I got an interesting question here recently from a listener who submitted a question, I guess, in the hopes of me covering it as an Ask Marco episode, and for the most part, that’s what I’m doing today, but I am just considering this a regular Tuesday morning episode. And the reason is that they are asking a question that basically compares partnering on a bigger deal, which is essentially a syndication, a group investment, or a partnership. Those are all the same thing versus purchasing their own deals. And their question is heavily skewed towards just the tax side of it, but really it’s a comparison. And so let me read the email and then I will answer the question that he is asking. So the question comes from Jacob and he says, hi Marco, I’m a big fan of your work. I follow several other big-name real estate investors. One of which is Grant Cardone.
I happen to know Grant, by the way, he’s been on my podcast. I’ve been on his show called Ask the Pros in his studio in Florida. So he and I have had some interesting conversations and a really good debate about the liquidity of apartment buildings versus single-family homes. And we completely don’t agree with each other on that, but everything else was just an incredible conversation and a great interview.
So Jacob goes on to say he says, my question is about his opportunity for accredited investors to partner with him on large multifamily unit deals, allowing the investor to take advantage of the tax benefits, appreciation, and cash flow that the property generates for someone like myself who lives in rural America and cannot benefit from steady local property appreciation. It sounds very appealing.
I will address that in a moment.
Recently on your podcast, you have had many discussions on the topic of real estate taxes. I wonder if purchasing my own properties will allow me to take further advantage of these taxes, then investing in something like Cardon Capital. The biggest downsides I see with investing in Cardone Capital or any syndication is one the inability to choose when to sell or cash out, meaning inaccessible funds. And number two, not being able to carry your funds over to another investment when the property does sell, like using a 1031 exchange, which is a tax-deferred exchange of that realized gain coming out of the property. So to summarize, I’d like to better understand the benefits, particularly with taxes of purchasing my own deals over partnering with a large group on bigger deals. I am a heavily taxed healthcare professional employee, just trying to offset some of my income.
Thanks for reading. And I appreciate any feedback you can provide.
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Well, first of all, thank you for the question. So Jacob, you know, for any individual who is a high-income earner and has heavily taxed, you obviously want to look for ways to minimize your tax impact and take as much of that active income and convert it into passive and portfolio income. So you are at lower tax brackets and it becomes more tax efficient. And of course, you convert active to passive income, which is the key and the secret to creating long-lasting wealth. So having said that, the fundamental question you’re asking here is, is it better to partner on a bigger deal through a group investment also known as syndication or to purchase your own deals? Well, let’s just do a quick recap. So when you look at the tax benefits of investing in real estate in general, this is what you basically have.
You have depreciation, of course. Now when it’s residential real estate, it depreciates over 27.5 years. It’s essentially what they refer to as straight-line depreciation. And that applies to you as an individual investor on your own properties or in a group investment. And that is just true for everybody. Now you share in your prorated share of that. So whether you’re taking a hundred thousand dollars of investible capital and purchasing one, two, three, or four single-family homes or duplexes or whatever they may be, or you are investing in syndication, the same concept applies. The depreciation works out to be the same thing. However, in a syndication that depreciation may actually be less than what you might get purchasing, single-family homes or duplexes or fourplexes with a hundred thousand. The variable here is this. It really comes down to what is the value of the improvements on the land when it comes to purchasing your own real estate, your single-family homes, and duplexes, et cetera, versus what that might be in the apartment deal, the multifamily apartment complex, or whatever the syndication is.
The other thing too is keep in mind that generally speaking with a group investment, such as a partnership or a syndication, you as the limited partner are typically benefiting from a prorated share of a, usually 70 to 80% of that deal. The other 20% to 30% of that deal goes to and belongs to the syndicator, the person who was basically putting the deal together and bringing it to you. So it is essentially their fee or what they earn for essentially putting the deal together and offering it to other investors like yourself. So if everything else being equal, that means the depreciation that you can use to minimize your tax impact. In other words, the, that you have as a write off would be lower on the syndication with everything else being equal. So I’m assuming you’re comparing apples to apples here. And the reason for that is this.
If the four properties that you were looking to invest in directly yourself were the properties that were in the syndication. If the syndicator is taking 20 to 30% of that, as their income, their equity gain, their tax benefit, their everything else, then essentially you are getting a prorated share of the remaining 80% or 70%. I hope that makes sense. So in other words, something’s being shaved off the top for the work and effort and time that the syndicator has put in that’s another, a good or a bad thing. It’s just what they’ve earned and what they’re making as being the syndicator or general partner of that deal. So everything else being equal, and generally speaking, you’re going to have less depreciation to write off and capture and take advantage. So, but that is one of the benefits it’s of real estate, regardless of whether it’s a single-family home or a group investment like a syndication.
And of course, if you get into the whole conversation of bonus depreciation, tax cuts and jobs act of 2017 has brought in well, that applies to both either eyes to real estate, residential real estate across the board. So it doesn’t matter whether you are building your own portfolio and you are essentially just the CEO of your own investment empire, and you have your property managers and other people working for you as your team members to essentially manage and control and help you build out and oversee that portfolio that you have. So the bonus depreciation also applies just the same regardless. And for those people who are thinking about accelerating the depreciation even further, there’s the concept of cost segregation, which is beyond the scope of this conversation. But essentially what it means is that you are doing a study on your real estate portfolio. It could be a bunch of single-family homes, or it could be an apartment complex, but you’re essentially breaking it down into all its little pieces and taking advantage of faster depreciation schedules on all those components that make up that real estate.
So it’s not just a building anymore or a house or a duplex. It’s now made up of the components such as the roof versus the hot water tank versus the furnishings versus the cabinetry versus the siding versus whatever it may be. They basically just chunk it get down. So anyway, that’s the depreciation side, the capital gains piece of it. Well, capital gains is capital gains, whatever gains you have through equity growth and appreciation over time is going to flow through to you on that group, investment on a K1 with your own portfolio, whatever those capital gains are is what they are. And again, that 80-20, or that 70-30 rule or however, the deal is structured. You have to keep in mind that you are, generally speaking, getting your prorated share of a smaller overall pie, if you will, through a syndication versus having your own portfolio.
So again, just assuming all things being equal, you should stand to gain more over time having your own portfolio versus having a syndication. Because again, the syndicator is going to have their 20, 25, 30%, sometimes more based on experience, but you know, 20 to 30% of the entire deal, that means the cash flow, the depreciation, the equity gains. Now, this is by no means a knock on syndications. They have their time and their place. And there’s many people who do group investments. I’ve done some myself. I have nothing against them. They are not for everybody, but for some people, they’re a perfect fit. So just keep in mind your own tolerance, willing to control and have direct control and direct ownership in the portfolio and having a certain level of trust or lack of trust in the partnership, the general partners, how well, you know them, their track record are all variables and factors that you have to consider.
If you’re going to look at a syndication. Okay. So the third thing is refinancing. When you have your own portfolio of properties, you can refinance anytime you want, as often as you want, it could be on the, on one property, two properties, the whole portfolio. It could be whatever you want it to be. When you are in a group investment, a partnership of some kind, the refinance doesn’t happen that often. And usually, it happens three to five to seven, sometimes 10 years down the road. And that’s the point where the syndicator either a sells the property and the partners, the general partners, and limited partners are essentially cashed out, hopefully with a profit. That’s the point in time where you move on and take that capital hopefully more and reinvest it elsewhere sometimes. And often it will be in other real estates, more real estate, but you have no say or control over the refinance.
Usually, a syndicator will have a plan from the very beginning and they will have some sort of plan to refinance the partners out and sell the property or refinance and repay as much of the initial principal invested from those limited partners. At some point down the road, that’s often five years down the road, sometimes seven just depends on the market and what the strategy is. If you’re just banking on appreciation, it might be a longer-term. If it’s forced appreciation where the syndicator will bring in a team to upgrade and renovate the property to add more value. And the way that’s actually done is by increasing the rents. It’s not just improvements on the property because don’t forget the multifamily unit, larger properties. In other words, apartments are valued on their NOI, their net operating income. So the larger the net operating income, the more valuable the property is worth.
The market value goes up. It’s based on income, not based on improvements, which is different than when you look at single-family homes, duplexes, and fourplexes, because you can add value by increasing square footage or adding value to the property by improving the kitchen, the bathrooms, and providing upgrades that give it more value compared to other properties in that area, that neighborhood, that market. So the way you increase value is different with one to four unit residential properties, as opposed to medium and large-scale apartment complexes. Okay. So back to the refinancing thing, when you talk about refinancing, you’re basically stuck with the timetable that the syndicator is giving to you. So if they’re basically coming up with a plan on day one, that it will be a refinance in five years, well, you’re going to be illiquid for five years and that could be a longer period of time.
But basically, that is their plan, right from the get go. And the next item, as far as a tax benefit or deduction, if you will, is the mortgage interest deduction. But here again, that applies to both syndicators and to you as a property owner. So whether you have a single-family home or a whole portfolio of rental properties, or you’re in a syndication, that tax deduction is a deduction. It is an expense that comes off of the P and L in the expense line item, and a that essentially reduces the taxable income from that property. So everyone benefits in that across the board. And of course, if there is a loss and often the loss is a paper loss, not a real loss, you still have positive cash flow, but on paper you could show a loss that you can carry forward and use to lower the tax impact on your taxes in future years.
That applies again, whether you are invested in a syndication or whether you’re investing in your own portfolio of rental properties. So carry losses are applicable in both scenarios. All right, now, just some things to keep in mind here between syndications and investing on your own. So as far as syndications or group investments go, they are the most passive of passive investment. So they’re essentially hands-off. You are a limited partner, not a general partner. You have no voting rights. You have no involvement in the day to day operations. You are as hands-off as it can be, and you will just receive distributions if they’re available, whether it be monthly or quarterly, sometimes every six months or every year, it just depends on the syndicator and how the deal is structured, but it is hands-off. But I will also say that having your own portfolio that is managed by professional full-service management companies is also very hands-off.
Your involvement is typically very, very low. It’s really just another monthly reports, checking your books. Maybe you have a bookkeeper. That’s doing it for you, or you’re keeping track of it in an app or on a spreadsheet, regardless of how it is. It may not be you, but if it’s five minutes per property per month, that’s pretty minimal, but that’s assuming you have your own portfolio. Otherwise with a syndication is as hands-off as it’s going to be the passive and residual income that comes from these investments are pretty much the same. So I will point out a difference though, between a syndication and having your own portfolio. And that is this again, keep in mind that with a syndication that you have a smaller prorated share of the depreciation. So when you are talking about the tax benefits of it, it might be, again, everything else being equal less on the syndication or group investment, then it will be having your own portfolio.
Again, they both offer tax benefits. Some of the negatives, if you will, about group investments, is what you had pointed out. That lack of control. You really have very little say in the day to day operations or in the annual decisions as to when to sell when to refinance also a big thing that you pointed out. And that’s a big thing that I have an issue with is the lack of liquidity because of this lack of liquidity, it would not be wise for you to invest significant portions of your investible capital into any one deal or any batch of syndications expect your capital to be locked up for three to five years. Sometimes as much as seven to ten, it really it’s deal-specific. So you got to keep it hold time in mind. The whole time is really once you’re in, you’re in and you are not getting out unless the syndicator works out a deal with you where they will cash you out or buy you out in exchange for someone else’s funds or maybe their funds.
And sometimes that comes at a cost, meaning that they will discount your capital if they cash you out for the end of that plan that they have for that investment. So if you come in with a hundred thousand dollars, they might want to discount a 10, 20, 30% in order to cash you out early. Think of it like a penalty. It might be a penalty. So here’s the biggest differences, with a group investment. It is more passive, not by much in my opinion, but it is more passive than just building a passive portfolio of rental properties in two or three different markets that are professionally managed by property managers. My second comment would be if you go solo, it more liquid now real estate in general is not a very liquid asset class, but single-family homes are probably the most liquid form of real estate given all the other options out there.
So it is reasonably liquid, but it is certainly not like the stock market where you could push a button and liquidate your, your position, your holdings, a big advantage. I like about building a real estate portfolio of single families. Duplexes, triplexes fourplexes is the fact that you are a direct owner, but regardless of whether you’re a direct owner or not meaning that you don’t hold title in your name, you put it in an LLC or whatever entity you have. You have direct control. Indirectly, you have complete ownership. You are a direct owner, but it’s the direct control that you have. You don’t have that option as a limited partner in a syndication. And again, generally speaking, but I can show this with example after example, your returns are typically better in wealth, chosen properties in the right neighborhoods, in good markets. I generally see cap rates of six to 8% with single-family homes, even duplexes and fourplexes.
And I don’t see that with syndications today, regardless of whether it is Cardone’s or it is with other syndicators. Those deals may be out there. But today because cap rates have been compressed pretty much across the country because everybody’s chasing after apartment buildings and has been for at least five years, that I can count that high competition limited supply and high demand has essentially pushed prices up. And so it has hard to find good deals the way to really make good money in the syndication space. Meaning larger multiunit properties is to find deals that are what we call value, add meaning that they are mismanaged or run down to some degree or dated. And they have room for improvement where you can come in, spend money to improve the units and improve the property. Thereby increasing the monthly rents and increasing the monthly rents. You increase the net operating income.
And by doing that on larger properties, you increase the value that doesn’t work on single-family homes. There are other ways to increase value, of course, but when it comes to larger multiunit properties, that’s where you’re going to find the better returns that aside, the only other way is to go into lesser desirable neighborhoods. In my opinion, what I’ll call C class neighborhoods. These are essentially a lower-income demographic. And the reason I bring that up is because that is where you’re going to find higher cap rates, higher capitalization rates. And in some cases with the financing, you’ll find higher cash on cash returns, but for a lot of investors, they want the higher returns, but they don’t want to be in C class neighborhoods or what some people will refer to as C class properties. A lot of investors I know who are investing in apartment complexes or larger multiunit properties, don’t want to be in neighborhoods that are less than a B, B plus, ideally, but no less than a B.
And then more premium properties such as what Cardon goes after those properties are generally speaking in A class neighborhoods. They’re more of your premium grade, really nice quality properties in quality neighborhoods. So yes, they are a premium property with a premium price. And the challenge there is that there’s very little room if any, to increase rents because they’re already in good shape and quite nice. Now that doesn’t mean that people like Grant or others are not still further improving the property and adding more value. That would be the smart thing to do if there’s room to do it. And in doing that, you can increase the rents and thereby increase the value of the property. And that’s a fantastic thing that doesn’t necessarily affect your annual cash flows directly to you. It might be a small difference, but the bigger difference is down the road, let’s say five, seven years down the road when it comes time to either refinance or sell that property where you’re going to see that in your pocketbook.
So as far as cap rates and cash on cash returns and the near term, not the long term, the better returns are certainly going to be in the portfolio of single families, duplexes, fourplexes, last but not least. You talked about taxes and tax benefits. They’re essentially the same. And the only time that you’re going to get shortchanged on that again, if everything else is equal, the tax benefits, meaning that the appreciation that is going to be flowed down to you through that partnership on that K1 statement is whatever depreciation is your prorated share of the share, going out to the investors. And like I said before, if the syndicator owns 20 to 25% of that deal, you are sharing in the remaining 75 to 80% of the depreciation and everything else for that matter. So the tax benefits on your investment may not be the same.
So anyway, that’s basically, an overview of all the points here that you’re bringing up. So yes, if the inability to choose when to sell or cash out as an issue, then maybe a syndication is not for you and not being able to carry your funds over to another investment might be the situation ultimately when you get your money back out of that deal, but there are always deals out there. And, and that’s especially true if you are working with the right team or you know where to look, but there are always opportunities out there. So anyway, that is it. I hope that helps Jacob. I appreciate the question. I hope I was not long-winded on this one, but I could go on, there are certainly other aspects to talk about when it comes to syndications and partnerships and the pros and cons as they relate, but they are good for some people, especially if you want to be as completely disconnected and passive as possible.
I don’t like that approach. And you really have to vet the team, the deal and the syndicators themselves, you know, their track record their history, but certainly, you’re underwriting the deal as well. So there are more pieces to it. But it works for some people. So I’m not going to knock it. I’ve, you know, I’ve been involved in some syndications myself and they have their place.
Alright, well, Jacob, thanks for the question. I appreciate it. So we’re going to wrap it up here today, download your free report, The Ultimate Guide to Passive Real Estate Investing. If you haven’t done so already, make sure you go to our websites and download that. If you are looking to discuss this topic or anything else in greater detail, or you’re just thinking about real estate as an investment, talk to our investment counselors and get your free strategy session. We’ll spend anywhere from 15 minutes to 60 minutes with you just depends on the complexity of what you’re talking about, but we’ll spend some time to help you map out a direction and see if there’s a fit for what we offer and what we can do for you. And keep in mind that our investment counseling services are free of charge. So if you’re working with us, we bring you the resources that you need, the knowledge you need, all the team players that you need, the people that we’ve vetted. And of course at the end of the food chain are the properties that you can pick and choose from in approximately 25 different markets around the United States, all that comes to you, that counseling that handholding is at no cost. So you have a lot to gain and really nothing to lose. That is it for today. I appreciate you listening and we will see you on our next episode.
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