What Money Sources Can I Use To Invest In Real Estate Syndications?
What Money Sources Can I Use To Invest In Real Estate Syndications?
Is it time to get out the hammer and smash the piggy bank?
The first taste of syndication cash flow is addictive. Investors often start turning out their wallets, looking for money to throw at apartment buildings. Others get FOMO from friends, relatives, or colleagues in the apartment game and start digging through the couch cushions to make their first investment. My advice is always to slow down.
Apartment syndication is not a no-lose proposition. These investments carry higher risk profiles commensurate with the higher available returns. A reputable deal sponsor like Investor Boardroom makes the proposition better, but not ironclad.
Bottom line — don’t invest the house payment in an apartment complex. You should only invest money you could afford to lose without facing financial ruin. Preferably, you shouldn’t even invest all your available money in one deal — it helps reduce your risk to spread your money around to different deals, so one underperformer can be offset by the others.
But if you’re convinced that passive investment in apartment syndication is the way to go and you’re ready to beat the bushes for every investment dollar you can squeeze, here are some money sources to consider:
Cash Savings as a money source
Obviously, the easiest source of cash to invest passively in apartment syndication is … cash. Whatever cash you have saved or sitting in reserve.
This could include savings accounts you have maintained yourself, but you can also check your brokerage account. If you have a portfolio under management, financial advisors often keep a portion of that portfolio as cash. This is part of their capital preservation and risk-management strategy. Can’t lose money you never invest, right?
Of course, that cash — all cash — is losing its value all the time. You have seen the news — inflation is at 50-year highs. In a sense, keeping cash on hand is the worst way to invest your money because it’s the only near guarantee that you will get poorer with time. If you invest it, at least there’s a chance it will grow in value — possibly even a good chance over a long-enough time frame.
So do smart investors invest every dollar into some asset like real estate to avoid inflation? Not necessarily. Smart investors think of cash not as cash, but dry powder — the clean, loose snow you find on ski slopes. Dry powder is easy to grab a handful of … and keeping a lot of cash on hand makes it easier to grab up a position in an investment — like a hot apartment complex — when it comes up.
If you have been sitting on some dry powder, don’t panic over inflation. You’re doing fine. Just remember — dry powder is there not to de-risk your portfolio, but to open up your portfolio to opportunities like passive apartment investments.
Stocks & Bonds as a money source
Ready to raid that brokerage account some more?
One of the advantages of stocks and bonds as investments is that they are liquid. There’s an open market for them, and you can sell your stocks and bonds on that open market for whatever they’re worth at the moment.
If you decide that the portion of your net worth you have allocated to stocks and bonds is better spent on passive investment in real estate syndication, you can do it quickly.
This isn’t the worst idea. Bonds rarely outpace inflation as an investment vehicle, nor are there tax advantages to holding them.
Stock indices tend to outpace real estate indices, but the index isn’t the whole story. The tax advantages and easy leverage available in real estate usually make the potential ROI of real estate much greater than that of stocks — especially since real estate can produce cash flow and appreciation at the same time.
Some things to consider:
- You may think a real estate investment has a greater ROI potential than your stock and bond portfolio, but remember — real estate is not as liquid as stocks or bonds. There’s no public market for passive shares of a real estate syndication. If you need cash quickly, it may be harder to liquidate your position than a position in a stock or bond.
- When you sell stocks and bonds at a profit, you have a realized gain. That means you will be taxed on those capital gains. If you left the money in the stock, it would not be taxable even if it’s worth more. But selling your stock for a profit? That is a taxable event.
- Alternatively, if your stocks are worth less than what you bought it for, it might be time for some tax-loss harvesting — selling at a realized loss so you can deduct the business loss. Added bonus — the cash is freed up for real estate investment.
Mortgage Refinance or Real Estate Line of Credit as a money source
If you have built up a great deal of equity in your personal residence or other investment real estate, a cash-out refinance loan or real estate equity line of credit may be a viable solution to raising funds for passive investment in real estate syndication.
It’s a tempting strategy. The anticipated ROI of most syndications far exceeds the APR of a first mortgage. However, with only a few exceptions, we recommend caution about going into debt to invest passively in real estate syndications.
Remember, you shouldn’t invest money you can’t afford to lose — especially if that’s money that might go towards repayment of a debt.
However, if you have a large stash of cash that you want to preserve for risk management or dry powder, borrowing against your real estate may be a great way to preserve that dry powder.
Margin Loans as a money source
A margin loan is a loan against a portfolio of stocks, usually extended by your broker. Again, the interest on the loan is often lower than the anticipated ROI of a real estate syndication deal … but again, be careful about going into debt to invest in real estate.
The main circumstance under which you might want to consider a margin loan is if you want to avoid capital gains taxes on stock that has appreciated in value. Selling stock at a profit is a taxable event, but borrowing money with the stock as collateral is not.
One advantage of a margin loan is that they have no repayment schedule. There’s no monthly or even minimum payment you have to make, despite the fact that interest is compounding on the balance if you never make payments. But if cash flow is a priority, you can easily manage cash flow with a margin loan.
On the negative side, if the stocks acting as collateral to the margin loan loses value, your loan-to-value ratio may fall below the maximum allowance of your broker/lender. The broker may start liquidating your position to cover the shortfall in a move called a margin call — essentially calling the loan duel. If the stock loses enough value, you could lose your entire position.
Whole Life Insurance Loans as a money source
If you have a whole life insurance policy, you may actually have a funding source you didn’t consider.
While term life insurance has few components to it other than the death benefit, whole life insurance policies often have a cash value. If your policy was fully-funded with a lump-sum premium payment at opening, that cash value may be quite high. Otherwise, it grows over time with each premium payment.
The life insurance company usually pays you a yield and/or a dividend on that cash value, so it is a kind of appreciating asset.
Your life insurance company will also lend money to you with the cash value as collateral, usually at very favorable interest rates — far below the threshold where the ROI of real estate investment justifies it.
Not only that, but as with margin loans, there is no set repayment schedule. You can repay as much or as little as you want each month, including $0 (just watch out — that interest keeps accruing).
Unlike margin loans, however, there’s no such thing as margin calls with loans against the cash value of your life insurance, making these loans less risky than margin loans.
Again, exercise caution when borrowing to fund real estate investments … but if I had to pick a loan to recommend, a life insurance loan would be at the top of the list.
A big cash source for passive investment in real estate syndication is retirement accounts — IRAs, 401(k)s, and other QRPs (qualified retirement plans). Using these funds to invest in real estate is a great way to grow these accounts with all the statutory tax advantages that come with them.
Your IRA or 401(k) custodian may have told you this is impossible … but that’s probably because they work for a big brokerage. They’re not just there to act as custodian for your retirement account — their job is also to make commissions for their company by buying and selling stocks and bonds to put into that retirement account. He can’t make a commission off placing your retirement funds in a passive real estate syndication.
However, nothing in the tax code forbids you from investing in real estate without penalties … as long as the investment is passive.
Sound perfect for passive investment in multifamily syndication? We agree — especially since it solves the liquidity problem. Unless you’re close to retirement, you’re not supposed to raid your retirement accounts for cash … so there’s no downside to investing money in an asset with a liquidity cycle of five years, seven years, even ten years or more.
Keep in mind, though — whatever cash flow or capital gains you reap from the investment, it has to stay in the IRA. Otherwise, it counts as a disbursal, and all the same IRS rules apply — including taxation and penalties for early withdrawal.
Another thing to keep in mind — if the investment is leveraged with debt (like most apartment syndications) you may owe unrelated business income tax (UBIT). This may be avoidable with some accounts, but not necessarily all of them.
So what kind of account do you need?
If your IRA custodian tells you you can’t invest in real estate with IRA funds, you need a self-directed IRA with a custodian who offers this kind of product. You can get any kind of IRA (Roth, SEP, BDA, traditional, etc.) as a self-directed account, and roll over funds from a like-kind IRA with a different broker.
IRA investments are eligible for UBIT.
A solo 401(k) is the 401(k) version of a self-directed IRA. Your 401(k) is usually stuck at the brokerage where your employer opened it … as long as you work there.
Solo 401(k)s are not eligible for UBIT. You can sometimes roll IRA funds into a Solo 401(k), but not always.
When it comes to identifying funding sources for passive real estate syndication investment, everyone will have different comfort zones. Some people prefer to maintain a huge cash cushion; other people want to get as much of their money out of inflating currency as possible. Some people are willing to borrow in pursuit of IRR arbitrage (greater ROI than the interest on the loan), while others aren’t at all comfortable with that level of debt.
I have said it before, but it bears repeating…
Do not invest money it would be absolutely devastating to lose. Sure, it’s never fun to lose money, but that’s part of the investing game. Don’t let anyone tell you real estate is a sure thing. That’s bullshit. People can and do lose their entire investments in this game.
My goal isn’t to scare you — obviously I want you to be excited about passive investment, and I believe the track record of Investor Boardroom will go a long way towards reassuring you that your investment dollars are in good hands. As long as you understand the risks and know what you’re getting yourself into, passive investing in real estate syndication can be a fantastic use for almost any stash of cash you have access to.
*Investor Boardroom is not a financial advisor or legal advisor in any way, and this isn’t to be considered financial or investing advice. We are sharing ideas and opinions for educational purposes only.
Resources available to you:
If you’re interested in learning more about the kinds of private real estate investment opportunities I referenced in this blog, download my free ebook titled “The Rapid Millionaire Blueprint” by clicking the link HERE.
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All the Best,