Scrambling for a Way to Offset Gains in 2021? Consider Commercial Real Estate Syndications

Seasons Greetings! After another crazy roller coaster ride of a year impacted by Covid, I'm sure many of us are grateful for this holiday season, when we can take some time to reflect on and appreciate our blessings.

It's also a good time to reflect on our taxes & investing strategy, as well. Whether you're in or nearing retirement, or just starting out on your investing journey, or somewhere in between, I think we can all agree that planning, taxes, investing, and personal finances, in general, can be both time-consuming and stressful. Yet having a good plan in place can also feel quite empowering, and instill confidence in your strategy.

While the 'what' you invest in plays a huge part of your planning, it's also wise to consider the tax implications of your choices. While I am a big advocate of diversifying across a multitude of asset classes, real estate, and specifically syndications, offers a great way to offset gains.

For those of you who don't know about real estate syndications, they are, simply put, a pool of investors coming together to invest in large real estate assets, with the sponsor/syndicator, sourcing, negotiating, managing & exiting the deals. Similar to buying rental properties, they offer the ability to leverage (by way of financing); they offer tax deductions; they offer a good hedge against inflation; and they appreciate over time. Unlike your average rental property, however, large syndications can also take advantage of something called bonus depreciation. When you own a rental, you generally use a 27.5 year depreciation schedule for your tax returns. With syndications, many operators can take accelerated depreciation in the first years, resulting in losses, on paper, come tax time. For example, an investor who's invested $50,000 in a syndication that offers significant bonus depreciation in year one, in addition to the expenses associated with being a landlord (interest, repairs, administration, and a multitude of others), they might see a loss of $25,000 or more in year one. These losses are a great way to offset other gains. In fact, many savvy syndication investors deploy something akin to a bond laddering strategy when investing in syndications, collecting monthly distributions along the way, and taking advantage of harvesting losses in years that would otherwise mean significant tax owed due to capital gains. And similar to any other tax losses, losses can be carried forward, so a very clever tax strategy can be created, wherein investors can effectively roll in and out of new deals, while minimizing tax obligations.

In addition to the ongoing distributions (similar to rent payments on rentals), when a capital event occurs (ie refinance or selling of the asset/s), many syndicators are offering the ability to utilize a 1031 exchange, so that the capital gains portion of the syndication returns can be rolled into the next project, thus deferring taxes & depreciation recapture. This is a strategy that many of our investors utilize, and a key part to the compounding returns in real estate syndications.

In practice, investors either utilize distributions as income (ranging between 5-10% per annum), or simply reinvest them. Then, in a few years' time, when the projects either refinance or sell, they are able to either simply cash out (no different to selling a rental property) & pay long term capital gains rates, or reinvest via 1031 into the next deal. Over time, this can be a way to generate far superior returns than simply buying and holding rental property. Why? Because investors are able to continue to invest MORE into new deals, taking advantage of leveraging (financing) on each one.

Let's use an example - an investor places $100k into a syndication fund in year one. Let's imagine that the investment hold time is 5 years (though in practice they tend to be on shorter cycles), and that, including gains on sale of the property, average annualized returns are 20%. Let's assume that the preferred shares are offered at 8%, and the additional returns (12%) stem from the sale in year 5. So, over 5 years, that investor would have collected $40,000 in the form of monthly distributions, and receive an additional $160,000 back on sale ($100k return of capital, and $60k in gains). In year 6, that investor could have either utilized the ongoing income for their living expenses, or enjoyed the additional returns on them in other investments. They could now invest $160,000 into the next deal. Using the same assumptions above, this is what this strategy looks like over time-

Years 1-5

$100k invested, $40k in distributions, $60k in gains (plus $100k return of capital/ROC) = $200k total

Years 6-10

$160k invested, $64k in distributions, $96k in gains (plus $160k ROC) = $320k total

Years 11-15

$256k invested, $102k in distributions, $154 in gains (plus $256k ROC) = $512k total

This is really powerful, as it allows investors the opportunity to create stable income streams as well as benefit from appreciation. Over time, you can invest in many of these sorts of syndications, giving you further diversification into different commercial real estate asset classes, as well as across differing geographies. As with any investment, there are no guarantees, but research goes a long way to mitigate your risk.

It is critical to partner with the right syndicator, as there are a number of factors that can influence your performance & outcome. Doing due diligence is important, getting educated on the subject is important, no different from understanding which stocks and funds to allocate your investments into in the stock market. A very big part of my work involves educating investors, and to determine if these sorts of investments are suitable for their overall investment strategy. For me, it's a purely data driven decision, and I like to work with operators who've got a solid track record, don't overpromise, and work in growth markets (evidenced by data). These are some of the primary criteria that are critical for me.

It's also important to consult with your tax professional, as each individual is different. If you plan to, or already on the path to investing in real estate, consulting a tax professional who understands real estate & syndications is ideal. They can help you plan your tax strategy for years to come.

Lastly, in case you don't think it's a big market, or that single family rentals is the only way to go, I'd like to point this CBRE research on the multifamily market - Multifamily Demand Sets Record in Q3 | CBRE.

Multifamily investment volume increased by 31% quarter-over-quarter in Q3 to $78.7 billion. With investment volume totaling nearly $179 billion year-to-date, the market is on track to well exceed 2019’s record total of $193 billion.

Source - CBRE Q3 2021 Multifamily Figures

In short, I'm a big fan of syndications. The mix of low volatility, stable income streams, historically above average returns, significant tax advantages, passive earning & exponential growth make this a very attractive asset class.

If you'd like to learn more about this, I'm a finance professional specializing in private equity into commercial real estate through syndications. I'm an SEC Registered Representative, and as such am held to high regulatory standards, particularly around ensuring that any advice or information I share with clients is serving their best interests. I raise capital for both individual deals, as well as funds, and have been investing in real estate & the stock market for over 25 years.