“Why should I invest in real estate versus the stock market?” This is a question our Director of investor relations, David Milan, gets a lot.
In these volatile times, investors are looking to potentially move their money from the stock market to real estate, and once you see how investing in a multifamily syndication works, you’re going to want to make this switch.
The returns are higher than the stock market, and with COVID and all that's going on right now, we're seeing unprecedented volatility in the stock market.
We are typically looking at average annual returns of 12 to 15%, while the stock market has been 7/1%.
How do real estate syndications manage to achieve returns of 13% or more?
The vehicle itself has higher returns; it’s just the way syndications are. One downside of syndications is, it’s not as liquid so you can't just call us up and say, “Hey, I've been in this deal for two years. I want my money out.” While we will work to get that out, it's not as easy as calling a stock broker. So the returns are higher than the stock market naturally.
Another reason the stock market is lower is because of the volatility. The average return has been seven years. Sometimes it goes up, and then it goes up, and then it goes back down, reducing the principal. The compounding is not there because the principal is being reduced by years where there are losses.
Better Performance During Recessions
Multifamily syndication of real estate performs much better in recessions. We saw that in 2008, and we're seeing it now. The stock market can lose 30 – 50%; we saw this in both recessions, and that can be very unsettling as you're trying to make financial plans for you and your family. You don't know when the next recession is going to come, and you could be down 30 or 50%.
Maybe you’re about to retire, or you need that money for college – and now it's worth 30 – 50%. That's a big problem. With real estate syndications, you have a consistency.
If you look at the last recession, real estate was hammered, but not every class of real estate. What was hammered was houses. We had a lot of foreclosures and short sales. House values in Florida and California collapsed by half. Office space got hammered; retail space got hammered; but multifamily space did not get hammered. Neither did mobile home parks and self storage, for example, they actually thrived in the recession. The reason for that is because there is a continued shortage of affordable housing.
People lose their jobs during a recession, but they need a place to live, so they downgrade to something more affordable.
COVID decimated the office and retail market space, but collections on the multifamily side have been surprisingly constant. Our collections are equal to or possibly greater than they were before COVID, so repeatedly throughout history, multifamily has performed very solidly in recession.
Tax laws are written so that the gains are highly advanced. You have huge tax advantages on the gain that you don't have in stocks – so your taxes are a lot lower.
Anytime the tax code gives you advantages, there's a reason for it, because the government wants you to invest in those things. That's why there are tax advantages, for example, investing in oil, and specifically drilling of oil. Because the government wants you to invest in exploratory activities.
The government also wants you to invest in rental housing because there's a shortage of affordable rental housing. So one things the government does to induce investors to invest in this asset class, is a tax advantage.
It’s the same thing with opportunities zones. These are tax programs that provide incentives for investors to do something like clean up city blocks. It's the same thing here.
Depreciation allows you to write off the value of a piece of real estate over 27 and a half years. Now, if you do a cost segregation analysis – you hire an engineer, and they break a building down into its constituent parts like nails, electrical, roofing, carpet, furniture – the tax code is written differently for how things can be depreciated. For example, wiring might last 10 years, flooring may last five years. They apply this analysis on a building, and 90% of the value building can now be depreciated over seven years, not 27 and a half years.
We bake that into each one of our deals and as a result, 90% of the building becomes a phantom expense. We'll send you $1,000 as a return on your $100,000 investment. Meanwhile, you might have a $40,000 loss because of depreciation.
Most importantly, there's cash flow in real estate syndications, which you don't get in the stock market unless you're doing very advanced call-and-put options strategies. So you actually have cash flow, which you can use to quit your job. You get to control your time.
You can do that either by investing actively, or passively – either one generates cash flow is a key component of this kind of investment because you can cover your living expenses with it.
We're looking for average cash on cash returns of 6 – 8%, meaning that if I invest $100,000 per year, I want to receive distributions in the amount of $60,000. But because of the tax advantages, when you get a K-1, after you put 6 or $7,000 into the bank, your K-1 shows a massive $40,000 loss because of the depreciation. The tax law allows you to do that. You put money in your pocket, yet you're not paying taxes on it.
Typically, we do value add deals, meaning that we're going to get into a situation where a property cash flows already, but it's not where it needs to be. It might take a year or two to get to that, s the first year might be, 3%, cash on cash, it might go to 5, but by year three, we want to be right in that target at 7%. It may get a little bit higher in year four, and year five until we eventually sell. So typically, our distributions are made quarterly.
They're made about six months after we close on a deal because we want to see how the property performs. We want to make sure that we retain a certain amount of cash for unforeseen circumstances. The first distribution usually happens six months after we close and then quarterly; once things really stabilize, we'll go to monthly distributions.
Those are the four main advantages of investing passively in syndications.
If you want to learn more about multifamily syndications and the benefits of real estate investing, please visit Nighthawkequity.com
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