What Is the Difference Between Real Estate Syndicates and Real Estate Investment Trusts in California?
Real estate investments have generated income for investors for about as long as the concept of private ownership of real property has existed. The fundamental concepts of real estate investment have not changed much over the centuries, but relatively recent innovations allow investors to entrust their money to professionals, freeing them from direct responsibility for managing investment properties. Real estate syndication allows investors to contribute capital to a development project under the management of a syndicator. Real estate investment trusts (REITs) own and manage portfolios of real estate holdings. Syndicates and REITs differ from each other in several important ways. Potential investors should understand these differences before deciding where to put their money.
Syndicates versus REITs
The most fundamental difference between syndicates and REITs involves their relative size and scope. REITs are, essentially by definition, larger than syndicates. They have more investors, and they generally manage portfolios aimed at longer-term holdings. Guidelines for the structure and management of REITs are found in the federal Internal Revenue Code (IRC).
Syndicates tend to be less formal than REITS, with fewer specific legal guidelines or restrictions. They are usually limited to a small number of development projects and therefore tend to focus on holdings and revenues on a shorter time scale than REITs. You can read our many articles about real estate syndication here.
Real Estate Syndicates
Neither federal law nor California law offers a distinct definition of a real estate syndicate. California repealed the Real Estate Syndicate Act several decades ago. The only state statute that currently addresses syndicates is § 25206 of the Corporations Code, which allows licensed real estate brokers to engage in certain transactions without having to register with state securities regulators. This exemption effectively defines a syndicate for the purposes of California law.
A California syndicate, under § 25206, can be almost any type of business entity, except for a corporation, and it cannot have more than 100 owners. The business entity must have the exclusive purpose, stated in its formation documents, of “investment in or gain from an interest in real property.”
Real Estate Investment Trusts
While syndicates in California are rather loosely defined by state law, REITs are strictly defined under federal law. Section 856 of the IRC defines a REIT, in part, as “a corporation, trust, or association” with “transferable shares” indicating ownership, and with at least 100 owners. The business entity must derive the overwhelming majority of its revenue from investment income or other income associated with real property ownership. It must file a form with the IRS in order to qualify as a REIT.
REITs engage in several different types of investment activity. “Equity REITs” focus on real estate holdings, with revenue coming from rental fees and gains from sales of real property. “Mortgage REITs” take out low-interest loans to purchase outstanding mortgages with higher interest rates, deriving income from the difference. The latter type of REIT tends to have a high degree of volatility and risk, while the former offers a comparatively stable income stream.