Joint Venture
Making Big Investors Out of Little Ones
By
Oct 8, 2005, 23:08

I said, “You probably have friends whose bankrolls are about the same size as yours. Did you ever think of suggesting to three of them that each of you chip in $5,000, so you can offer twenty grand for a piece of one of those big attractive investments?”

No, he hadn’t thought of it. But now he’s doing it, and gurgling happily all the way to the bank. By pooling their spare cash, he and his friends sometimes earn three to six times the amount they put in, not counting the tax benefits.

The strategy of cash-pooling – sharing ownership through partnerships or other forms of syndication – is the wave of the future in real estate. During the 1980s it will be the smartest shortcut to big profits.

A buyer’s market in real estate is emerging. Property prices have climbed too far too fast. Asking prices on homes were out of line. We have seen home appreciation come to a halt in the last few months, and in some areas slide backward … there is over double the number of properties in the distressed category now as compared to a year ago, and w have a full-blown buyer’s market.

This trend is likely to last for years to come. Deep-seated economic forces will continue to cause unemployment and business failures, which in turn will cause many property owners to sell for whatever they can get.

Today smart investors are putting together syndicates that can buy big properties. Wouldn’t you rather own 5 percent of a milling-dollar property than all of a $50,000 house? Big investments tend to be better investments. Even a $100,000 apartment building is likely to be in bad shape, while a $10 million apartment complex is prime property – it has usually better tenants and faster cash flow. Its value rises more steadily. And the actual risk to its owners is less than in small properties, even though more dollars are at stake.

Think in millions. Maybe the biggest buy you’ve made so far is a $10,000 car with $1,000 down and three ears to pay, but don’t let a string of seven or eight digits scare you. You can negotiate a million-dollar transaction more easily than a small one, because the negotiators and lenders will treat you as a Very Important Person.

There are more big properties for sale than there are qualified bidders. A bank’s high interest rates needn’t deter these bidders. As I often point out, it’s not how much you pay for the rental of money that’s important, it’s how much you’ll make from the use of it.

For these and other reasons, I advise you to give thought to shared-ownership ventures – eventually organizing them yourself when you’re experienced enough, but probably starting by going into ventures organized by others when you find good ones.

What is a syndicate? Don’t be afraid of the word. It has various dictionary meanings, most of which don’t apply to real estate.

One of my dictionaries, published in 1948, says a syndicate is “a combination of bankers or capitalists formed for the purpose of carrying out some project requiring large resources of capital.” A more recent dictionary loosens up the definition a bit: “An association of individuals united to negotiate some business or to carry on some enterprise requiring large capital.” That’s approximately what the word still means in real estate, although the term “real estate syndicate” has no special legal significance. It includes any grouping investors for the purpose of buying and owing property together.

Of course “syndicate” has other meanings too. Newspaper columnists and comic strips are distributed to many newspapers by agencies called syndicates, such as the King Features Syndicate or the Times-Mirror Syndicate. And in recent years some dictionaries have included a more sinister meaning: “a loose association of racketeers in control of organized crime.”

Put all those connotations out of your mind. There’s nothing evil about a real estate syndicate. It’s entirely legal, peaceable, and – if well run – deliciously profitable. To repeat, I think you should get into one or several syndicates.

In this article, the word “syndicate” means group ownership of income-producing real estate. It is a tool that investors can use to make a lot of money, even though they may not have much money as individuals at the start.

Most syndicates are limited partnerships, but several other forms of group ownership can also be called syndicates. Let’s get the less common ones out of the way first.

Suppose five acquaintances sit around shooting the breeze about possible real estate transaction. Each has $50,000 to invest, we’ll say. One remarks, “I just heard about a good apartment complex for sale. Fifty unites, in a fast-growing part of town.”

Somebody asks the price. The owner reportedly wants $1.2 million with $200,000 down. The balance can be carried back on a wraparound mortgage at 10 percent.

“Too rich for my blood,” one of the five says, “But wait a minute, why don’t all five of us chip in, and buy it together?”

So the group starts considering possibilities. There are several ways they might organize themselves.

Forming a corporation is the first way they think about. An attorney can set up the Friendly Five Corporation as a legal entity. This corporation could buy and operate the apartment complex. What would be the advantages and disadvantages?

Here’s one big advantage. Each founder of the corporation, and any other investors they bring in, would have only “limited liability.”

That is, they might lose whatever they paid for stock in the corporation, but no more, regardless of the corporation’s debts. They can’t be sued individually for anything Friendly Five does or doesn’t do.

In forming the corporation, the five founders might each put in $50,000 for one-fifth of all Friendly Five stock, so that their corporation would be “capitalized” at $250,000.

A corporation is a person in the eyes of the law – able to buy property just as an individual can. But, unlike a real person, it is immortal; its life doesn’t end unless its stockholders dissolve it, or unless it is put out of business by the state that chartered it. This gives the corporate form another advantage: if a stockholder dies, or sells his shares, the financial structure isn’t affected. Investors can buy or sell shares in a corporation more easily than in a partnership.

So if our imaginary quintet goes corporate, it signs a purchase contract with the owner of the complex, and opens an escrow in the name of Friendly Five Corporation. It makes the $200,000 down payment, keeping $50,000 in its bank account. When the escrow closes, title is in the name of the corporation.

The corporation operates the property. The five investors (or more, if they decide to sell some of their shares) are the stockholders and probably will become the board of directors, with final decision making powers. If they choose, they can hire someone else for day-to-day operation of the corporation.

As a person, Friendly Five Corporation will file its own tax returns and pay its own taxes. But here we come to some big disadvantages.

If a corporation suffers an operating loss, that loss may be carried forward for tax purposes, but it can’t be passed through to its stockholders for use in their own tax returns. The only ways the red ink might help them financially would be if they sell their stock for less than their purchase price, and report this transaction as a capital loss – or if they collect dividends that are ruled non-taxable because of the corporation’s losses. Even when the corporation nets a profit, the stockholders won’t be enriched as much as they would through other forms of ownership. You see, the profit is going to be taxed twice. Not only must the owners pay taxes on Friendly Five income distributed to them as dividends, but the corporation itself must pay taxes on its income before it can be distributed. Furthermore, dividends are taxed as ordinary income, not as capital gains.

Another disadvantage of incorporating is that expenses will generally be higher than in partnerships. It costs money to go through the legal formalities of incorporating. And it costs money to do the incessant, voluminous paperwork required by various government bureaus. You can’t imagine how tightly corporations are hemmed in by FEPC, OSHA, SEC, FTC, and countless other federal and sate watchdogs.

There are other small pluses and minuses attached to incorporating, but let’s just say that for most real estate syndicates, a corporation isn’t the optimum form.

A general partnership is the next possibility. an attorney can draft a general partnership agreement giving each of them a one-fifth interest in the partnership, so that there'll be a five-way split of the apartment building's income and expense. everyone will have an equal say - so in managing the partnership's affairs - theoretically, at least.