While it can seem easy to get into real estate investing with single-family homes, many investors choose to skip the single-family route altogether for an investment in syndication. Multifamily syndications pool funds from passive investors to purchase large apartment complexes while providing greater asset protection than single-family homes.
Apartment Buildings Offer Safer Debt Than Single-Family Rentals
Most single-family real estate “gurus” preach that it’s fine to personally guarantee mortgages in your own name to qualify for lower interest rates and down payments. However, there is a downside to securing a mortgage in your own name.
If the investment fails or there’s a market downturn and the lender forecloses, you are personally on the hook for that debt. Often, lenders come after your other assets to make up for their losses. Even if you are successful in negotiating debt forgiveness with your lender, the IRS considers the forgiven debt taxable income, which you will end up paying taxes on. For some, this leaves bankruptcy as the only way out.
This type of cross-collateralization is the reason many real estate empires, mom and pop landlords, as well as young investors like myself lost it all in the 2008 housing bust.
While many single-family landlords still turn a blind eye to these risks, it is not a worry for investors in apartment syndications. Since occupied apartments are income-producing businesses, lenders provide loans without a personal guarantee, collateralizing the debt with the asset itself. Furthermore, the loans are only signed by the fund managers, reducing investors‘ risk to the amount they have invested only.
Syndications Protect You From Your Investment
Imagine that you own a single-family rental. Your tenant’s guest gets drunk, falls off the deck, and dies. The family of the deceased wants to sue you personally. If the property is owned in your own name instead of an LLC, then the rental is cross-collateralized with your other personal assets. The family’s attorney can quickly do a search of the public county tax records, identify you and any properties in your name, add up your estimated net worth, and gladly come after everything you own.
There are two ways single-family investors try to protect themselves from this liability, but in my opinion, neither are good options.
1. The first is to transfer ownership of the property to an LLC, which would limit the lawsuit to equity in that one rental. However, if your lender finds out about the transfer, they can exercise a “due on sale” clause and immediately call the balance of the loan due. This can leave you scrambling to refinance the property and, if you can’t secure a new loan in time, perhaps because it happened during a market downturn, the bank can take the property through foreclosure.
2. The second option is to carry a $1 million liability insurance policy. While they believe insurance will protect them from lawsuits, some attorneys see these as big paydays. In the case of litigation, the landlord will find themselves paying out of pocket for a long and expensive lawsuit in hopes of a settlement, all the while crossing their fingers in hopes their insurance will pony up for the settlement without a fight.
Syndications offer a couple of layers of protection against this. With multifamily syndications, each investment is purchased in dedicated LLCs. Furthermore, investors are limited partners in a securities offering, protected with liability limited to their investment.
Syndications Protect Your Investments From Each Other
Once single-family investors build a large portfolio of rentals, they can package them into one LLC and get a portfolio loan that doesn’t require a personal guarantee. While this protects them personally from lawsuits, it exposes the equity in all the properties within the LLC to each other. If one of the rentals is sued or fails to perform, it can’t be foreclosed on individually, which drains the cash flow and equity of the entire portfolio.
Syndications are all held in their own LLCs without the requirement of a personal guarantee. If one undergoes a lawsuit, underperforms or forecloses, there is no personal effect on the investor, their credit or their other properties.
Syndications Protect Your Investments From You
Many investors buy real estate to build an inheritance for their children and grandchildren. It’s a sad day when a legal judgment removes wealth from generations of a family. When held in the right type of entity, multifamily syndications can help protect the inheritance you’re building from personal judgments against you.
Imagine that you caused a fatal car wreck, are sued and lose. If you are unable to pay the resulting judgment, the court may require you to list all your assets and exercise charging orders in which it can force the sale of your investments. To protect against this, investors choose to form holding companies in states that do not enforce charging orders, such as an LLC headquartered in Wyoming, making them far less attractive for lawsuits.
Both single-family homes and multifamily syndication investments can also be placed into trusts, which can help your heirs avoid probate court, minimize estate taxes and help keep your financial affairs private.
Syndications Are Not Right For Everyone
Though multifamily syndications offer a number of asset protection advantages, they are not right for everyone. For example, if you want the freedom to liquidate your investments as needed, syndication is not right for you. Investments in syndication are held until the sponsor sells or refinances the investment, which you, as an investor, have no control over. For greater liquidity, you may want to consider other income-producing real estate investments such as REITs. Talk to your CPA to see which investments work best with your goals.
Invest With Peace Of Mind
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There are two types of syndication investors, accredited and non-accredited (sophisticated). Many current property syndications allow both types of investors to participate as limited partners in multifamily investing deals. In most instances, there are no requirements for previous experience as a property syndication investor.
In addition, there is often no limit to the number of participating investors in a multifamily syndication. This is actually an ideal type of property deal for an inexperienced property investor. It is true that the larger the number of investors funding a property investment, the smaller the amount of financial return will be for each investor. Yet the larger the number of participating investors in an investment project, the lower the risk factor will be for each investor.
If a multifamily syndication has the status of 506(C), investing will only be open to accredited property investors. The requirements for becoming an accredited investor are set by the SEC. Accredited investors are required to have a specific net worth or annual income, either as an individual or jointly with a spouse.
The current SEC requirements for qualifying as an accredited investor for syndication property deals are as follows:
- For the past two years, your income as an individual was more than $200,000 (or you and your spouse had a combined income of $300,000). You are also required to have the reasonable assurance of having the same amount of income or more during the current year.
- You as an individual or jointly with your spouse have a net worth of more than one million dollars. The one million dollar amount does not include the market value of your primary residence.
Multifamily syndications with 506(B) status are open to both accredited and sophisticated investors. Although sophisticated investors do not have the high net worth that is required to qualify as accredited investors, those who are suitable for these types of investments have significant investing experience and a preexisting good relationship with the general partner (sponsor).
Some syndication investment deals may place limits on the number of participating limited partners who are sophisticated (unaccredited) investors. Often in large property investments like multifamily complexes, major syndicators will not offer as many investing opportunities to sophisticated investors as the number that are open to accredited investors. These property syndicators tend to place more value on the accredited investors due to their qualifications.
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