Investing in multifamily syndications has long been accepted as a stable, recession-resistant investment. Great wealth has been created with commercial real estate like apartments. On the flip side, great losses have been experienced as well. As all investments carry inherent risk, the benefits and disadvantages should be weighed and considered.
Multifamily properties play a vital role in the nation’s economy. People need a place to live and many cannot afford or do not prefer to own. People at various stages of their lives have different needs, and desire flexibility over permanence. Many need the affordability that apartments can offer, and even the sense of a close community and availability of resident amenities.
There are many pluses and minuses when considering multifamily syndications as an investment. These are not the right vehicle for everyone. Before moving forward on a multifamily project, you should be familiar with the pros and cons of this property category.
Multifamily Syndication – Pros
Ability for Forced Appreciation – Forced appreciation is a term used in commercial real estate that means improving a property in order to increase its value. This is the opposite of market appreciation, which is the natural or organic increase that happens over time or due to local growth. A multifamily property gets its value from the calculation of net operating expenses divided by the prevailing cap rate of an area, neighborhood or property. Therefore, as an apartment syndication’s income rises (in relation to expenses), the higher it is valued. In some cases, this can be dramatic which makes investing in apartment communities so appealing.
Cash Flow – One of the biggest wealth preservation strategies is to invest in things that make money. Investing in multifamily real estate allows for just that, and investing in a syndication eliminates the managerial hassle compared to buying a property by yourself. Investors in multifamily syndications get to participate in the cash flow in the form of monthly or quarterly distributions. Although positive cash flow does not automatically happen in every case, it certainly is a prevalent scenario. By looking at an investment opportunity pro forma, assuming accurate and conservative underwriting, you should be able to determine if a project realistically has the ability to make money.
Tax Protection – Since one of the government’s goals for its citizens is to provide affordable housing, it incentivizes investors with tax breaks. One of these tax benefits is called depreciation. This is one of the single greatest things about investing in multifamily properties. Many investment vehicles to not offer such advantages. Depreciation, an accounting process that allows for the expensing an asset’s cost over its useful life, is a phantom expense and can be used to offset a significant portion of income, making commercial real estate an attractive asset class for investors.
Spreading the Risk – Ideally, when you invest in a multifamily syndication, you are one of many investors participating in the project. This allows individuals access to opportunities of scale available only to larger investors, and spreads the risk to the many participants. To further diversify your portfolio, you will want to invest your money in several syndications rather than putting all your money into one single project.
Economies of Scale – Managing a rental property can be very labor intensive. Thank goodness you are here on this website learning about how syndicators do that work for you in exchange for allowing them to use your cash. Properties with under 50-85 units can be comparatively expensive per unit when it comes to property management due to the people needed to provide the management function. The larger properties are the ones that can support a more cost-effective work force. Further, the bigger the property, the better the bargaining power when it comes to making bulk purchases of building materials, appliances, and flooring.
Different Multifamily Types – Just like there are different types of commercial property like office, retail and storage, there are different types of multifamily properties. Kind of like different flavors of jelly beans. There are high rises, garden apartments, short-term rentals and traditional long-term rentals. There are also apartments catering to certain niches like senior communities, student housing, and assisted living facilities. Diversifying your multifamily syndication investments across many of these types of investments can be beneficial.
Different Ways to Invest – I mention this here because I want to bring your attention to crowdfunding. Historically, an investor would know the syndicators very well and have a symbiotic relationship. It was more difficult to find multifamily investment opportunities than it is today. In 2009, crowdfunding began to emerge as a major funding source for multifamily syndicators, and gained traction after the 2012 Jumpstart Our Business Startups (JOBS) Act was signed into law. This lessened regulatory burdens on small businesses and legalized equity crowdfunding as we know it today. The net effect for the real estate market was to make investing in syndications more accessible and more mainstream. Crowdfunded or not, you can invest in a syndication using your post-tax cash or even using your retirement account like a SDIRA or Solo 401(k). You can invest from a trust, LLC or partnership. Whatever meets your goals.
Affordable Acquisition Cost – One of the nice things about investing in multifamily housing is the cost per unit (also known as cost per door). When compared to single-family housing, multifamily apartments weigh in as much cheaper to buy. According to the Marcus & Millichap report*, 2020 North America Multifamily Investment Forecast, the average apartment cost per unit in Cincinnati is $54,082. Compare that with the estimated median house or condo value, as reported on City-Data.com**, of $143,100. In this case, a single-family home costs 2.6 times the cost of an apartment unit. Generally speaking, this ratio, though higher or lower, plays out in a similar fashion throughout the United States. This underscores the efficiency in cost of multifamily property.
Favorable Financing – Banks make their financing decisions based on the underlying business of an apartment complex rather than the people sponsoring the multifamily syndication, although they do take a look at that too. To qualify for a commercial loan, the projected rental income from the project is used as well as the business plan proposed.
Multifamily Syndication – Cons
Syndications Gone Wrong – Like most investment options, there are risks. Every once in a while, there are syndicators who begin a project and they are so in over their head that they seem to make all the wrong moves – or at worst, they don’t know what they’re doing. Projected incomes might not generate sufficient revenue to support the returns promised to investors. Basically, unrealistic underwriting can lead to serious problems. Ensuring that you do your due diligence on the syndicators themselves will go a long way toward making a bad investment. Ask the sponsor to provide analysis that stress tests the deal by showing what happens to returns when occupancy, rents don’t meet forecast under different scenarios.
Intensity of Management – There is a lot to do to manage a multifamily community. Processes must be orchestrated and honed, and there are a lot of moving parts. While experienced sponsors have these skills, not all of them actually do. Outsourcing the property management function to a third-party company is often a preferable option. Managing a multifamily property includes dealing with numerous separate leases, working with diverse tenants who have different repair and maintenance requests, interacting with tenants who choose to communicate in different ways, and accommodating the best ways for each tenant to pay their bills. On top of this, the management team will be on point to oversee value-add construction projects, negotiate with contractors, and take on marketing and accounting roles.
Experience Needed – While property management takes a lot of coordination and effort, so does the asset management. This is where the syndicator is managing the manager, and working the business plan. It is the sponsor’s job to make sure the strategies are being followed and costs are contained. The skills in overseeing all the moving parts comes with practice, and is complicated, and prone to unexpected occurrences. Decision making is vital. This ability also comes with time.
High Barrier to Entry – Being successful in multifamily real estate takes more than just an eagerness to initiate a project. It takes money, time, and a high-quality network of relationships with brokers, insurance agents and real estate attorneys. There are high costs borne by sponsors at the offering and contract stages, even before they can accept funding from their investors. These include earnest money, travel expenses, due diligence costs and legal fees. As acquisition costs of apartment communities are very high, usually in the $3-25M range, syndicators have to work with a wide variety and quantity of accredited and sophisticated investors to get their projects off the ground. Additionally, a lot of time is spent negotiating a purchase and then working through all the contract details and inspections – sometimes months.
Landlord/Tenant Regulations – These are different in every state and are always changing, with some states benefiting landlords and others not so much. Some states have laws that make it really tough on landlords. Most syndicators will be comfortable with the laws governing their projects, but as an investor, especially if you’re out of state, it is good to be able to follow along. Rent control can impede a business plan by limiting future rent increases, and can be found in California, Oregon, New Jersey and Maryland. States that are more friendly to renters are Vermont, Hawaii and Delaware, while states more friendly to landlords are West Virginia and Arkansas. Multifamily properties must comply with a dizzying range of laws that cover nearly every aspect of operations.
Helpful Links
**http://www.city-data.com/city/Cincinnati-Ohio.html
The Hands-Off Investor, an Insider’s Guide to Investing in Passive Real Estate Syndications by Brian Burke