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The distinction between Real Estate Syndications and Single Family Homes

We've discussed the advantages and disadvantages of passive commercial real estate investing in Syndications versus REITs, but what about another type of real estate — single family homes? Passively investing in single family homes (SFRs) entails purchasing an SFR with the intention of holding it as a rental property from a turnkey provider who handles all aspects of the transaction. To participate in and profit from a commercial real estate syndication — a partnership between an operator who handles all aspects of the transaction and a passive investor who funds a portion of the down payment and rehab costs.

Because both strategies are passive, they have the same level of control (or lack thereof). However, because they are two distinct types of real estate, the advantages and disadvantages of each differ. So, to see which passive investment strategy is best for you, let's compare and contrast them based on three criteria: time commitment, returns, and risks.

1. Commitment of Time

A completely passive investment does not exist. Both strategies require similar time commitments: you must initially qualify the sponsor/turnkey provider, qualify their deals before investing, and stay up to date on the progress of the deal after it closes.

There are also distinctions.

Understanding and evaluating an SFR is simple because it is a one-unit residential house. You most likely have the necessary education to obtain a passive SFR investment. Apartments, on the other hand, are a more complex asset class. Before you can become a passive investor, you should probably educate yourself on the apartment syndication process.

Passively investing in apartment syndications makes scaling easier. After you've qualified the sponsor, all they have to do is send you a deal and you decide whether or not to invest. You will choose from a menu of deals for each SFR investment. It can take months to find one that meets your investment objectives, after which the process is repeated.

Furthermore, because you're limited to the number of residential loans you can obtain, which is usually around ten or so, you'll eventually have to buy SFRs with all cash or with creative financing, both of which take longer than traditional financing. You can usually invest any amount — though a minimum investment of around $50,000 is common — an unlimited number of times in apartment syndications without having to worry about securing or qualifying for financing. This reduces your ongoing time commitment while increasing your scalability.

2. Returns

In terms of returns, the two factors to consider are cash flow and equity. Cash flow is the ongoing profit distributed to the passive investor, whereas equity is the profit captured at sale and/or refinance.

As a passive investor in a single-family home, you own 100% of the property and thus receive 100% of the profits. Because an SFR only has one rentable unit, the returns are more volatile. If you have one vacancy, you are completely vacant. If you have a single maintenance issue or an expensive turn, your cash flow can be wiped out for a few months to a few years.

After owning a few single-family home rentals, I can tell you that all of my cash flow projections before purchasing them were incorrect due to unexpected expenses that wiped out any gains I anticipated. Because you only own a portion of the property as a passive apartment investor, you receive a smaller percentage of the profits. However, because apartments contain hundreds of units, a few vacancies, evictions, or maintenance issues have a smaller impact on cash flow. Simultaneously, you are usually offered a preferred return, which is a minimum return distributed to investors before the sponsor is paid. A greater number of units combined with a preferred return results in greater cash flow certainty.

The value of SFRs is determined by the market, which is outside of your control. Sure, in a rising market, you could double the value of your home. However, you may be unlucky if the market is stagnant or depreciating.

The value of an apartment is determined by revenue rather than the market, which is under your – or technically, the sponsors' – control. The sponsor can raise rents by renovating and increase revenue by providing certain amenities (i.e., coin-operated laundry, carports, storage lockers, etc.). Luck has been replaced with skill. If the sponsor follows through on the business plan and increases revenue, the property value, and thus your investment, rises.

3. Risk

As a passive investor, you have 100% ownership in a single-family home, which means you share 100% of the upside and 100% of the downside. You bear the entire risk. Because you signed the loan, you are fully responsible for the debt. If you miss a payment, you will suffer the consequences.

Because there is only one rentable unit, the SFR cash flow is more vulnerable. This risk, however, is mitigated once you've reached a certain number of SFRs.

A passive portfolio of 100 SFRs, on the other hand, is not the same as passively investing in a 100-unit apartment community. Because single-family homes are dispersed throughout the market, economies of scale are not as beneficial. Management and contractor fees (e.g., landscapers, maintenance personnel, etc.) are higher. The advantage is that you own 100% of the 100 SFRs rather than a portion of the 100-unit apartment community, which means you have more long-term upside potential.

Because you are not signing a loan, passively investing in commercial syndications is less risky. The risk is also reduced from the start because you are investing in multiple units rather than having to scale to hundreds of units. With hundreds of units in one centralized location, economies of scale are realized, resulting in lower management and contractor costs.

Who is the victor?

Commercial syndications, in my opinion and that of many other investors, have a lower time commitment, more predictable returns, and lower risk. SFRs have lower scalability, higher risk, and more volatile returns in the medium term, but higher long-term upside potential.

At the end of the day, the best strategy is determined by weighing the pros and cons of each and determining which one best aligns with your risk tolerance, time commitment, and return goals.

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