For many people, the opportunity to invest passively in real estate is the perfect way to participate in the real estate sector. You might understand the benefits to investing in real estate but not necessarily have the time or interest to do it all yourself. From there though, you might not understand which is a better choice for you – crowdfunding or syndication. It is a logical question to ponder as they have a lot in common. However, I thought it might be helpful to point out some of the differences in order to help you determine which might be a better choice for you if you are looking to invest passively in real estate.
As a way to compare the two, a couple of points to consider are as follows:
1. INVESTMENT MINIMUMS
Crowdfunding often times will allow you to invest with lower minimums (frequently $25k but sometimes as little as $5-10k) than with syndications which are frequently $50k minimums or more. Some people will prefer the lower minimums as it allows them to diversify and get into more deals with lower amounts. Also, it takes less time to save up $10-25k to invest so that money can be deployed quicker than if you are waiting to save up $50k. On the other hand, some people might like investing $50k to $100k at one time as it is less paperwork and time spent evaluating a particular sponsor or deal and if you already go to the effort of spending that time evaluating the project than it can make sense to commit a larger amount of money to it.
2. RELATIONSHIP WITH SPONSOR
One of the key features of syndications is that the syndication sponsors generally look to develop ongoing, long-term relationships with their investors. In part this may be done by helping to educate their investors over time and by making themselves directly available regarding questions related to the investment property or providing information related to the performance of the property. This benefits the sponsor in the way that with each successful project they grow the relationship and grow the investor base that continues to invest with them on future opportunities. It also benefits the investor by having a solid understanding of the sponsor’s underwriting criteria and management style so they know exactly the type of deals they will have access to through that sponsor. One of the big components of investing passively is that you vet the team you choose to invest with, so if you grow a relationship with a sponsor over time you have confidence in the deals that they offer. (To read more about vetting a sponsor, read this article.)
With crowdfunding, the investor’s “relationship” is more with the crowdfunding platform itself and the ultimate experience beyond the returns will largely be determined by how good or bad of an experience you have with the platform itself – can you communicate with them easily?, are they responsive to your questions?, are you able to get questions answered about the investments you are participating in?, does the platform have a satisfactory investor portal you can interact with?, etc.
In summary, the key difference here is that with syndication the opportunity to develop a more dynamic relationship with the sponsor exists compared to the more impersonal interaction between the investor and a deal through a crowdfunding platform.
3. EQUITY vs. DEBT DEALS
Another point worth mentioning is the difference in the type of deal participation offered by crowdfunding vs. syndications. Crowdfunding platforms frequently have both equity and debt opportunities whereas most of the syndication opportunities are for equity participation. So what does this mean and why does it matter? One significant consideration is in the taxation of each. Investing in a debt deal is essentially like lending money to someone and you earn interest income on that money with subsequent taxation of that income occurring at your ordinary income rates. In other words, no clear benefit from your earned income other than the fact that it is not income you had to trade time for money. On the other hand, income from equity real estate investments can be more tax advantaged due to the depreciation deduction minimizing the net income that is even subject to taxation. There are other considerations in regards to equity versus debt deals – risk, potential for upside, holding periods, whether you are using a taxable account or retirement fund money to invest with, etc. However, since the tax advantaged nature of real estate is one major benefit, it would definitely be worth taking into consideration the tax implications on either type of investment.
Crowdfunding platforms obviously generate their revenue by being compensated for serving as the “middleman”, so to speak, between the investor and the sponsor and providing a technology platform from which to connect the two. This is an ongoing service they are compensated for as they are responsible for maintaining the investor throughout the life cycle of the investment. Not that it is a complete negative, as they are in fact providing a necessary service of maintaining investor relations throughout that investment, but just be aware that this is an additional cost or layer of expense in between you and the returns of the investment. Through syndication, the sponsor can either raise funds directly from their network or engage a private equity company through which they have access to a larger pool of investors. For the situation of the sponsor raising funds directly themselves there would not be much significant additional expense to doing this other than the cost of bookkeeping and time spent on investor tracking and communications. Private equity groups that participate in raising funds for syndications are of course compensated for that service as well, generally based on some negotiated percentage of funds raised, but sometimes the private equity group can negotiate favorable terms for the investors it brings in if they can commit to a significant enough portion of the capital necessary, thus a win/win situation for all. For many sponsors, access to their deals is only through such private equity groups as the sponsor frequently wants to focus on what they do best - acquisition and operation of properties - instead of investor relations and capital raising.
Hopefully this has given you a few points to differentiate and think about in regards to crowdfunding versus syndication investments and clarify which might be a better fit for you if you are considering passive real estate investments.
Feel free to share your thoughts and experiences related to your participation in either form of investing. As always, reach out with any questions. Meanwhile, happy investing!