We learned why we should invest in Real Estate Syndications, but “how” are we actually making money and building wealth? We will go through the three most common ways you get returns in the order you should experience them as part of your investment journey.
1. Distributions
For many of us, real estate’s appeal is all about that “mailbox money” that arrives like clockwork monthly or quarterly. This is what the distributions are – your return as part of the operation of the asset. The cool thing about distributions is that often they end up being effectively tax-free for you because of the depreciation that the asset is providing during the investment years. We love being able to delay tax responsibility, as every dollar we receive today is worth less in the future. Further, we can re-invest the distributions in other syndications helping to accelerate our wealth-building path.
A few points about Distributions:
- Depending on the type of investment, you might not get distributions at all – Examples: Land, New development, etc.
- You will most often see quarterly or monthly distributions unless otherwise specified in your PPM.
- If the investment is experiencing hard times, you might not get any distributions.
- Distributions for value add investments might start slow and accelerate as the asset is stabilized.
- Your sponsor should have outlined what the expectations are as part of the marketing materials.
- Distributions do not equal Preferred returns. Distributions are the way you get your preferred return.
2. Refinance
The second possible, emphasizing “possible,” way to get returns from real estate syndications is through a Refinance. Refinance is a way for the sponsor to return a significant amount on investment to the investor, making them happier and increasing the IRR for bragging rights. Be wary and make sure you pay attention to your PPM to ensure that it is a return ON investment, not a return OF investment. The former is good for you the latter is good only for the sponsor.
The emphasis on “possible” is because not every investment is a good candidate, and it might not be possible to execute if, for example, the interest rates have gone up. Even if the sponsor has an illustration of a refinance as part of their material, take that as an “it would be nice” illustration, not an “it is going to happen” one.
So in short:
- Refinance might or might not happen – it is a nice marketing line
- Not all investments are a good candidate for refinancing
- Refinance can be very good for you as an investor if executed correctly
3. Sale
The third way you get your money back is likely where you will be getting the largest check – the sale or the disposition of the asset. The sale (unless there was a refinancing event) will usually bring more than 50% of your total return. While exciting, there are two things you should start preparing when you are informed of possible sales: taxes and reinvestment.
Yes, everyone hates taxes; however, one of the really awesome things about Real Estate is the tax treatment. We will cover taxes in depth in another article, but if you have been investing in real estate and are continuing to invest, it is completely possible that you will pay $0 in taxes for the tax year because of carryover passive loss or a 1031 exchange. No, you will not avoid taxes forever, but the further you push your tax responsibility, the cheaper it is for you.
Reinvestment – we are here to build wealth, right?! Yes, you should be planning for reinvestment (this can offset your tax liability as well). Always keep your eye open for a deal. In some cases (although rare), it is also possible that the existing syndicator would offer the investors the possibility to roll your investment into a 1031 deal. If the new deal makes sense, go for it, but do not let your desire to save some tax money bring you into a bad deal.
To see how reinvesting your fund can help you grow your wealth faster, try out our Syndication Investment Calculator!
Conclusion
Distributions, Refinance and Sale, are the three most common ways you earn returns and build wealth through Real Estate Syndications. We hope this helps you in your journey of building wealth smarter through syndications!
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Photo by Karolina Grabowska.
