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01. This Book - The real estate syndicate, in its present form, is a new investment medium, not too well understood by the gen­eral public. Potential investors receive a lot of promo­tional literature, but are not told what to look for. The ideal objectives of the investor are always the same: safety of principal combined with high yield, substantial growth and liquidity. Unfortunately, such an ideal investment does not exist.

02. Syndicate Boom - The real estate syndicate is a pooling of resources of many investors to buy a building or long-term lease-hold. When you buy an interest or participation in a real estate syndicate, you buy a part of a building or the lease-hold.

The real estate syndicate with large public participa­tion is about 10 years old. It sure is big business now.

03. Get Information - First make sure you have the full brochure or pros­pectus, not just the "Sales letter." Most real estate syndicators are honest and want to give you all the pertinent facts in their brochure. Many syndicators are members of the Association of Real Estate Syndicators, Inc., whose code of ethics requires full disclosure of all material facts. Furthermore, most state laws require full disclosure of all important facts.

04. Syndicator - You will receive a booklet (the brochure or prospec-pectus) crammed full with information concerning the propery, its tenants, location, the projected distributions, leases, mortgages, refinancing, distribution of proceeds of sale, repurchase agreement, tax treatment, opinion from attorneys and accountants, lease-backs and summary of purchase contact.

05. How much? - In a very prominent spot, the brochure will have a statement about the anticipated yearly distribution. Note the words anticipated, and distribution. The syndicator has evaluated the property, but does not know and can­not always know whether throughout the years—or even next year—it will show a sufficient return to make the payments which are hoped for.

06. Depreciation - You may be tempted to skip this part and leave it to the tax expert. Don't. You simply must know something about depreciation. We will try to keep it simple.

Suppose you use a car in your business. You buy a new car for $3,000. After five years, it is worthless. You have to shell out another $3,000 to buy a new car (if you are lucky and the price has not gone up).

07. Depreciation Applied - The traveling salesman uses the car in his business. The manufacturer uses machines. In a syndicate—your equipment—your means of making money is the build­ing which is owned by the syndicate. The building, like any other piece of equipment, is subject to wear and tear and to obsolescence. The tenants, users, and the elements all cause the wear and tear. But do not underestimate ob­solescence.

08. Declining Balance - Look at these figures which are typical and which are taken from an actual syndicate. They show the estimated percentages and amount of annual distribution on which the investor must pay income taxes during the first five years based on an investment of $5,000.

Total                           Taxable                      Taxable
Cash                           Amount                     Percentage
Distribution
1st year                          $500                       $129.25 25.85%
2nd year                         $500                       $181.75 36.35%
3rd year                          $500                      $233.00 46.60%
4th year                          $500                      $283.00 56.60%
5th year                          $500                      $335.55 67.11%

If you invest in this syndicate, you should ask two questions.

09. Straight Line - In some cases the syndicator will take the same depre­ciation allowance every year. If the syndicator adopts the straight line method of depreciation it will be stated in the brochure. The following is an example of the straight line depreciation taken from a syndicate offering bro­chure.

The following table provides a breakdown of the cash distribution to a holder of a $10,000 Participation during the first year of ownership:

10. Paying Taxes - The following are quotations from brochures recently examined.

Syndicate No. 1

In the llth year of ownership, the amount report-able as taxable income will exceed the cash distribu­tion at which time the amount of taxable income will be $573.91 as compared to the cash distribution of $550.00 per unit. In the 12th and succeeding years, the excess of taxable income over the cash distribution will increase.

11. Pay Mortgage - Assuming that the syndicate buys a building for $900,000. It pays $300,000 in cash and gives a mortgage for $600,000. It agrees to make constant payments on the mortgage at the rate of $60,000 per year. These payments are to be applied first to 6% interest on the balance which may be due on the mortgage. The rest of the pay­ment is used to reduce the amount of the mortgage.

12. Income Taxes - If you have read the chapter about the declining bal­ance method of depreciation, you will know that an ever-increasing portion of the distribution may become tax­able because of the choice of the method of depreciation. Now let us examine the combination of the effect of the declining balance method of depreciation and of the change in the character of the mortgage payments as we have discussed them so far.

13. Paper Loss - Sometimes you see that in the first year or even in the first few years the syndicate, while making its regular yearly distributions, sustains a loss on paper. As a result you won't have to pay any income taxes on your distribution. In fact for tax purposes you are deemed to have sus­tained a loss which you may use to offset other income.

14. Tax Shelter - Take a look at the following excerpts from recent syn­dicate brochures. (The names of the accountants whose opinions are quoted are omitted.)

Accountant estimates that the first five years an av­erage of 63% of the annual cash distributions will not be reportable for federal income tax purposes. For the first 10 years, the amount not reportable will average about 53% per year.

15. Rent? - It is anticipated that the first distribution will be made sixty days after the closing of title.

You may find two sentences like the ones above in your brochure, but you will not find them often together in one spot. We have arranged them that way for your con­venience.

Title closing consists mainly of two things. The seller gives the buyer the deed to the property. The buyer gives the seller the purchase price. In the case of a syndicate, the buyer pays with your money.

16. Syndicator Units - Since we are on the subject of the syndicator's profit, we may as well consider additional methods employed by the syndicator to obtain his share of the profits.

In the first place he could buy the property and then sell it to the syndicate at a profit. This is perfectly legal, as long as he discloses all the facts to the investors. In such a case the brochure should even state the amount of the profit realized by the syndicator.

17. Wear + Tear - In previous chapters we examined the tax effects of de­preciation. The major feature which we examined was, that every year you may keep some of the money which comes in without having to pay income taxes. To under­stand other aspects of depreciation we will forget about the syndicate for a moment. Think of your building or any property which you use in your own business.

18. Lease-Hold - Suppose the syndicate acquires a 50 year lease-hold. This means that the syndicate does not acquire owner­ship of the land and building but leases it for 50 years with the right to sublet or make its own leases with the tenants during that period. The source of the income and profit of the syndicate will be the difference between the rent which the syndicate will have to pay to the owner and the rent which the syndicate collects from sub­tenants.

19. Building - Think of any good, well kept, apartment house in a prime location or of any good office building in the cen­ter of your city. Practically all of them are worth a great deal more now than they were 25 years ago. One of the factors behind that increase is certainly the prosperity which we have now while 25 years ago we were in a de­pression

20. Comparison - Look at the two examples we just discussed and notice the totally different results achieved by depreciation. We chose the example of a lease-hold, because it can be seen so easily that after a number of years nothing of your in­vestment remains at all. In the case of the building the value of your investment may have gone up considerably.

21. Specialized Properties - Syndication is not confined to real estate and lease-holds any more. True, there are usually one or more build­ings involved. But when you buy a bowling alley, a motel, a hotel, or a sanatorium, you are really investing in a bus­iness. If you are not convinced, just think of what you would do with an empty bowling alley 5 miles from the center of a small city if people for one reason or another stopped bowling or stopped coming to your bowling alley.

22. Growth - During the past 10 years the purchasing power of your dollar has declined about 50%. Think back a little further. Remember when you could buy a loaf of bread for 11 cents? Then ask an old-timer and let him tell you that 40 or 50 years ago he worked for $2.50 a week.

If anyone tries to tell you that inflation is just a tem­porary phenomenon, don't you believe it. It has been going on for centuries and is going to continue.

23. Leverage - A lever is one of the oldest tools known to man. You want to move a heavy stone which you could not budge with your bare hands. A lever applied in the right place will enable you to do the job for which otherwise several men would be required. Investment leverage works the same way. A dollar strategically placed can do the work of several dollars. An illustration of the operation of lev­erage follows

24. Share Growth - We have seen that there is an excellent possibility of growth in real estate. But what is important to you is whether you are going to participate in that growth. You may think that if the property is carefully selected, bought at a fair price, in good condition, in a good loca­tion, and well managed, and if past development is a yardstick, the property should increase in value over the years. Right you are.

25. Why + How - How does the value of any business increase? Of course, you know the answer to that question. If the business makes more money, its value increases. And if you own a part or share of that business, your part or share will increase in value. And how does the value of a build­ing increase? The answer is the same. If it makes more money for its owners, its value increases.

26. Syndicate Agreement - We said that as a business increases in value the part or share which you own will also increase in value. This is ordinarily true in real estate. But if the business agree­ment were so worded that all or part of the increased earnings were to be withheld from you, your share would of course not go up, even if the earnings of the business will go up.

27. Net Lease - In this chapter we are not concerned with the long term lease sometimes made to a nationally known firm, but with a long term lease to the syndicator, seller, or an insider. In order not to repeat syndicator, seller or insider throughout this example, we shall assume that the lease was taken by the syndicator. Such a lease provides in sub­stance that the whole building will be rented to a corpo­ration controlled by the syndicator.

28. Long-term Lease - At times you may examine the brochure very care­fully. Yet when you read about the long term lease you will notice that the syndicator, who is also the tenant of the syndicate, does not take in much more rent than he pays to the syndicate. Why then does the syndicator go to all the trouble of dealing with the tenants while the rewards seem so small? The answer lies in growth or an­ticipated growth

29. No Guarantee - You may believe that in view of the long term lease to the syndicator or to another insider you are at least as­sured of receiving your monthly distributions for the term of the lease. There is no such assurance in most of the cases examined. Bear in mind that the lease is made to a corporation controlled by the syndicator or an in­sider.

30. Inflation Clauses - In many cases, the long term net lease will have a so-called inflation clause. It provides that if the lessee (the syndicator's corporation in our case) collects rents in ex­cess of a certain sum, that the investors get a part of such excess rents. Read that clause carefully. How much more rent is there to be collected before the investors get addi­tional payments?

31. "Inflation Clause" Works - To examine the operation of the inflation clause we shall have to do some figuring. In order to keep it simple, we are working with round figures, not actually taken from a brochure. But the figures and assumptions corre­spond substantially to actual syndicate offerings.

The property of the syndicate is net-leased to a tenant. The tenant collects $75,000 in rentals.

32. Inflation Clause? - Suppose you have reached the conclusion that substan­tial rent increases may be in prospect in the reasonable future, so that some overage will go to the syndicate. You must take another look at the brochure to determine what you will get. See how the overage rent is divided be­tween the syndicator (yes, he is also your partner in the syndicate) and the investors. It is not enough that some overage rent may be payable to the syndicate. You should get a reasonable share.

33. Mortgage Due - A mortgage is a debt. Its distinguishing feature from an ordinary debt is that a building is pledged to secure the mortgage debt. Most mortgages provide for regular payments to be made monthly or quarterly. Part of such payments cover interest on the indebtedness. The re­mainder of the regular payments ordinarily are payments on the indebtedness itself.

34. Interest Rates - It is not enough to know that a certain sum has to be paid each year on the mortgage. The rate of interest which has to be paid on the mortgage is important. The following example will show you that two deals with equal yearly payments are by no means identical.

Two syndicates buy buildings subject to a $1,000,000 mortgage.

35. Short Term Mortgage - The advantages of paying a low rate of interest are obvious. There is, however, one situation in which a low interest rate may be a danger signal for you. That is in a situation where the mortgage is due in the near future.

Suppose that interest on the mortgage is 4% and that a $1,000,000 balance on that mortgage is due now. Inter­est rates have gone up.

36. Good Mortgages - Most buildings are sold subject to mortgages. If you read the chapter on leverage, you will know that mort­gages play an important part in the growth of real estate equity. Over the years, payments made on the mortgage from the income of the property reduce the mortgage in­debtedness. As the indebtedness is reduced, the owner's equity in the building—the value of what he owns over and above the mortgage—increases.

37. Refinancing - If a building is held for any length of time, it often be­comes necessary or advisable to give a new mortgage. (Note, the owner borrows money and gives a mortgage to the lender). For instance, suppose that a syndicate buys a building for f 600,000, $200,000 cash and a mort­gage of $400,000. Suppose that the unpaid balance on the mortgage becomes due 10 years later.

38. Refinancing Clauses - The reasons for borrowing money and giving a new mortgage do not matter. Suffice it that very frequently it is done because it is necessary or makes good business sense. Now look at the above example where the mort­gage indebtedness was reduced from $400,000 to $200,000 over a period of 10 years. Since the balance is due at the expiration of 10 years, a new loan must be negotiated and a new mortgage must be given.

39. Share of Mortgage - We have examined syndicate brochures where the in­vestors are to get 80% of the overage of any funds bor­rowed, others where they are to get 50%, and even some where they are to get as little as 33.3%. The rest goes to the syndicator or seller or lessee, or is divided between them. This bears repeating. We have seen brochures where on property owned by a syndicate, money may be borrowed in such a way that the investors get only $1 out of every $3 borrowed.

40. Share of Profit - You were careful and invested in a winner. There is an unusual opportunity to dispose of the property at a sub­stantial profit. If a profit is made on the sale, who gets it? How much will you get? The profits on a sale are dis­tributed in proportion to the original investment or to the ownership of the syndication units unless the agree­ment which you signed provides otherwise

41. Purchase Options - In recent years, some syndicates offered to the public contained repurchase or purchase options. The syndicator or seller reserved the right to repurchase the prop­erty which he is selling to you and your co-investors. Sometimes the lessee has the option to purchase the prop­erty.

What is meant by a purchase or repurchase option? It is the right of one party to buy the property. Note that it is a right—not an obligation.

42. How Purchase Options - Let us see how such a purchase option affects the growth potential of your investment. Suppose the syndi­cate has bought a property for $1,000,000. It paid $200,000 cash and gave a mortgage for $800,000. The syndicator has the option to repurchase the property. He must pay a price which will give you 4% profit on your investment for every year the property was held.

43. Stunt the Growth - We have stressed the importance of the growth poten­tial of your investment. Naturally, everything which stunts growth is important when you make your invest­ment decision. The various factors are treated in separate chapters. But in view of the importance of the subject, let us set down in one place the main factors which in­hibit full growth

44. "Subordination" - One way for the syndicator to be paid for his work and efforts is to obtain a certain number of partnership units in the syndicate as his "cut". As a rule, he does not pay cash for these units. Very often he ends up with these free units and a substantial share in the growth of the syndicate without investing any money of his own.

45. Long Term Lease - We discussed the effects of a long term lease to a cor­poration controlled by the seller or syndicator or other insider. We pointed out many of its drawbacks. Is a long term lease to a national corporation different? A national corporation, rated AAA (over $1 million), will, at the time of the leasing probably require certain concessions, since it is such a desirable tenant. The rent will probably be low.

46. Business Organizations - Some syndicates are organized as corporations. Others as trusts, partnerships, joint ventures, tenancies in com­mon, or limited partnerships. You may and must assume that the syndicator has chosen the form best suited for your syndicate. In any event, you will have no say on that matter. When you receive the brochure, it will tell you the type of business organization selected for the syndi­cate. You cannot change it

47. Syndicate Debts? - When you make your investment in a syndicate, you participate in a business. Any business, even a well man­aged one, may fail. The question is whether there is any possibility that you, as a co-owner of the business may be called upon to pay its debts. The chances that such a sit­uation will arise with a real estate syndicate are probably slim.

48. Management - What are your rights to participate in the management of the syndicate and in the major decisions? The bro­chure will state all that. You may be reasonably sure that you will have no voice in the management. That is prob­ably what you want. Anyhow, it would be rather difficult to manage a building, if you have to call a meeting of all the investors, each time a decision has to be made.

49. Your Consent? - Whether the syndicator may sell or mortgage the prop­erty of the syndicate without your consent or even with­out consulting you depends entirely on the agreement. Very often the management has the power to make these decisions. In other cases, the brochure states that the management will not sell unless it obtains the consent of a stated percentage of the investors, for instance, one-half or two-thirds of the investors.

50. Sell Your Unit - We have tried to examine the factors which determine the value of the syndicate and the participating units. Value is relative. You have certainly heard of cases where a person has some valuable property—a painting or ob jet d'art—but cannot find a buyer who wants to pay the price which reflects the true value of the object. There is no ready market for it. Value is often said to be "what a willing buyer would pay to a willing seller."

51. Investment Trust? - The ideal type of business organization for the investor would have the following characteristics.

First: Limit the investor's liability to the sum invested.

Second: Continue in existence even if the principal (syndicator) dies or goes into bankruptcy.

Third: Not be subject to federal or state income taxes, but pass on all of its earnings to its investors free of taxes.

52. Business Syndicate - You have seen syndicates which offer initial yearly dis­tributions of 8%. Others offer 17.5%. There may be nu­merous reasons for these differences. Perhaps the growth prospects of the first syndicate are substantially greater than that of the second one. Perhaps the first syndicate is safer. We hope that by this time you know that a larger monthly distribution is not necessarily the sole factor which determines the quality of your investment.

53. Multiple Properties - Lately, we have seen offers of participations in syndi­cates which intend to acquire several properties. There are also the combinations of existing properties and prop­erties under construction, or of leaseholds and properties under construction. The sales argument given to you on these offerings is that diversification offers greater safety. The diversification slogan is taken from the stock market, but is it true when it comes to syndicates? In the stock market, you take your pick.

54. Dream or Reality? - Every brochure contains estimates or projections of dis­tributions and of income which shall be used to make such distributions. Are those projections fair and real­istic, or are they starry eyed hopes of the man trying to sell you a unit?

If you have a building which has been in existence for a number of years and if the projections are stated to be based on past earnings, you are probably on solid ground.

55. Syndicator's Background - The property which the syndicate will acquire is the key to its success. Therefore, we gave you the yardsticks of value and pointed out the factors which affect the value of your investment. However, you must not forget one important element, the human one.

Who is the syndicator? If someone else is going to man­age or operate the property, who is he? Even though the property and the projected income appear satisfactory, you should know something about the people to whom you entrust your funds.

56. Value of Guarantees - At times you will be told that the yearly distributions to investors are guaranteed for the first 2, 3 or 4 years. Often such a guarantee may indicate that the deal is a little more risky than the average one. You will find that such a guarantee is most often mentioned in connection with ventures which are still in the planning stage.

Obviously, your investment will only be safe if pay­ments will be kept up over a far longer period than 3 or 4 years. But since the guarantee is given, you may as well try to evaluate it.

57. Look for Yourself - If you make use of the knowledge acquired and scru­tinize syndicate brochures with an eye on value, you will eliminate quite a few offerings which do not satisfy your requirements. Some investments will appear attractive. You have read the description and looked at pictures of the property.

There is one more thing you must do and we cannot do it for you. Go out and take a look at the property, if at all possible. Even if it is in a different part of the city or 50 miles from your home? Even then.

58. Conclusion - Now that you have read this book, we come to the acid test—putting the know-how which is available in the book to work for you—so that you can choose from among the various syndicates and decide which is the best deal for you. Before you get ready to make your invest­ment, you will want to analyze a half dozen deals avail­able in the market. Only by comparing what's available today can you decide which is the best syndicate to invest in.

Appendices - How many days after you send in your money do dis­tributions start?

Percentage return on investment. Are anticipated distributions reasonably safe? Safety factors:

1. Solvent tenant or tenants.
2. Does tenant of net lease make profit?   (Safety "cushion").
3. Subordination of syndicator's units   (for how long?)
4. Guarantees by solvent persons or corporations.
5. Is property well maintained and in good neighborhood?
6. Experienced management.

THE END