Meet Jack. He’s a 58-year old engineer, lives in Los Angeles, and owns four residential rental properties. He manages them himself, and lately, it’s been exhausting. As Jack starts planning for retirement, he thinks his time might be better spent off the highway traveling between his properties, and concentrating on the next chapter in his life. Jack doesn’t want to sell his properties because he likes the extra income, but wonders if it’s become too much work. He also worries about a large capital gains tax bill when he sells.
Solving the capital gains tax issue is easy. When you perform a 1031 Exchange, you sell your investment property, following certain IRS guidelines, and then purchase other investment property to replace it. You can perform a full exchange or take out some cash from the investment property sale. You only pay capital gains tax on any amount you take out of the transaction. This amount is called “boot”.
Jack’s not alone—plenty of people own residential rental properties from which they earn some income but they must deal with the daily requirements of tenants, taxes, and clogged toilets. It’s possible to make smarter real-estate investments which are completely hands-off from your perspective. Welcome to the world of institutional investing in syndicated real estate.
Institutional investing is a big term for a small concept. It means that an individual has the capacity (and the capital) to invest at the same level as pension funds, Real Estate Investment Trusts (REITs), foundations, college endowments, and insurance companies. These institutions typically invest in large-scale projects, rather than single family homes or apartments. Accredited investors can access similar investments by pooling their resources with others to invest in properties worth $20 million to over $100 million. The pooling of funds from several investors in real estate is called syndicated real estate.
You’re probably wondering how individuals are eligible to make institutional-level investments in real property, right? Only a small segment of the American population qualifies to make these kind of transactions, and they are called accredited investors. Most people in this category are over 50 years old, and the SEC defines an accredited investor as someone who:
- Has a net worth of at least $1 million (not including the value of their primary residence), OR;
- Has had an income of at least $200,000 each year for the past two years ($300,000 combined with your spouse, if married) with the expectation of making the same amount or more in the current year.
Only 8.5 percent of the population qualifies as accredited investors. If you’re one of them, institutional investing might provide a great opportunity that leaves you more time to do what you love.
How does this work? First, firms known as “Sponsors” acquire institutional grade property, add financing, package it into what’s known as a Delaware Statutory Trust (DST) legal structure, and offer it as an investment to accredited investors. The Sponsors manage the property until its ultimate sale. In institutional investing, the Sponsor does all the heavy lifting, even though you own the property. These types of investments typically are held for five to seven years, so when the sponsor sells the property, investors will have accumulated any cash flow, pay down of loan principal and property appreciation without dealing with all the hassles of property management themselves.
A few pointers to keep in mind as you navigate DSTs… How and where you invest is critical, because your investment funds represent years of hard work, discipline and effort, especially if they came from investments in smaller properties. Remember Jack? He made sure his property was rented and maintained and did everything possible to increase his return. With syndicated investing, Sponsors do much the same thing, but on a larger scale and with a level of professionalism and expertise most residential investors don’t have. They also work to improve the property in order to raise rents.
Choose your Sponsors carefully. Before committing, make sure the sponsor you’re buying from has a great performance record. Good Sponsors should have a portfolio of properties in different regions, and usually select properties rated Class-A—high quality, newer buildings with top amenities and low vacancy rates.
Syndicated investing alleviates the burden of property management while allowing investors to typically earn higher cash flow. Much like we might hire a financial planner to manage our assets, investing in syndicated real estate means that professionals do the work for you. DSTs allow you to graduate from smaller residential investments to institutional-grade investment properties. You’ll partner with seasoned professionals with decades of experience, leveraging the power of economies of scale. And you’ll increase returns with business practices that no individual investor can match.
It’s just as important to work with an investment advisor or registered representative with experience handling syndicated investments. Although DSTs are securities, at their core, they are real estate, and real estate expertise and talent are far more important skillsets to find in your advisor than a traditional securities background.
Perhaps you’re like Jack. You’ve worked hard for your money over many decades. You spent countless hours choosing the right investments, too, trying to make wise decisions when it came to real estate, maybe even doting on your rental properties like an expectant parent. You watched your portfolio grow, and you poured out endless resources of time and attention to make them as profitable as possible.
It’s time for that portfolio to do something for you.
As retirement grows nearer, your investments should be doing the heavy lifting, not you. Your time is valuable. So is your health and sanity. You only get one life—it’s up to you how you live it. You owe it to yourself to make sure you investigate the possibilities that will provide more time, potentially more money, and more freedom. You want to make your retirement the best it can be.
By Leslie Pappas, Founder and CEO