to you? How important is economies of scale? How important is that lower risk?
For those worth the extra time investment required to actually enter the apartment syndication field, in regards to the education, experience, building your team and raising money aspect. For some people, they might say “Well, all that time that it’s gonna take to educate myself and gain experience isn’t worth the extra benefits of apartment syndication, so I’m just gonna continue investing in single-family rentals.” That’s fine, but I do recommend continuing to listen to the Syndication School, because we’re going to give you lots and lots of tips on how to expedite the educational and experience requirements.
That’s how we’re gonna approach this and learn all the different benefits and the cons of becoming an apartment syndicator compared to all the other strategies, to make sure that it is going to be the ideal fit for you. So that concludes this series, “Why apartment syndication?”
In part one we discussed what apartment syndications are, and talked about the pros and cons of raising money versus using other people’s money, as well as whether you should be an active syndicator or passively invest first.
Then, in part two, we discussed the pros and cons of apartment syndications compared to four different strategies – single-family rentals, smaller multifamily (2 to 50 units), REITs and development.
The next series in the Syndication School is going to be a conversation around the requirements needed before becoming an apartment syndicator.
Thank you for listening, and I will see you next week.
