Passive Investor Series Part 6: Short Term vs Long Term Hold
When investing in or operating a syndication, the common hold time for a property usually falls between 4-7 years with at least a 15% IRR or annualized return. This means an investor is projected to double their invested capital during the hold period. After the investment is sold, the investor can take the proceeds and continue to reinvest with the syndication sponsors, if they have another deal available or invest it somewhere else. This continuous cycle of reinvesting capital will occur every 4-7 years.
The reasoning for the 4-7 year period is to allow investors to maximize their returns with a medium-term hold. In this current environment of maximizing returns in the shortest time possible, anything more than this hold period can turn off many investors to the investment opportunity.
Before totally eliminating longer hold investments, there are several reasons to invest in them or at least consider them versus the common syndication. We will discuss three reasons to consider long-term holds below.
1. Tax Efficiency
When an investment is sold, the gains from the sale are going to be taxed. These capital gains taxes luckily will be calculated at the long term rate as long as the investment was held at least one year or more, which is usually 15%-20%.
There are ways to defer the capital gains by using a 1031 exchange. Another alternative is to use passive losses to offset the gains, but you aren’t guaranteed to have enough losses available, especially if you do not have a large portfolio of passive investments to offset all the gains.
These capital gains taxes will be accumulated every single time the investment is sold.
When you hold an investment long-term, there are not these capital gains taxes you will need to worry about as often. The gains will continue to accumulate, but so will your potential passive losses to help offset the gains.
2. Cash Flow Stability
When investing in a syndication, the overwhelming majority are value-add properties, which means the property has some deficiencies that will be corrected before it can be stabilized and provide the projected returns. Some of these value adds include major or minor rehab, operational deficiencies, or repositioning. When a property is value add, it does not cash flow efficiently and distributions to the investors will not occur immediately. Once the property is stabilized, then the distributions will be more regular and predictable. It is typical in a syndication that distributions will be held up to 12 months on a value add and 24 months for new development to allow the operators to stabilize the property.
When a syndication is sold every 4-7 years, you are forced to start over and invest in a new investment which may not provide distributions immediately. If you are relying upon this cash flow distribution, you will need to anticipate lower cash flow until this new investment stabilizes.
When you invest for the long term, the cash flow distributions should be consistent and reliable once the property is stabilized.
3. Next Deal Risk
When you finally find a syndication to invest in that provides great returns and cash flow, then because the business plan is written for only a 4-7 year hold, it is now being sold. That’s great you doubled your money during this hold period, but now what? Can you find another deal that can provide the same returns? How can you know for certain? Will the operator you’ve learned to trust and like working with have another deal for you to invest in? This is the risk you will face every time the sponsors of the syndication sell the property you’re invested in.
Before completely eliminating any long term syndication investment, several factors should be considered. The three reasons provided above are strong reasons to consider holding some longer-term investments and not always trying to maximize your returns in the shortest amount of time. The amount should be based upon your risk tolerance and your investment criteria.