Ready to Invest in Syndication? Stop! Read This First

Investing in real estate syndications has the potential to greatly accelerate wealth building. However, in order to make an informed decision, an investor should be aware of the factors involved before committing to such investments. In this post, we will explore crucial factors that an investor should keep in mind before making a decision to invest in a syndication.

Long Term Investment Commitment 

Unlike publicly traded stocks or bonds, you cannot easily sell your investment in a syndication for cash. Although most investments may distribute cash from operational returns, the principal investment may remain inaccessible to the investor during the investment period. The holding period for these investments typically ranges from 5 to 7 years, so as the investment grows, investors should be aware that they will have limited access to their capital during this time. 

Limited Control Over Decision Making

Investing as a passive limited partner in a syndication can yield high returns without having to handle the daily responsibilities of property ownership. However, it means relinquishing direct control over decision-making. The syndication sponsor, or general partner, manages operations and makes key decisions. So, while investing with a sponsor simplifies the process and opens up real estate opportunities, it's vital to assess the sponsor's track record and expertise to ensure that the investment aligns with your goals.

Risks, Similar to Any Investment

All investments carries some amount of risk. Even though multifamily syndications offer a favorable return-to-risk ratio as compared to most other common investment options, they are not risk-free and can be affected by external factors such as market fluctuations, economic downturns, tenant turnover, and unforeseen expenses. Investors should carefully consider these risks before committing to a syndication investment.

Complexity in Taxes

While multifamily syndications offer higher returns and potential tax savings, they can also add complexity to your tax situation. These investments are often structured as partnerships, and investors receive a K-1 form for tax purposes. For those who do their own taxes, it could be a little intimidating initially to process these forms. Seeking guidance from a qualified tax professional is recommended to maximize potential benefits and ensure compliance.

May Require Filing Tax Extension

To generate K-1 tax forms, the management team needs to gather and process all the necessary data to produce annual financial statements, file taxes for the investment itself, and create the tax forms. This task often coincides with the busiest time of the year for CPAs, so they may not always be able to provide the tax forms to investors on time. In such cases, investors may need to request tax extensions. If handled timely, the process for tax extensions is straightforward. However it is recommended to talk to a qualified tax professional.

Risk and Returns in the Capital Stack

Understanding your position in the capital stack is crucial when investing in multifamily syndications. Senior lenders, preferred equity investors, and common equity investors all bear different levels of risk and have varying return potential. Familiarize yourself with the capital stack to assess your risk tolerance and investment objectives. A good sponsor will structure the investment to minimize risk for investors.

Deviation from the Business Plan

While syndications typically have a business plan outlining the investment strategy, projected cash flow, value-add opportunities, and exit strategy, it's important to recognize that deviations from the plan can occur. Investors should be prepared for ups and downs, as nothing goes exactly as planned. Nonetheless, having a solid business plan serves as a roadmap to achieve the project's full potential.

Investing in multifamily syndications can be a powerful wealth-building strategy. By being aware of the above factors, an investor can make an informed decision and avoid unexpected surprises after making the investment.