We have been investing in real estate since 2000 and have yet to lose money in a real estate investment. Our real estate returns are more or less infinite. Why? We focus only on deals that match our stringent criteria, or that are in our strike zone. To date, we have invested in 21 apartment syndications as Passive Investors, which is synonymous with being a Limited Partner, and 8 apartment syndications as a General Partner, or Deal Sponsor.  

We have achieved this by only investing in properties that have the highest chance of performing well – we do not waste our time or capital looking at deals outside our stringent criteria. Life is too short! 

You cannot control the crime in the neighborhood, the growth, or lack thereof, the rate of job and wage growth, the city council, the mayor, the county, the governor, the flood zone, etc. With this in mind, here is the criteria that brings us success, in order of importance:  

• Landlord and business friendly municipalities.  
• The city, county, and state.  
• Located outside of a flood zone.  

• Kids can walk to top-rated schools.  
• Located in a few specific cities, within specific neighborhoods in those cities.  
• Close to the hospital—medical professionals rarely, if ever, get downsized or laid off.  
• Not located across the demarcation line, or “across the railroad tracks.”  
• Has a longer term, 7–10-year hold.  

The building should be either:  

• Ground up new construction
  We develop the land and hold the property for one economic cycle, about ten years. Our build-to-rent townhomes often had around 50% equity at the end of construction.  

Or   

• Meet a specific building type
  We look for a garden style building, built in the mid 1980’s or newer. Class B or in some cases Class A. It should have units that haven’t been remodeled and property management that lacks the ability to manage the property well.

Let’s take a closer look at some of these points in detail. 

Landlord and Business Friendly Municipalities 

We watched the city of Seattle erode the landlord tenant laws and punish businesses for being very successful. We don’t want to invest in like-minded city, county, or states.  

Amazon’s corporate headquarters has been practically driven out of Seattle and is now quietly moving most new hires over to Bellevue, WA, a conservative island, in a sea of progressives. Much the opposite of Austin, TX, an island of progressives in a sea of conservatives. We personally don’t invest in progressive or “woke” areas.   

To expand further, in Seattle, the first “qualified applicant” who completes a tenant application automatically secures the rental. Past and/or current criminal behavior is not a reason for denial. Landlords cannot use social security numbers to run background checks.  

We want to choose who our tenants are to ensure they are a good fit and vibe with other residents in a complex. This is why we have sold all but one property in the state of Washington, and the other will be put on the market soon.  

FEMA Flood Maps 

It is essential to review FEMA flood maps before investing to ensure that the property is not at risk for flooding. Knowing the flood zone of a property can help you decide whether it is a viable option for investment. It is essential to review the FEMA Flood Maps to ensure the property isn’t at risk for flooding.  

You MUST click on the map and zoom in. I start by zooming in ALL the way and going to get a cup of coffee while the map loads. Remember, it is a government created website processing a large amount of data. IT. IS. SLOW.  

When looking at a FEMA flood map, blue shaded areas have a 1% chance of flooding annually. Insurance considers this a flood zone. An area with a 2% chance of flooding is tan in color.  

To give it a try, enter Galveston, TX in the FEMA Flood Map search. To get the FEMA flood map to display any data, your need to zoom in to a neighborhood or street level and wait a little bit.  The maps process a lot of data and are slow.  

 A Grade Schools 

Some ask why we only invest in apartment syndications in areas with high quality schools. The answer is simple. Quality schools often mean parents are involved in their children’s education. Parents interested in their kid’s education are responsible parents.  

Responsible people pay rent. Responsible people care about the community they live in. Responsible people typically do not trash the units. Responsible people don’t throw their trash out in the parking lot. Get the idea?  

I included the screenshot from GreatSchools.org showing Tomball, TX, where we are General Partners in a 206-unit apartment building constructed in the 1980s. Tomball is in the Houston School District. You can clearly see that Tomball High School ranks 9/10 in the district.   

 Why Explosive Growth? 

We also look for cities with current or planned rapid growth. And we mean explosive growth with various industries moving in and spending billions of dollars in manufacturing plants or millions of square-feet of office/warehousing/or flex parks. All this drives economic and population growth.  

For example, we did an internet search for news about planned developments in Tomball, TX. We used searches like “new business parks, Tomball, TX” or “massive expansion Tomball, TX.” After digging around, we discovered plans to build a new Costco, a new 3.3 million square-foot office park, and 2 additional office parks of approximately 1 million square-feet each. What we found is that, when added together, Tomball, a town of 12,500 people on the edge of Houston, is developing over 5 million square feet of “Flex Space!”   

Flex Space is modern version of an Office Park. Most Flex Spaces allow light industrial, warehousing, and offices. Typically, large warehouses are built with store fronts and entrances. The spaces are also easily changed to fit each tenant. For instance, if the tenant leasing 30,000 square-feet moves out, new walls can be placed inside, and two 15,000 square-foot spaces are created. There is obviously immense growth planned for this area, which also means? You got it. More tenants!  

Why Near Hospitals? 

The reason we were looking into Tomball was our great relationship with Clayton Bownds, who had a deal under contract in the area. The more we researched Tomball, the more we loved it.  And the apartments Clayton found happened to be 1,000 feet from HCA Houston Hospital.  

The reason we love to invest near hospitals is simple. Medical professionals make stable tenants.  They typically move in after college, keep their credit score clean, save money, and eventually go purchase a house. In the meantime, they pay their rent-on time. In my mind, that is the dream tenant – a person with goals, and desiring a better life.   

 Why We Avoid “The Wrong Side of the Tracks?” 

Think of the town you grew up in.  There was probably the “nice neighborhood”, then the proverbial “train track”, or street.  On one side of the street, it’s all roses and flower beds.  On the other side is nothing but broken-down cars and refuse in the front yard.  A thousand feet matters a great deal in many locations.   

You could use CityData.com to get a rough idea.  But you’re really need to walk around an area to get a true feeling for how rough a neighborhood is.  If you feel you need a flack-jacket to walk down the street, why on earth would you want to own an investment there?   

Some people, say, I only own where I want to stay. When I was in my 20s, I would have loved living in some of the apartments we own. Now? Grade A all the way! However, we love Class B apartments. Correction, we love investing in Class B apartments! 

Why 7-10 Year Holds 

With passive investing in apartment syndications, we are seeking long-term stable cash flow. 7–10-year holds will bring stable, profitable investments. Take for example a 1990s property that hasn’t been remodeled since it was built. We can rehab all the units, freshen up the exterior, refinance the property during the second year of ownership, take 70-80% of the investment out as debt, and re-investing those funds into another property, rinse, and repeat, and repeat. Within 10-years you can have 2-3 properties with infinite returns and stable cash flow.  

The Property 

There is a term in all real estate – Functionally Obsolete. The concept is simple, we can exaggerate that a concrete apartment building built in 1950 with tiny windows, electric baseboard heat, one bedroom, a 2-square-foot closet, a tiny kitchen with a 24”-wide fridge, and no room for a TV in the living room—because there were no TV’s back then, is functionally obsolete.   

What about 1970’s construction?  I still feel like it is too functionally obsolete.  Just like in 10 years 1980’s properties will be functionally obsolete. In many cases, it is not economically feasible to bring older buildings up to modern standards.  Load bearing walls need to be moved, new concrete footings need to be poured….it is expensive and time-consuming. I would prefer others people enjoy the pain and suffering of figuring all that out.   

Not Remodeled Since New 

In a property that hasn’t been remodeled, no one has gone in and messed anything up yet. That means we have a blank slate to make the units desirable, without spending a lot of money. We can install new modern-looking cabinet doors, replace the Formica countertops with granite in the kitchen and bath, and install virtually indestructible, yet natural looking Luxury Vinyl Plank (LVP) flooring.  

You have the chance to do simple, clean remodels and provide units with modern features like dimmable LED lights, new chrome or brushed nickel faucets, doorknobs and hinges, and ceiling fans that aren’t sagging.   

With simple math, if you can increase rent $150 on 100 units by making improvements, a property will earn $15,000 more per month.  That means $180,000 in 12 months.  

If you take $180,000 divided by the market caprate of a conservative number like 5.5%, there is a $3,272,727 increase in value.  At a 5.0% cap rate an additional value of $3.6 million, or $36,000 per unit!  

It is low hanging fruit and easy to do.  There are contractors who specialize in apartment remodels for around $6,000 per unit.  Once remodeled it is easier to increase the rent, resulting in a significant increase in apartment value.  

In some sub-markets there is a high demand for luxury rentals and Class A properties. In these cases, it might take an investment of up to $15,000 per unit. This means fancy fixtures and smart home systems with high-tech locks, thermostats, and lights. But the return on investment is also higher.  

Most improvements are inexpensive but make a big impact on potential tenants and the rents they are willing to pay.  

Exterior Improvements  

Single-family homes aren’t the only real estate that need curb appeal. Making exterior improvements can have as much impact as renovations in the units. Some examples include:  

• Re-surfacing the parking area  
• Painting parking stripes and fire lanes with vibrant paint 
• Offering reserved parking 
• Adding Car ports  

• Improve external lighting  
• Adding inviting landscaping  

Laundry  

Laundry can have a big impact on the rent tenants are willing to pay. If you can, installing washers and dryers in each unit is the most desirable. You can even charge $50 a month to lease them. If that isn’t an option, updating the laundry rooms with new flooring, fresh paint, better exhaust fans, vending machines for soap and dryer sheets, can all be done at a fair price.  

Hi-tech Fees  

Today, everything is high tech. It is a high-value item for a lot of tenants, and they are willing to pay for it. Consider having a hi-tech fee that includes items like high-speed internet, cable tv packages, electronic/keyless locks, or smart thermostats. Adding or improving this infrastructure will attract higher quality tenants. With a large enough property, you can even look at adding a local cell tower.  

Energy Efficiency and Utility Costs  

Much like technology, tenants are concerned with energy efficiency and utility costs. There are several ways to address this with property improvements. For example, you can add energy efficient lights in units, implement water conservation, or offer a Ratio Utility Billing System (RUBS).  

• Energy Efficient Lighting in Units 
• Water Conservation 
• RUBS (Ratio Utility Billing System) 

Add Amenities  

Amenities attract stable families and tenants which in turn improves community health and the sense of community among residents. Some examples include adding storage units, vending machines or even private yards or patios, if possible. Additional ideas include:  

• Pet amenities like a dog park. By fencing in an area and adding a fake fire hydrant and a small jungle gym for dogs you can say the building offers a dog park. For the convenience, you can charge $20 per pet. $20 x 25 pet owners x 12 months = $6,000 annually.  Divided by a 5% capitalization rate = $120,000 increase in value. Not bad!  
• Children’s activities like a playground. This goes back to attracting quality family tenants. Families with children will pay a premium to have these facilities right outside their door.  

• Resort-like amenities. While more costly, updating the fitness center, or adding a small one in an unused space, can have a large impact. The pool should also be sparkling clean, and adding items like outdoor BBQs add appeal. If there is a club house, offering clubhouse rentals can bring in additional revenue.  

Many of these improvements are easy to do, buy many current owners do not see the value in spending capital on their apartments. That is where you can step in and maximize your investment in a way they haven’t been able to figure out.  

Poor Property Management 

We have seen all types of property management companies. Some are great companies with bad employees. Some are great employees working for an unsupportive company. Some don’t train employees on new methods, laws, or even how to use a new complicated software system. None of these make an effective combination. Can you do better? Absolutely.  

I love finding an apartment in a B neighborhood with an absentee owner who just doesn’t care and a poorly run property management company. Yes, there will be 6 months to a year of hassles, like removing non-paying tenants and making repairs. But, in the end it is fairly low hanging fruit to increase the income, lower the expenses, which also increases the NOI and forces appreciation.   

In Conclusion 

This is just a high-altitude overview of the underwriting guidelines we use to find a strike zone and identify worthy investments.  

If you think passive real estate investing might be right for you, or you would like to learn more, please join our real estate investment community!  Reach out and contact us. 

Most of our investments require a previous relationship with our investors. Which means we have to know each other. 

Economic Vacancy, its practical use. 

A new Apartment Syndicator calls us up and gleefully tells us about this awesome deal he found! It is a 100-unit apartment that is 100% occupied, or put another way, has a vacancy rate of 0%. 

Sounds awesome! 

But there is always more to the story. 

Delinquent rent: 

• Frank only paid 50% of his rent. He has been laid off. But his unit is occupied! 

• Sally paid did better; she was able to pay 75% of her rent. But her unit is occupied! 
• Little Johnny, well… He didn’t pay any rent. But his unit is occupied! 

Rent Concessions: 

• Twelve retired people on fixed income are receiving a 10% discount. But those 12 units are occupied! 
• Mike got the first month rent free at move in. 

Employee Allowances: 

• The awesome property manager gets a free unit, but, you guessed it, her unit is occupied. 
• The maintenance guy is the best. He gets 50% off – still occupied. 

You get the picture. 0% vacancy, but not economically. 

But Wait, it gets WORSE! 

 Gain/Loss to Lease: 

• The business plan for the apartment syndication you are considering investing in is based on the theory that the market rent is $150 more per month than people are paying. What about all the tenants who still have 5 or 6 months left on their leases and who are not paying market rent? Gain/Loss to Lease is the term for that. 

Bad Debt Write Off 

• What about those tenants we evicted and were behind a few months when the judge finally approved their eviction? 

Model Units 

• Units that are used as model units for showings. They typically are staged with furniture. 

Units Down for Remodeling 

• Units are down for remodeling. Well, they aren’t listed in many T12s.   Or they are grouped under “Vacancy Lost.” 

A T12 is a 12-month lookback at the Profit and Loss of an apartment. 

The T12s I love have a row called Gross Possible Rent or Gross Potential Rent. Some are vague and will call it Market Rental Income.  

Here is an excerpt from a T12 for a 160-unit apartment in Houston, TX. This apartment required unit remodels, exterior paint, and driveway and parking lot resurfacing. A “Heavy Lift,” as the people who use buzz words would call it.  

 Practically Speaking 

A stable, well-run 100 to 400-unit apartment typically has an 8% – 12% Economic Vacancy. Again, it depends on the market the property is located in. Dallas typically has an economic vacancy of  8% to 10%. Houston generally is 10%-12%.  

 If we know a stable apartment in Houston has 10 – 12% economic vacancy, we will remodel 50% of the units in 18 months. The Economic Vacancy rate must be 15% to 25%.   

We know very experienced operators who remodel units and keep the Economic Vacancy at 15%. I wish we could share with you how they do it, but we pledged to them we would not.   

Conversely, inexperienced, first-time syndicators seem to have 23% – 25% Economic Vacancy in the first year, and around 18% in the second year, leveling off at about 10% about eighteen months into ownership.

The difference is in the experience level. Experienced syndicators know what kitchen and bath fixtures they will use, cabinet doors, countertops, light fixtures, and flooring. They will pre-order everything and have it in stock, and other efficiencies we can not discuss.  

Inexperienced will try remodeling a few units with granite countertops, tan walls, and nickel-looking fixtures. Then mix and match finishes with two more with Formica countertops, gray walls, and chrome fixtures.   

They have committee meetings trying to find the best solution. It is painful for me to watch.   

The key takeaway is simple. Suppose you see underwriting where the business plan for the apartment is to remodel 50% or 100% of the units, the Economic Vacancy is not displayed and you need a calculator to figure out the Economic Vacancy manually; when you do the math, the economic Vacancy is 10% every year – RUN!    

 Here is an excerpt from a deal we did invest in because the underwriting was conservative.  They had 26% economic vacancy the 1st year and 18% the second year.

Even though this was the General Partners’ 3rd deal, we did invest in it. We know, like, and trust the GPs; the underwriting was very conservative. This has proven to be a solid investment for us since 2019.  

In 2008 through 2011, even though people lost their homes, they still needed shelter. Many turned to less expensive apartments.  

Apartments hedge against inflation because leases are renewed yearly, keeping up with inflation. 

Leases are typically renewed once a year and rental rates adjust with prevailing market conditions.  This causes rents to rise in times of inflation and ensures landlords can keep up with rising prices while still maintaining cash flow.  

Currently, there is a home ownership affordability crisis – pushing our country into a Renter’s Nation. 
 

The homeownership affordability crisis is pushing our country towards a renter’s nation, making apartment syndications an even more attractive investment option in the long-term.  

Investing in apartments can provide you with steady cash flow and the potential for capital appreciation and hedging against inflation.  We strongly believe everybody should own rental property.  

There is a lack of supply of apartments projected for decades to come. 
 

Many industry experts and economists are forecasting the apartment shortage trend to continue. This means that we expected a lack of supply in the market for decades, especially as demand increases and new construction projects are hampered by rising costs and increasing regulations. This can lead to higher prices and increased competition amongst investors looking to enter the multifamily market.  

Municipalities are adding regulations further driving up the cost of construction.  
 

Municipalities are making it increasingly difficult to construct new apartments because of the new regulations they are implementing. These regulations have driven up development costs making it impossible to build work force housing in many areas like Seattle, San Francisco, and Portland.  

Since no new workforce housing is coming on the market, the older Class C apartments are seeing an increase in rent. This is driving up the cost to purchase Class C apartments and causing apartments to become a limited commodity.  

Tax Benefits for real estate are amazing with bonus depreciation, opportunity zones and tax abatements. 
 

Sometimes, with bonus depreciation, investors can take a larger deduction up front to offset their income and reduce their tax obligations.  

There is an adage: “PIGs can only be offset by PALs”. Passive Income Gains can only be offset by Passive Activity Losses (not active income).   

Additionally, Opportunity Zones provide substantial tax incentives for investments in economically distressed areas. However, in some cities experiencing economic growth, the Governors in a few states have made entire cities an Opportunity Zone.  Even those areas experiencing economic growth, such as the area around the Cleveland Clinic in Cleveland, OH.  Even though there is a major expansion of the hospital bringing in 20,000 new jobs, the area around the clinic is named an opportunity zone, allowing investors to delay paying capital gains taxes on the funds they invested into the area. 

Municipalities may offer Tax Abatements to encourage businesses and developers to invest in their communities.  

As always, talk to your accountant who knows your own unique situation, they can help you strategically reduce your taxes to near zero levels by investing smartly in real estate.  

Over time real estate appreciates in value. 

Real estate is a proven asset class that has been steadily appreciating in value. This stability and appreciation is attributed to the laws of supply and demand.  

With population growth expected to persist, alongside constraints on supply because of rising construction material costs and regulatory barriers, the demand for real estate will continue to increase. As a result, property values are likely to rise as a greater number of people compete or a limited amount of space.  

In Conclusion: 

 Don’t wait to buy real estate, buy real estate and wait!   

 The adage “Don’t wait to buy real estate, buy real estate and wait!” is still as true today as it was when it was first uttered by Will Rogers.  

Andrew Carnegie said, “ninety percent of all millionaires become so through owning real estate.”  

Real estate has consistently proven to be among the top methods of generating wealth over time. Investing can provide financial security and stability in contract to more volatile investments like stocks.  

Investing passively in apartment syndications is a great option if you are looking to outpace inflation, enjoy your free time, and not have all your eggs in the volatile stock market basket.  

We LOVE passively investing in Real Estate!  We have been actively investing since 2000, and still do. But, once we started passively investing, we gained our time back, and continue to grow our wealth. We strive to outpace inflation by investing in areas that are in the path of progress, in business and landlord friendly municipalities, and in areas with explosive growth in manufacturing and job creation.   

If you want to learn how to passively invest in real estate to create a stable financial future and time to pursue other goals and interests, check out one of our courses where we share our expertise to help you get started!  

These should include questions about the experience and capabilities of the general partner’s team, the portfolio strategy they will execute on, what sets them apart from other apartment syndicators, and how they plan to mitigate risks and uncertainties in today’s volatile real estate market. 

What should I avoid when looking at a General Partnership team? 

In the 28 apartment syndications we have invested in, we have worked with both brand new and highly experienced syndicators with over a decade of experience and a staff of 16 employees. Both have advantages and disadvantages. The main takeaway is to feel comfortable investing with the General Partner you know.  

Avoid the used car salesman.  

Some General Partners use high-pressure tactics to convince us to invest, which we decline. For us, the used car salesman approach doesn’t work. When we invest passively, we look for smart, creative, articulate, and down-to-earth individuals.  

Do their words speak louder than their results?  

We also avoid empty suits—or those people who know all the latest buzzwords. They will tell you they are working with a family office that represents $100 million, and then beg you to invest $50,000. Then, they will even reduce it to $5,000. The worst deals we have seen are from this type of person, and we run away!  

Is a celebrity partner really better?  

You also need to watch out for the “celebrities.”  I bet, if you can find somebody who has invested in a celebrity’s deal, and you ask how it went and what the final returns were, the outcome will have been dismal.  

What is the General Partners experience?  

The reality is it is essential to work with an experienced sponsorship team. That said, we have invested with inexperienced General Partners. However, they were directed and led by General Partners with 10+ years of experience. New syndicators need the resources and expertise of highly experienced investors, and this is a great way for them to learn about the business.  

When inexperienced General Partners team up with highly experienced General Partners, you, as the passive investor can benefit. The deal will typically be more stable. The Deal Sponsor can give tasks to the inexperienced GPs to gain knowledge and become more valuable in future deals.  

So, what qualities should an expert-level General Partner have?  

Knowledge in  

• The market 
• Property management 
• Insurance 
• Cost segregation 
• Accounting 
• Underwriting 
• Risk mitigation 
• FEMA flood zones 
• Financial expertise 
• Legal documents 

Contacts with 

• Lenders 
• Commercial Brokers 
• Insurance Agents 
• Cost Segregation Experts 
• Accountants 
• Lawyers 
• Contractors in every submarket 
  • Subcontractors- 
    • Electricians 
    • Plumbers 
    • Sewer repair 
    • Roofers 

Their finances 

• Net Worth 
• Liquidity 
• Fannie Mae “Experience” 
• Local Bankers 
• Regional Bankers 
• National Bankers 
• Loan Brokers 

For a new GP on your first deal, your limited partners will feel more comfortable investing their hard-earned money into the deal, knowing there is a very experienced team standing behind you. As a passive investor, it allows you to work with an expert-level team, even if there is an inexperienced GP involved.  

How long will the property be held? 

As a passive investor, consider both long- and short-term options when looking at the holding period of an apartment syndication. What should you look for when considering each option?  

Long-term holds   

An example of a long-term syndication hold would be 10 years. The plan with a longer-term hold is to rehab all the units, and then refinance during year two or three. After the property is refinanced the lion’s share of the investment is returned to the Limited Partners. Since it is debt, it is not a taxable event. Also, the cash flow should increase to around 15% to 20% during the third or fourth year. These are the properties we prefer because we love the stable and steady cash flow, and we love receiving the bulk of our investment back which we can re-deploy in another deal to create infinite wealth. 

Short-term holds  

Some syndications are held 3 to 5 years, are considered short-term. In this case, ideally about half of the units would be remodeled. Once the property is stable after the remodel, it is then sold. The goal is to double the investors investment. But it is a taxable event. So, in many cases the investors need to pay taxes on their massive gain. We do not enjoy giving up a 37% of the profit in the form of taxes, so we strive for longer term holds. 

Many investors do like the short-term model, but we personally, enjoy the “Steady Eddie” cash flow of the long-term holds! But, since we know investors who enjoy both, when we are General Partners, we try to have a mixture of short term and long term holds every year. 

What legal regulations will be followed, and documents provided?  

It is always important to understand what legal regulations will be followed and what legal documents will be provided.  

As a passive investor, you should always confirm that any syndication deals are well structured in accordance with SEC Reg D 506(b) or 506(c) offering guidelines. 

It is always important to review any legal documents associated with the syndication deal. This includes the Operating Agreement and other applicable documents that outline the roles and responsibilities of the General Partner.  

In all the deals we have invested in there have been three legal documents to sign:  

1. LLC Agreement 

The apartment will be owned by an LLC with an LLC Agreement, which should give you, the limited partner or member of the LLC, certain rights. Conversely, it will control the General Partners, or Managers, and not allow them too much leeway. 

1. Private Placement Memorandum 

The Private Placement Memorandum (PPM) is a document that breaks down the business plan for the investment. It isn’t required for a 506(c) offering, which is only for accredited investors. But in every deal, we have invested in the PPM is included.  

1. Syndication Agreement  

The Syndication Agreement breaks down how many shares you are purchasing and the method you are choosing to invest through. For example:  

• A Self-Directed IRA. (read “The Dirty Little Secret” about SDIRA investing here.) 
• A Solo 401k. 
• Investing with your spouse, and you both sign.  
• Investing with your spouse, but the spousal consent is NOT required. (For Elena and I it is just easier to quickly fill out the paperwork.) 
• Investing via an LLC.  
• As a foreign national via a domestic LLC.  
• As a Tenant-in-Common, TIC (Pronounced “Tick”).  

When combined, the three documents can total 150 pages or more.  

By taking the time to review the legal documents thoroughly, you can protect yourself and maximize your returns when investing in apartment syndication deals. There should always be verbiage in the LLC Agreement stating what your options are in certain situations. God forbid you get divorced, pass away, or the Deal Sponsors commit fraud. A scroll through the documents can bring up any red flags and save you major headaches in the future.   

You might think it odd for me to give you tips to ensure you are investing in a legitimate syndication. However, we have seen some strange deals lately. In one proposal, we received a three-page contract drafted by the sole General Partner. Please run from deals like that!  

Ask about tax reporting 

When investing in an apartment syndication, passive investors should also be aware of K-1 forms and the associated reporting requirements.  

Investors file K-1s with their taxes each year, which report their portion of the income, deductions, credits, and more from a specific property. It is the Deal Sponsor’s responsibility to ensure these documents are completed accurately and sent in a timely manner. 

There are circumstances when the K-1’s will be delayed, and you will need to file an extension with the IRS. This year, we are in the middle of gathering 21 K-1’s. We know some will be late and have already filed our extension, as we have done every year since investing in apartments. It’s not a big deal or a red flag with the IRS, rather a common occurrence sophisticated investors have.  The IRS understands this.  

When acting as a General Partner or Deal Sponsor, we strive to provide K-1s promptly so that investors can complete their taxes without delay or disruption. 

How reliable will the distributions be? 

Another important thing for a passive investor to be aware of is the distribution schedule and anticipate cash flows from their apartment syndication investments. 

In some cases, there won’t be a distribution for the first six months. During this time, if units are being remodeled, the vacancy rates will be high. Cash reserves are being added to the apartment specific LLC bank account for rainy days or emergency repairs. 

In many deals, the estimated cash flow is broken down annually. Typically, it will be around 4% to 5% the first year, 6% the second year, 8% the third, ramping up as the rents are raised over time. Generally, on average over 5 years we expect to see 8%. We’ve invested in a few with cash flow around 4%, but we sold within 3 years and nearly doubled our investment.  

Plan on quarterly distributions that ramp up over time. Plan on years of recession with lower to zero distributions. Plan on years with more distributions. In other words, be prepared for anything!  

Investing with second mortgage or HELOC funds 

You might be tempted to take out a second mortgage on your house. We generally don’t recommend this in investing in apartment syndications because cash distributions can be sporadic.  

A recession can happen, you could lose your W-2 job (and therefore your income), while at the same time cash distributions become non-existent. And you’re left having to pay your second mortgage on top of your first mortgage. Which puts your home at risk. 

By taking a more conservative approach, you can protect yourself from potential losses while still reaping the rewards of apartment syndication. 

We are risk averse, which is why we love apartments. There is no need to make it a risky investment!  

If you do not learn to invest passively, you will work until you die. 

Without a form of passive income to cover your expenses you will ALWAYS need a job with a salary or hourly wages to pay for your expenses. By learning how to invest passively, however, you can build up a reliable income stream that will provide financial security and allow you to enjoy retirement sooner. 

As you grow as an investor, you can create diversity in your investments for even more financial security. We invest passively in many deals to create diversity. We also reinvest most of the cash flow into future deals creating infinite wealth. It is great to see our investments double every 5 years, ensuring our financial stability for years to come.  

At Andover Holdings we have decades of successful investing experience, and we want to share that knowledge with you. If you want to learn more about creating a lifetime of wealth, we invite you to check out our course in passive investing for apartments where you will learn the warning signs and risks associated with apartment investments and how to spot lucrative deals. By providing you the necessary knowledge, we want to help you feel empowered to make decisions about apartment investing!  

We want to clarify; this is for knowledge sharing only and is not tax advice. Please consult your tax advisor, financial planner, and lawyer for advice regarding your specific situation. If you do not already have a team of professionals, we are happy to refer you to accountants and estate planning attorneys that can help you.

We have been learning about the tax code since 2005, when we first met our accountant, Thomas Howell. A very creative man who tempers common sense and a solid moral compass with the tax code. We feel Thomas provides us with the maximum tax benefits the tax code allows.

We are going to start by talking about the tax code. Most people consider it a rule book full of penalties and punishments. Instead, you should switch your thinking around and view it as a comprehensive guidebook to all the government incentives.

In the case of apartments, the government wants responsible citizens of this great country to provide clean, safe, and affordable housing. Therefore, Congress passed several laws in the tax code to encourage investors to provide housing:

• Depreciation rules.
• Bonus depreciation rules.
• The tax code also allows your investments to grow tax deferred via a Solo 401k or IRA.
• If you hold the property for more than five years, your tax rate significantly reduces from ordinary income rates, which top out at 37.5%, to capital gains rates, which currently top out at 15%.

The uneducated call these incentives “tax loopholes for the rich.” When they are rules, codes, and laws purposefully placed in the tax code for you, me, your neighbor, and every American advantage, tax professionals tell us that most countries have similar tax laws. However, at least 95% of America would rather waste their free time than spend time learning about methods the wealthy use.

Solo 401k Plan Overview

We have invested in seven apartment syndications using our Solo 401k dollars, our funds to grow TAX-FREE until it is withdrawn from the Solo 401k, just like any other 401k account. If you’re considering investing in apartments with your Solo 401k, you could take advantage of some great tax benefits. Here are just a few of the ways Solo 401k investors can save on taxes:

1. Your Solo 401k contributions are generally tax deductible. That means you can reduce your taxable income and possibly save on taxes at the end of the year.
2. You can also take advantage of tax-deferred growth with Solo 401k investments. That means you won’t have to pay taxes on any gains until you start withdrawing money from your account, potentially resulting in significant tax savings over time.
3. You can also rollover other retirement accounts into Solo 401ks, allowing for greater diversification and tax efficiency.
4. Finally, Solo 401k investors may be eligible for Solo 401k loans that can help pay for their investments in apartments, providing additional tax benefits. The loan must be a non-recourse loan.

All the above tax savings compound. While most people receive a paycheck AFTER all taxes have been taken out, as a small business owner, you pay yourself first and all your company expenses, then the company pays tax on the profit that is left. The funding of a Solo 401k would be a business expense, reducing the company’s profit.

Then as an added benefit, you will not pay capital gains or ordinary income tax on the 401k investments. Again, think about this, you do not pay taxes on the growth of your investment!* *(Until you withdraw the funds.)

That is a considerable saving. We choose to invest those dollars into another apartment deal. It is ALL about infinite returns to grow your money. Elena and I like to picture a snowball pushed over the hill, and it becomes an ever-growing force, gathering more and more momentum as it goes, ultimately creating legacy wealth for our heirs.

How to set up a Solo 401k
To have a Solo 401k, you must own a business. Don’t have a business? Start one.

Then you will need a plan administrator. The administrator we use to set up our Solo 401k is, MySolo401k.com. Setting up a Solo 401k is a straightforward process with just a few pieces of paper. My Solo 401k will create a customized and IRS-approved solo 401k plan.

The solo 401k plan will be a trust type of account in the name of the company with you as the beneficiary. It will have a name like My Company LLC Trust for the benefit of John Smith.

Next, you will need a financial institution to hold the funds, which is also simple. Finally, you will open up a trust account at a financial institution in the name of your Solo 401k plan, My Company LLC Trust, for the benefit of John Smith. We like Fidelity because they make the process very simple.

You will have complete control over your solo 401k funds. Which means you can wire funds at any time. Or you can even use a checkbook.

We have used Fidelity Investments to hold our Solo 401k funds for 13 years. Many companies with thousands of employees use Fidelity to manage their 401k plans. Nothing is stopping you from doing the same thing.

How to Fund Your Company’s Solo 401k

One easy method is to roll over existing retirement accounts into your new Solo 401k. You can even roll over IRA funds. WARNING – set up your Solo 401k first! And have the custodian of your retirement account wire the funds directly into the Solo 401k. It must NEVER go through your personal bank account, or you must pay taxes on it.

We have funded our 401k since 2010 using employer contributions. The employer is our own company.

The 401k tax laws allow for up to $22,500 of your income to go into the plan, this is called an Employee Deferral, and you would pay no income tax on that amount. Furthermore, your Employer (the company you own) can contribute $43,500 to the Solo 401k plan. For a total of $66,000 Per Year. Or $73,500 for those over 50 using “Catch-up Contributions.”

The contributions amount your company pays into your 401k is an ordinary business expense. Meaning it lowers the Net Income. So congratulations, now your company is not paying taxes on $66,000 or on $73,500 if you are using Catch-up Contributions.

How to invest with a Solo 401k

The trust will have an EIN, Employer Identification Number. It will be the same EIN as your company. Here is a link to a W-9 you can use as an example. This link comes from MySolo 401k.com

Caveats of investing with a Solo 401k
Major caveat: When you take your money out of the 401k, it will be taxed as ordinary income, just as any 401k.

Other fine print and caveats to be aware of:

• Solo 401ks are specifically designed for self-employed individuals, freelancers, and small business owners without employees (other than themselves or their spouse).
• It is a 401k account with the same withdrawal rules and penalties as any other 401k.
• You cannot use Solo 401k funds to purchase a property you will have use of or have material participation in. In other words, passively investing in apartment syndications is a perfect way to grow your wealth tax free using a Solo 401k.
• Do not comingle Solo 401k funds with your own funds.
  • Do not get a credit card in the name of the Solo 401k.
  • Do not pay personal expenses using your Solo 401k.
  • Do not pay yourself a salary from your Solo 401k.

By setting up a Solo 401k, you can enjoy the same tax benefits as traditional 401(k) plans and have more control over your retirement savings. Solo 401ks offer flexibility and customization options that other retirement plans don’t provide. So if you’re a small business owner, the Solo 401k plan may be the perfect solution for your retirement savings.

As stated earlier, we have been using a Solo 401k for 13 years. The tax benefits and freedom of controlling our 401k account have been very rewarding for us!

CONSULT YOUR ACCOUNTANT, CPA, EA, and or Attorney! We can’t say that enough. We are not accountants, CPAs, EAs, or any form of a tax advisor. The information contained in this article and all articles on our website is for knowledge sharing only and not intended as tax advice!

REITs and Apartment Syndications both own property and are methods used to invest in real estate passively. A REIT is a publicly traded entity. You can invest in a wide range of real estate through a REIT: office buildings, shopping centers, apartment complexes, warehouses, and more.

Real Estate Investment Trusts are publicly traded. Therefore they are easier to find and open to all investors. Real Estate Investment Trusts are heavily regulated by the SEC. A REIT must distribute 90% of its taxable income to shareholders via dividends.

Are Real Estate Investment Trusts better than the stock market or apartment syndications?
Based on my 23 years of investing in various real estate assets, REITs’ performance is not as good as most other real estate investing methods. In fact, according to Motley Fool, the average REIT returns less than the S&P 500 in both 5-year and 10-year market cycles ending in 2022.

What is an Apartment Syndication?
Apartment Syndications also have SEC guidelines and, for the most part, have higher returns.

Apartment Syndications typically involve two groups of investors: the General Partners and the Limited Partners. The General Partners, called Lead Syndicators or Deal Sponsors, find and manage the asset.

The other group is Passive Investors, who can be accredited or sophisticated investors. The Limited Partners are indeed Passive Investors, meaning they do not have any duties or responsibilities.

Like Real Estate Investment Trusts, Apartment Syndications also have SEC guidelines. For example, many Syndications fall under SEC Reg D, 506(b). SEC Regulation D, 506(b) is an essential part of the securities law that affects how syndications can raise capital.

The most significant benefit of using Reg D, 506(b) is that it allows the General Partners to raise capital from friends and family members to invest in a syndication, without public advertising. This saves the GP’s money on marketing costs, which can be very expensive when raising capital.

Another advantage of Reg D, 506(b) is that the rules distinguish between “sophisticated” investors and “accredited” investors. Sophisticated investors have sufficient knowledge to evaluate the risks of investing in a company and make their own decisions about whether or not to invest. Accredited investors, on the other hand, are considered financially capable because they meet certain income or net worth requirements. Here is a link to an article about Accredited Investor Requirements.

Reg D, 506(b) also limits how much friends and family can invest in a company. This ensures that companies do not get too heavily reliant on one investor or group of investors, which could put the company at risk if they were to decide to pull out their investment suddenly.

All 27 of the apartment syndication we have invested in have had extensive legal documents ensuring compliance with SEC laws, providing us with peace of mind knowing the rules are regulations are being followed.

In most Apartment Syndications we invest in, the plan is to improve around half the units. By enhancing the units, we achieve rapid income growth, which forces appreciation. Based on our experience in 13 current deals as Passive Investors and 5 “Full Cycle” deals, we far outpace the S&P 500.

On the apartments that have sold and gone “Full Cycle,” our average return has averaged around 20% to 25% per year. It is not uncommon to double our money over three years. Our worst deal had a 16% Internal Rate of Return, IRR. A fancy way of saying 16% per year. However, there have been times, like now, in 2023, when the General Partners decide to “error on the side of caution” and retain significant amounts of cash to build up a rainy day fund, which decreases cash flow. I think this is a great idea, and I do not mind that the cash flow declines.

In conclusion, REITs and Apartment Syndications are both viable options for investors looking to invest in the real estate market. REITs offer a lower level of risk and a steady stream of lower income. In essence, REITS are very easy with lackluster returns, in my humble opinion, based on 23 years of active real estate investing.

Apartment Syndications offer the potential for higher returns. However, most Apartment Syndications have 5, 7, or 10-year business plans for investors who desire more cash flow over more extended periods with a large payout when the property sells.

What are your investment goals? Determining your investment goals based on your short-term and long-term dreams and desires is very beneficial. Then decide whether a REIT or a Syndication is right for you!

What steps do I need to take to be certified as an accredited investor, and what are the verification steps?

To become an accredited investor, you must meet certain net worth or income criteria established by the Securities and Exchange Commission (SEC). We will first show how most of our investors qualify as accredited investors. Then show how to be certified as an accredited investor. Lastly, we will go over the new categories the SEC allows. Then, just for fun, what the future holds for the $1,000,000 net worth hurdle.

To be an Accredited Investor, Most People Qualify Based on Income and/or Net Worth:
Verify your income: You must have an earned income of at least $200,000 for the last two years (or $300,000 for joint income with a spouse) and have the reasonable expectation to make the same amount this year.

OR

Meet a net worth hurdle of at least $1 million, excluding your primary residence. Either individually or jointly with your spouse. This net worth must not include the value of your primary residence.

OR

Hold a Series 7, 65, or 82 license.

Accredited Investor Certification

Once you have met one of the above hurdles, in many cases, you can self-certify, which is checking a box and signing your name to it. That’s it. You do not need to share your private financial information with the General Partners in an apartment syndication.

However, in 506(c) offerings, you will most likely need to have your: licensed broker-dealer, investment advisor, licensed attorney, certified public accountant, or enrolled agent fill out a form verifying you are accredited. It is a simple form called an Accredited Investor Verification Letter. Here is the one which we use for our investors. In Media folder/forms you do not need to share your net worth or income with the General Partners in a deal.

More Methods of Being an Accredited Investor

Any trust, with total assets in excess of $5 million, not formed specifically to purchase the subject securities, whose purchase is directed by a sophisticated person. A sophisticated person means the person must have sufficient knowledge and experience in financial matters to evaluate the merits and risks of the prospective investment.

OR

Certain entity with total investments in excess of $5 million, not formed to specifically purchase the subject securities.

OR

Any entity in which all of the equity owners are accredited investors.

If you do not meet those requirements, you may still qualify to invest in some real estate syndication deals as a sophisticated investor.

Even more ways to meet the accredited investor requirements

The above has been the requirements since 1982, when Regulation D was adopted by the SEC. In 2019 the SEC amended the criteria to become an accredited investor and added optional entity requirements as well:

• Investment advisers registered with the Commission
• State-registered investment advisers
• Exempt reporting advisers
• Rural business investment companies
• Limited liability companies with more than $5 million in assets
• Certain family offices and family clients
• Entities owning investments in excess of $5 million

Future Accredited Net Worth Hurdles to be Raised in 2023:

It is expected that sometime in 2023, the accredited investor requirements will be raised to keep pace with inflation. The current hurdles were placed in 1982! When adjusted for inflation to 2023 dollars the numbers are as follows:

The rumors are the accreditation hurdle is expected to be reset by congress in 2023 to:

• $3,000,000 in net worth or
• $300,000 income or
• $500,000 joint income if filing with your spouse

Here is more information right from the SEC themselves

**There is a Dirty Little Secret about investing in Real Estate using a Self Directed IRA!!!

That’s right: get into property investment without debt or tapping personal finances. As an SDIRA holder, not only will you be able to choose from various types of real estate investments but you will also benefit from increased diversity as well as hedging against inflation. But make sure that whatever decision is made complies with IRS regulations, so your plan status remains qualified for tax exemption purposes.

The IRS rules are very strict. We have included some below.

What your SDIRA can own:

• Land, whether it is undeveloped or is developed.
• Residential real estate
• Commercial real estate (apartments.)
• Trust Deeds
• Mortgage Notes
• Real Estate Options

There are rules governing Self Directed IRA rules. However, we strongly suggest, encourage, more or less demand, you speak to your own tax advisor before setting up an SDIRA to invest in apartment syndications, or self-storage, office parks, stand alone commercial spaces like Dollar Stores, Drug Stores, etc.

The IRS rules are stringent. We have included some below. Let me stress: Some, not all.

You and your family can not benefit from SDIRA owned property. The IRS calls yourself and your family “Disqualified persons.” This includes yourself, your spouse, children, parents, grandparents, grandchildren, and their spouses, any lineal ascendants, and descendants.

Technically speaking, your mother-in-law may be allowed to benefit from an SDIRA. I would not take that chance, though! Your adopted children could not benefit.

The disqualified persons listed above can not benefit in any way. They can not rent your property or work on the property. Furthermore, the companies that you and all the other disqualified persons own can not work on the property. These transactions are called Prohibited transactions.

If your father owns a roofing business, you hire the business to re-roof your apartment building. That would be a Prohibited Transaction. Do not do that!

How to fund your IRA

1. Transfer funds from another IRA you own. By transfer, we mean from one IRA account directly into another IRA account. Never pass retirement through your personal account, not even for 1/100th of a second.
2. Rollover funds from a previous employer’s 401(k). A rollover, unlike a transfer, is a reportable event.
3. You can always contribute money from your personal accounts to your SDIRA. Maybe set up an automatic monthly contribution.

How do you fund a real estate purchase?
There are several ways to fund a real estate purchase. You can:

Making a direct purchase using the funds in your IRA is the easiest and simplest way to purchase a property. Your IRA pays cash for the investment and holds the property title. Also, you will avoid a large UBIT tax. See below under “Must Read Gotchas.”

Partner your IRA funds with personal funds, money in another IRA you own, or with funds owned by another person. You divide ownership based on the investment of both parties. Read our report to learn more about Partnering with Self-Directed IRAs.

Make a leveraged purchase. Your IRA can borrow money to purchase a property with a non-recourse loan.

Form an LLC in which the SDIRA holds an interest. Then title the property in the name of the LLC. Have the assistance of a competent legal and/ or tax advisor before entering into this type of arrangement!

Then you need to direct your IRA Custodian to make the Purchase.

All related income and expenses must be paid to or from the IRA. Rent checks must be sent to your property manager or directly to your Custodian to be deposited into your IRA account. If you employ a property manager or hire a plumber to make repairs, they need to be paid directly from the IRA.

All contracts and agreements for roofers, plumbers, property management services, tenant agreements, insurance policies, and tenant agreements every agreement must be in the custodian name.

It will look something like this: Custodian Name FBO, Your Name, Account #11223344. FBO means “For Benefit Of.”

Must read Gotcha’s
This has more caveats and gotcha’s than investing with a Self Directed IRA:

• The DIRTY LITTLE SECRET is UBIT, Unrelated Business Income Tax. UBIT is triggered in most real estate investing because income that is generated from debt-financed property is taxable. It is taxable up to the full 37% tax bracket and kicks in only after $14,450 in income for 2023.
  • We know people who, after they have retired, under the supervision of a competent accountant, have legally started a company, set up a Solo 401k Plan, and rolled their SDIRA into the Solo 401k to solve their UBIT penalty. Personally, I would only do this with help and supervision from our accountant, as it requires knowledge and planning.
• As with the Solo 401k, you cannot use the property. Also, your family members or, in Tax Lingo, a “disqualified member” family.

There many advantages to investing with an SDIRA, but you need to know the downsides too.

I beg of you, if you are considering using an SDIRA seek help from a competent tax advisor. In a simple website article, there is no way you are armed with enough knowledge to set off and buy a property with Self Directed IRA funds.