What are the pros and cons of investing in a syndication and buying a turnkey single-family home?
When you invest passively in an apartment syndication, you don’t have to worry about the day-to-day operations of the business, maintenance, or anything of the sort. You simply buy shares of the investment and receive distributions.
With a turnkey single-family rental, you have more responsibilities. You’ll have to worry about the day-to-day operations, tax preparation, and vacancies. However, with that level of control, there’s a great opportunity for upside — particularly if you don’t rely on a management company.
In this article, we’ll review the benefits and drawbacks of each option, so you can make an appropriate decision based on your own situation.
Pros: Buying a Turnkey Single-Family Home as a Rental
For both options, you’re looking to generate some level of income as a result of the investment, while preserving your capital.
You can find turnkey rentals from certain turnkey providers. As long as you fund the deal, the provider will find and get the property ready for you, and sometimes that even includes a management company.
You Have More Control
The biggest benefit to a single-family rental is the most obvious: you have more control. And, if you’re experienced and hard-working, nobody can manage your house better than you.
Buying a home is a major investment, one that many people aren’t ready for. Almost 70% of Millennials regret buying their own homes — a percentage that’s twice that of Boomers. Why? Two reasons: 1) many of them felt they spent too much on the down payment, and 2) they underestimated the ongoing costs. When you’re buying a single-family home as a permanent residence for yourself or your family, you have to factor in the mortgage, taxes, HOA fees, special assessments, maintenance (which you’ll either pay now or pay later when you try to sell), insurance, and any other miscellaneous expenses.
When you buy a single-family home as a rental, you also have to factor in vacancy rates and management fees, if you opt for a professional management company.
At this point, it might sound like all doom and gloom. However, with that control comes an opportunity for upside. If you understand the investment that you’re making and the time and capital it requires, you have the opportunity to make a great return on your investment.
The biggest benefit to a single-family rental is the most obvious: you have more control. And, if you’re experienced and hard-working, nobody can manage your house better than you.
Opportunity for Upside
So, while the average Millennial home buyer might have a little bit of buyer’s remorse, if you find the right opportunity for a value-add investment, the payoff could be very substantial.
Cons: Buying a Turnkey Single-Family Home as a Rental
So, what are the downsides to investing in a turnkey single-family home?
You Have To Set up Your Own Entity Structure
If you want to protect your investment from liability issues, you’re going to have to set up some entity that controls the investment.
Two common business entities for real estate investors are an LLC (limited liability company) or an LP (limited partnership).
The tax benefits for businesses and investments differ, and you’ll likely want to run your rental as a business to receive maximum tax benefits.
Taxes are More Complicated
As a result of greater control, being able to write off what you want, taxes become much more complicated. There are some real estate write-offs that businesses can use, like home office deductions, start-up expenses deductions, and Section 179 expensing — and then there are others that are only available to investors.
Chances are that you’ll be better off incorporating and using the business-related write-offs, but it’s another hurdle to successful and savvy turnkey investing. Talk to your accountant about your options.
You Need Reserves Set Aside for Vacancies and Maintenance
You should expect to put away 1-4% of your home’s value for maintenance every year. For most homes, that costs anywhere from $2-10k or more.
Replacing an HVAC system, for instance, costs about $3-6k. If you’re looking to hold the house long-term, that’s an expense you’ll need to factor in at some point.
Furthermore, in case you can’t find a tenant, you’ll need to be able to continue making payments for all of the necessary expenses without any cash flow from the rental. That means you need to make sure you’re still paying for the utilities and covering the mortgage.
When you buy a single-family home as a rental, you also have to factor in vacancy rates and management fees, if you opt for a professional management company.
You’ll need to find a management company if you don’t want to do the day-to-day
Finally, if managing the rental feels like too much work and you want to hire a management company, you need to properly vet them as well. Another downside is that, since a management company doesn’t have a vested interest in the property, they’ll never care as much as the owner. It can be very difficult to find a good management company — and then you have to factor in the management company’s fees, as well.
Pros: Investing Passively in a Syndication
Truly Passive Income: Fund the Deal and Get Distributions
When it comes to investing in a syndication, all you have to do is fund the investment and receive distributions. Your sponsor is already doing the majority of the work.
If you’re looking to invest in real estate as passively as possible, syndications and turnkey investing can’t really be compared. When it comes to individual properties, management companies lack a vested interest in keeping them in tip-top condition. When you invest in a syndication, you know the sponsor cares about the investment as much as you do because you both have capital on the line.
When you invest in a syndication, you know the sponsor cares about the investment as much as you do because you both have capital on the line.
When It Comes to Liability, You’re Already Protected
You may want to open a business entity for tax purposes, but the syndication is professionally managed, set up as a business entity, and insured by your sponsor. You benefit by working with someone who’s experienced.
Taxes are Simple and Still Offer Great Benefits
When you invest in a syndication, you have the same tax benefits as you would if you owned a rental property. You will receive a K1 Form from the sponsor that is easy to fill out, too, making tax season less of a headache.
Returns are Similar, if Not Greater for Syndications
If you’re buying a turnkey property, chances are the provider also purchased the property as a fixer-upper; potentially owns the contracting company that did the renovations (or receives a serious referral for using that company); and also owns the management company that overlooks the property and its tenants (or receives a serious referral for using that company). They’ve often monetized every step of the process, except they don’t actually have to hold the property; they leave that up to their investors. That means you’re holding on to the majority of the risk while they make money on fee-based and contract-based work, but even though the mortgage is in your name, that doesn’t mean that you’ll be getting a bigger slice of the pie than you do when you invest in syndications.
A way to easily maximize your income when investing in a turnkey property is to manage it yourself, but then it isn’t really passive income, is it?
If you do your homework on a great syndication and you trust the sponsor, you can receive great returns. You’re exposed to the real estate market without a lot of work.
If you do your homework on a great syndication and you trust the sponsor, you can receive great returns. You’re exposed to the real estate market without a lot of work, and you’ll likely receive cash-on-cash returns that are just as great if not greater than what you’d get with a turnkey property.
Cons: Passively Investing in a Syndication
You’re Reliant on the Sponsor
While investing in syndications is truly passive, you’re also relying on the sponsor to deliver good returns. If the sponsor doesn’t have a solid understanding of the market area, or if there’s some bigger, underlying managerial issue, the investment might not generate as much income as you would hope.
If the sponsor isn’t delivering good returns, it sometimes isn’t easy to leave the investment either.
Your Money Can Be Tied Up for a While
When you first invest in a syndication, make sure you understand when you’re going to get paid — and why you’re going to get paid at that time. Sometimes it takes a while for the property to stabilize after the purchase, so you might not start receiving distributions for months after your investment, especially if it’s a value-add opportunity. The sponsor needs to make sure that there’s cash on hand to cover any issues that might occur with the renovations or rebranding.
Most syndications are long-term. Usually, you can expect a full pay-out in five years or more.
Furthermore, you normally can’t leave a syndication at any time without having another investor buy you out. The investment, then, isn’t very liquid — especially if you compare the investment to stocks and bonds. If you’re investing in a turnkey home, you could always choose to sell to get out from under it. While you might sell in a down market and incur some hefty fees, you definitely have more liquidity.
Most syndications are long-term. Usually, you can expect a full pay-out in five years or more.
You Might Have to be an Accredited Investor
Some syndications require you to be an accredited investor. In the U.S., that means you must either have an income of $200,000 or more for the past two years (with the expectation of making just as much or more in the next year) or have a net worth of $1m.
If you’re investing in a turnkey property, you just need enough money to qualify for the down payment, with some reserves set aside.
Conclusion: Pros and Cons of Investing Passively in a Syndication vs Buying a Turnkey Single-Family Home
When you invest in a syndication, you don’t have to worry about managing it personally. You’re truly a passive investor. You fund the deal and receive distributions.
When you buy a turnkey single-family home, it isn’t completely passive. If the tenant’s toilet stops working or the sink won’t drain and they can’t get a hold of the property manager, your phone could ring.
Both options have their benefits and drawbacks. If you’re managing a turnkey single-family home yourself, then chances are you have a greater chance of returns, but if you hire out a property management company, that’s going to eat away at a solid chunk of your cash flow. However, the tax benefits might make it a great deal for your particular situation.
With a syndication, You can expect average cash-on-cash returns on par with a turnkey single-family home, at least. You don’t have to worry about day-to-day management, but you do have to trust your sponsor to do a good job and deliver those returns. In a syndication, your money is also not as liquid (although a turnkey single-family home isn’t very liquid, either).
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