Apartment Vs. REIT: Which Is The Better Passive Investment?
Originally Featured on Forbes.com here.
In real estate investing, there are two major strategies to choose from, and each can be used to pursue a variety of different opportunities. In passive real estate investing, two of the most popular investment opportunities are apartment syndications and real estate investment trusts, or REITs.
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. An apartment syndication is when a syndicator (i.e., the general partner) pools together capital from passive investors (i.e., the limited partners) to purchase an apartment community while sharing in the profits.
In both cases, the passive investor is investing in real estate. However, the investment structures differ, which means that there are distinct pros and cons for each strategy. From my experience syndicating over $300,000,000 in apartment communities, when compared to REITs, I’ve found six pros and cons of passively investing in an apartment syndication.
With REITs, you have the ability to buy and sell like a standard stock. If you find yourself needing to pull out your capital, you can do so relatively quickly. Conversely, a passive apartment syndication is less liquid. Your initial investment is locked in until the end of the projected hold period. However, depending on the syndicator, there may be exceptions to this rule.
First, the syndication may have a clause that allows you to sell your shares of the company with the written consent of the general partnership. It is not as fast or as simple as selling shares of a REIT, but if an emergency were to arise and the syndication has such a clause, there is a process for reclaiming your investment. But overall, the passive apartment syndication is less liquid than a passive REIT investment.
In regards to liquidly, REITs win. REITs 1, apartments 0.
2. Barrier To Entry
To invest in a REIT, a large sum of capital isn’t required. Most REITs have no minimum investment, although they may require that you purchase blocks of 10 or 100 shares. That means you can invest in a REIT with less than $1,000, whereas apartment syndications have a higher barrier to entry.
First, you may need to be accredited, which means having an annual income of $200,000 or $300,000 for joint income for the last two years, or an individual or joint net worth exceeding $1 million. Additionally, apartment syndication may require a minimum investment. For example, my company requires a first-time minimum investment of $50,000 and then $25,000 thereafter. You can find syndicators that don’t require a minimum investment or for which you meet the accredited investor qualifications, but regardless, the financial barrier of entry is higher for apartment syndications than REITs.
REITs 2, apartments 0.
With REITs, you invest in a diversified portfolio of properties that provide a blended return. Because the risk is shared across a pool of assets, you will not see major fluctuations in your returns and portfolio value. With a passive apartment investment, your return is directly tied to the performance of a single asset. If something negative happens to the property or the submarket in which the property is located, your projected returns will be reduced accordingly. However, the same logic applies to the upside as well.
Of course, this risk can be greatly reduced by only investing with apartment syndicators who follow the Three Immutable Laws of Real Estate Investing. Additionally, you can make up for the lack of diversification by investing in multiple apartment syndication deals, essentially creating your own personal REIT.
I’m calling this one a draw. So, the score remains: REITs 2, apartments 0.
The major benefit of passively investing in apartment syndications is the higher average returns. The total REIT return over the last five years (May 2013 to 2018) is 25.213%, including dividends and distributions. If you initially invested $100,000 in May 2013, your total profit by May 2018 is $25,213. As a comparison, my company does not purchase an apartment community unless the average annual return exceeds 9% and the five-year internal rate of return exceeds 16% to our passive investors. On a deal we purchased in 2015, we projected a 13.5% average annual return and a 20% five-year IRR to our passive investors, which would result in a total five-year profit of $102,805. As of this writing, not only are we on pace to exceed these projections, but we were able to refinance the property into a new loan and return about 40% of our passive investors initial capital. That is the power of apartment syndications.
Money is the crux of why people invest in real estate at all, so I’m giving apartments three points on this consideration. REITs 2, apartments 3.
When investing in an apartment syndication, you also benefit from having direct ownership of the underlying asset. The major benefit of direct ownership is transparency — you see the actual asset you are investing in. As the general partnership progresses through the business plan, you will receive updates where, again, you can to see the actual asset, along with pictures of the updates and a variety of KPIs (rents, occupancy, etc.).
Another — and essential — benefit is having the direct contact information of the person calling the shots. If you have a question, you won’t have to worry about speaking with customer service or an automated phone service. Instead, you have direct access to the general partner who is managing the asset.
Another point for apartments: REITs 2, apartments 4.
From a tax perspective, both REITs and apartment syndications will pass the depreciation benefits through to the passive investor. However, where these two strategies differ is with the profit at sale. For a passive apartment syndication investment, you have the opportunity to utilize the 1031 exchange tax instrument, which allows you to defer the taxes on your profit at sale by reinvesting in another deal with the same syndicator.
The final tally: REITs 2, apartments 5.
While the returns on both REITs and apartments have historically exceeded those of regular stocks as long as you are financially qualified and willing to tie up your capital for five to 10 years, passively investing in apartment syndications is, overall, the superior strategy.
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Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.