Real Estate Syndication vs. REITs: What's the Difference?

Real Estate Syndication vs. REITs: What's the Difference?

This blog explores the key differences between Real Estate Syndications and Real Estate Investment Trusts (REITs), two popular investment vehicles for gaining exposure to real estate. It breaks down the structure, benefits, risks, and returns of each option to help investors make informed decisions. Whether you're looking for higher returns with more involvement or a passive, liquid investment, this guide will help you navigate the best path for your real estate portfolio.

Alexander Kim

Oct 1, 2024

Blog

Real estate has long been a favored asset class for investors looking to diversify their portfolios, generate passive income, and achieve capital appreciation. However, diving into real estate investing can be complex, especially when faced with a myriad of options. Two popular investment vehicles that often surface in these discussions are Real Estate Syndications and Real Estate Investment Trusts (REITs). While both offer exposure to real estate, they are vastly different in structure, returns, risks, and investor involvement.

In this blog, we will break down the core differences between real estate syndications and REITs to help you make an informed decision based on your investment goals. Whether you're a seasoned investor or a beginner, understanding the nuances of these investment vehicles can significantly impact your real estate strategy.

What is Real Estate Syndication?

A real estate syndication is a partnership where multiple investors pool their money to purchase a property or portfolio of properties. In this structure, there are typically two primary roles:

Syndicator or Sponsor: This is the individual or group responsible for managing the entire investment process, from acquiring the property, handling operations, to eventually selling it. The sponsor typically contributes little capital but is compensated with a portion of the profits and management fees.

Passive Investors: These investors provide the capital required to acquire the property but have limited or no involvement in day-to-day operations. Their role is largely passive, as they trust the sponsor to manage the investment.

Syndications are typically structured for larger commercial real estate projects, such as apartment complexes, office buildings, or shopping centers, which may be out of reach for individual investors acting alone. By pooling resources, investors gain access to lucrative real estate deals they might not have otherwise been able to participate in.

What is a REIT?

A Real Estate Investment Trust (REIT) is a company that owns, operates, or finances income-producing real estate. Investors can buy shares in a REIT, much like they would buy shares in a stock or mutual fund. REITs are publicly traded on stock exchanges, offering liquidity and ease of access to anyone with a brokerage account.

REITs are required by law to distribute at least 90% of their taxable income to shareholders in the form of dividends, making them a popular choice for investors looking for steady income streams. There are two main types of REITs:

Equity REITs: These REITs own and operate income-generating properties. Most REITs fall into this category.

Mortgage REITs (mREITs): These REITs provide financing for income-producing real estate by purchasing or originating mortgages and mortgage-backed securities.

Key Differences Between Syndications and REITs

Now that we've outlined the basic definitions, let’s dive deeper into the major differences between real estate syndications and REITs.

1. Ownership Structure

In a real estate syndication, investors own a direct piece of the real estate property itself. When you invest in a syndication, you are buying an actual portion of the property along with the other investors. As an owner, you are entitled to your share of the income (rent) generated by the property as well as your share of the profits when the property is eventually sold.

With a REIT, you are buying shares in a company that owns or finances properties. You are not a direct owner of any specific property but rather a shareholder in the company. As a shareholder, your returns come from the dividends distributed by the REIT, and any appreciation in the stock price if the REIT performs well.

2. Level of Control and Involvement

Real estate syndications offer a more hands-on experience, particularly for those who enjoy being closer to the action of real estate investing. Although passive investors in a syndication typically rely on the sponsor to manage the property, they may have a say in major decisions (such as when to sell). Syndications are private investments, and investors can communicate directly with the sponsor.

REIT investors, on the other hand, have no direct control over the management or decisions involving the properties within the REIT’s portfolio. They are simply shareholders in a publicly traded entity. The advantage is that this requires zero involvement beyond buying and selling shares, making it an attractive option for investors who want to be completely hands-off.

3. Liquidity

One of the primary advantages of REITs is liquidity. Since most REITs are publicly traded, you can buy and sell shares on the stock market at any time. This makes REITs an excellent choice for investors who might need access to their cash on short notice.

Syndications, on the other hand, are illiquid investments. Once you invest in a syndication, your money is typically tied up for the duration of the project, which could be anywhere from 3 to 7 years. While syndications have the potential for higher returns, they require a longer-term commitment.

4. Investment Minimums

The minimum investment amount for a real estate syndication is usually higher than for a REIT. Syndications often require investors to commit anywhere from $25,000 to $100,000 or more per deal. This higher minimum reflects the direct ownership and participation in larger commercial properties.

REITs, by contrast, allow for much lower minimum investments. Since REIT shares are publicly traded on stock exchanges, you can buy shares for as little as the cost of one share. This makes REITs accessible to a broader range of investors.

5. Tax Benefits

Real estate syndications offer potential tax advantages that REITs do not. Syndication investors are often able to benefit from depreciation deductions, which can reduce the taxable income generated by the property. This means that the income you receive from a syndication can often be tax-sheltered to some extent.

REITs, while still offering dividends, do not provide the same level of tax benefits. Dividends from REITs are typically taxed as ordinary income, which can be higher than the tax rates on long-term capital gains. Some REITs may qualify for the Qualified Business Income (QBI) deduction, allowing a portion of dividends to be taxed at a lower rate, but the tax advantages are generally not as favorable as those available in a syndication.

6. Return Potential

Syndications generally offer higher potential returns compared to REITs. This is because syndications involve direct ownership of real estate, which can generate income from rent and significant profits from appreciation when the property is sold. Investors in syndications often aim for internal rates of return (IRR) between 12% and 20%, depending on the project and market conditions.

In contrast, REITs tend to offer more modest returns. While REITs are a reliable source of income due to their mandatory dividend payouts, the returns typically range between 6% and 12% annually, depending on the performance of the REIT and the overall market. However, REITs are generally considered less risky than syndications due to their diversified portfolios and liquidity.

7. Risk Profile

Real estate syndications carry a higher level of risk due to the concentration in a single property or a small portfolio of properties. If the property underperforms or faces market challenges, the entire investment could suffer. Syndications are also subject to market cycles, property management quality, and unforeseen events like natural disasters.

REITs offer diversification across multiple properties and sometimes even across property types and geographic regions. This diversification lowers the overall risk compared to a syndication that relies on the performance of one property. However, REITs are still subject to market volatility, especially in times of economic downturns.

Which is Right for You?

Choosing between a real estate syndication and a REIT largely depends on your financial goals, risk tolerance, and how involved you want to be in the investment process.

If you’re looking for higher potential returns, are willing to lock up your money for several years, and want to directly own part of a property, a real estate syndication might be the right choice for you. However, syndications require larger investments, more patience, and a higher level of trust in the sponsor.

On the other hand, if you prefer a more liquid, passive investment with regular income, lower investment minimums, and less risk, then REITs might be a better fit. REITs allow you to gain exposure to real estate without the hands-on involvement, and you can easily buy and sell shares whenever you want.

Final Thoughts

Both real estate syndications and REITs offer unique benefits for investors, and the decision to invest in one over the other depends on your individual circumstances. While REITs provide a low-barrier entry and liquidity, syndications offer the potential for higher returns and tax advantages but come with more significant risks and illiquidity.

By understanding these key differences, you can align your real estate investment strategy with your financial goals and risk tolerance. Additionally, using a trusted platform such as Homebase can help you confidently navigate the legal landscape of real estate syndication and make sound investment decisions.

ALEX KIM is the co-founder at Homebase, a former engineer / program manager at Alveo, and passionate real estate investor.