A highly intriguing table was used for advertising purposes by a real estate syndication firm a short time ago. This is the table:

ANNUAL RETURN ON $10,000 INVESTED IN VARIOUS WAYS

* Married and filing joint tax return
f Disregarding 4% dividend credit or $50 exclusion
° Based on average 11% distribution, half of which is tax-deductible.

TYPE OF INVESTMENT, PER CENT RETURN AND DOLLAR RETURN BEFORE TAXES

The table shows the return on $10,000 invested in various ways. These are the basic returns:

The returns on savings bank deposits and on savings and loan association investments are correct, and while the return on stocks and mutual funds is debatable, the important thing in the table is the return on real estate syndica­tions of 11%. Even more remarkable about the disparity in returns between a real estate syndication and other possible investments listed is the tax status of the syndications. The table shows that the higher a person's income the more value to him the real estate syndication. If the investor is married and has an income of $88,000 to $100,000, he can keep after taxes the following income on $10,000 from the various types of investment:

The conclusion might be drawn that anyone should put his money into a real estate syndication in preference to any other investment listed in the table, particularly if he is in the higher income tax brackets; but regardless of income tax bracket, the real estate syndication is the thing.

How is it possible to get 11% on a real estate syndication, and why do they have preferred tax treatment?

A real estate syndication is a kind of partnership (although it may take the form of a corporation) set up to own income-producing property—an apartment house, an office building, a shopping center. The partnership or corporate form of organization is used so that a good number of investors can be brought in, each contributing a relatively small proportion of the cost of purchasing a large property. It is easier to raise a large sum of money by securing relatively small investments from a number of people than by trying to get it all from one per­son. Then, too, the risk is spread, so that if anything goes wrong with the syn­dication the whole loss does not fall on one person.

If the cost of a building is $100,000 this cost can be broken down into partner­ship units of $1,000 each. There will thus be 100 partnership units of $1,000 each in the $100,000 project.
In practice there are few commercial buildings, which are not mortgaged. A mortgage is a cheap way of raising money to purchase or construct any build­ing, whether commercial or private, and in the above hypothetical case a mortgage of $60,000 is a reasonable amount. There would thus have to be raised only the remaining $40,000, and this could be accomplished by creating 40 partnership units of $1,000 each.

This is sufficient theoretical background on what a real estate syndication is. Now let us examine a specific syndication offered recently, covering an office building in the Central West. These are the financial data:

In a normal business operation such figures would hardly induce any investors to risk their money. Not so with a real estate syndication. Here are further figures:

This $550 annual cash payment to each of the $5,000 partners is the 11% that the above table refers to.

Now why is preferred tax status accorded this $550? This is a third part of the financial presentation on the above syndication:

Obviously nothing is taxable. The project operates at a loss, and the income tax applies only when there is income, and not when there is a loss.

How then can such a project possibly be a good business proposition? The answer lies in depreciation. The depreciation is unrealistic, and it is purposely made so. It is made so because by establishing sufficient depreciation all the earnings are eliminated, and such a rate of depreciation is allowed by the Inter­nal Revenue Service. In some ways the depreciation rules of the Service are inflexible and unrealistic. A few years ago I put a considerable amount of money into the rehabilitation of a building, mostly into new plaster, paint and wallpaper. For tax purposes I had to add these improvements to the cost of my property, and the depreciation was taken on the total amount. The rate of depreciation which my tax accountant felt the Internal Revenue Service would allow was based on a 40 year life of the original cost plus improvements. When I remonstrated that my plaster, painting and wallpaper could not possibly last 40 years, he informed me that that was too bad but that was the way the Internal Revenue Service saw things.

A real estate syndication uses the 40 year depreciation figure, or some com­parable rate, that they think the Internal Revenue Service will allow (or require), and then offer the syndication to the investing public on the theory that the property will not depreciate at all, but that it can be sold later on for what it cost. This theory in a number of cases is entirely correct. The property may be sold for even more than it was purchased for. But the entire return of 10% or 11% or 13% is based on the theory that the property will not decline in value and that the depreciation charge is fictitious. From an accounting point of view most syndications are losing propositions, at least those I have looked at. In another actual offering these are the estimates of returns to be paid out over a period of four years:

ESTIMATED NET RECEIPTS ON A CASH BASIS

ANALYSIS OF ESTIMATED CASH DISTRIBUTION TO PARTNERSHIP INTEREST OF $6,000

* This may be set off against other income of the individual.

In this real estate syndication of a shopping center the project gets into the black after the first year, or so it is estimated. It never earns very much, and if this were the only consideration in this business proposition the project would be mediocre at best. If, however, we do not take depreciation out of income it becomes inter­esting. The cash distribution annually is 10% on the investment and this 10% is for the most part tax free. The depreciation is set up on a declining dollar amount each year at the same time that net income after expenses, but before depreciation, is going up, so that the business becomes more profitable as time goes on, and more of the income from the 10% annual distribution is real taxable income. For this reason, as the years pass, less and less of the 10% is tax de­ductible.

Almost every week the New York Times, as well as other metropolitan news­papers, offer syndications, and you can secure the prospectus by answering the advertisement. Many realtors in major cities offer syndications from time to time, and it is only necessary to call some of these on the phone and ask them what they are presently offering. They will be glad to send you a prospectus and to discuss the real estate syndication with you in person.
These are some of the criteria that you should apply to a real estate syndication:

1. What is the business reputation of the organization offering the real estate syndication? Is it a respected realtor? This is all important.



2. Is the building in existence or is it just planned? Although a building, which is planned, may work out well, estimates for the future are frequently more rosy than they turn out to be.



3. Is the building fully rented, or if not rented fully, contracted for on a long-term basis by reputable tenants? One syndicator offers a shopping center leased by such tenants as Montgomery Ward, Kresge, Gimbel's, Grand Union and Loft's. The real estate syndication prospectus states, "Nationally known tenants occupy approximately 75% of the space." Such tenants are prime.



4. How was the building bought? Recently a real estate syndication was offered on a Connecti­cut Avenue apartment house in Washington by one of the leading realtors in the city. The building was bought directly from the builder at a fair profit to him. This is a good cost basis. Many of the buildings which are syndicated now have been sold many times, each time for a higher price, so that with each sale they become less desirable as a real estate syndication.
   
   Sometimes the syndicator or his small group buys the property and resells it at a handsome profit to a corporation controlled by him. The real estate syndication is then worked out on this higher cost basis. This is a double dealing kind of proposition and is to be avoided. Yet it is very common, and the profit is out of the deal before the participants in the real estate syndication ever hear of it.



5. How much does the syndicator himself get? In the case of the Washington property described above the realtor got 10% of the total stock (the offering was on a stock basis rather than on a partnership basis) plus a management fee of 3% of the rents. This 3% is standard for any management corporation, and 10% is a reasonable cut for getting the apartment, buying it at a fair price and putting together the deal.



6. Is the property new? A new property is likely to stay in the "new" category for from five to ten years. A real estate syndication on a new but occupied property is desirable.



7. Is the property in good physical condition or will it require much rehabilitation? Rehabilitation can cost a great deal of money, so much perhaps, that the real estate syndication becomes undesirable.



8. Does the syndication call for rehabilitation and rent increases? Rehabilitation plus rent increases can result in a very good business proposition, but risk is involved. Rent increases may result in wholesale evacuation of apartments or offices. It may be that the property is extremely run down and vast outlays are necessary to make it appeal to an entirely new class of tenant. Such major rehabilitations can work out
   very well by changing the entire nature of the building to appeal to a much higher-grade tenant, but they involve much speculation as to the future and much risk.



9. How realistic are the accounting estimates of income and costs in the future? These can be gone over with a rental agent or with another realtor—a firm other than the one offering the syndication, just as a check. The estimate of each item of expense should be compared with the expenses in the past, item by item. It is easy enough to say, "They spent too much on this. We are going to cut it down."



10. What has been the percentage of occupancy in the past as compared with forecast percentage of occupancy? Here again it is very easy to say, "We will make the place so attractive that we will keep it 100% rented." Or it can be said, "They were only 60% rented because they never advertised. No one ever knew what a wonderful apartment he could get at such a low rental." The best kind of syndication is based on a continuation of income and expenses, as they existed in the past. This is the most realistic approach to syndication. Anything that is done to improve income and expense can be viewed as a kind of bonus.



11. What is the price trend for properties of the type being syndicated in your city and in the particular part of the city in which the property is located? In the past four years Washington, D. C. properties have in many cases skyrocketed, so that syndications have worked out even better than anticipated. But not all Washington properties have gone up in value. There is a local situation in Washington in which racial group movements affect property values significantly. These movements and commercial and industrial developments, as well as the development of suburban communities, have a direct bearing on the success of any syndications, and these factors must be looked into carefully. In Washington, D. C. the changing nature of various parts of the city is charted on a large map of the city by the Zoning Commission, and the personnel of the Commission are intimately familiar with commercial, industrial and population movements in the entire metropolitan area. From this knowledge, which you can secure by visiting the Commission, it can be determined whether a particular syndicated property is in a growing and improving neighborhood or in one that is declining or being abandoned.

You cannot intelligently enter into a syndication without a thorough examina­tion which should start with a detailed study of the syndication prospectus. This must be given to you by the syndicator. The examination should branch out from there, and it must be remembered that almost every syndication is based on the assumption that the property really will not decline in value and that the depreciation is fictitious and not real. The 10% or 13% return is not in any way an accounting profit, and the profit may well be a negative figure.

In the fall of 1960 Public Law 86-779 was passed which may offer the investor a whole new group of companies in which to invest. To date real estate syndica­tions have been confined to the ownership of one or a few properties; the shares of partnership interest have been large in size, and the syndications have often been confined to the residents of a particular state. In the advertisements of each real estate syndication in the New York Times the restriction is often added that the syndication is confined to bona fide residents of the State of New York.

Public Law 86-779 allows the formation of real estate investment trusts which issue shares of beneficial interest. These shares can sell for a few dollars each and are traded in much the same way that corporation securities are. There is not a ready market for real estate syndication participations, and the new law adds immensely to the liquidity of participating interests in real estate.

Another advantage of the new real estate investment trusts is that larger aggregations of capital can be brought together than in the case of the orthodox syndications because: (1) the shares being smaller can tap a wider market and (2) distribution of the beneficial shares of the investment trusts can be handled by underwriting firms. The investor will now be able to contact his broker either to buy or sell real estate shares.

Because the aggregations of capital, which can be brought together in real estate investment trusts, are larger, the money can be diversified among a num­ber of buildings of various kinds and in various locations. The risk to the investor is thus spread. This is not the only advantage from the point of view of the investor, however. The investment trust can own not only income-producing property, but undeveloped property as well as mortgages on property and securities of various kinds. The risk to the individual investor can thus be made much smaller through diversification than in the case of the real estate syndication.

Yet all of the tax advantages of the syndication remain. There is no corporate tax on the investment trust provided 90% or more of its income is paid out to the investors, and the investor pays no tax until his initial investment is returned to him through distributions extending over a period of years. Then if payments are made to him out of depreciation, he is taxed on these payments only at the capital gains rate, which is essentially half the ordinary income tax rate.

The analysis which the investor must make to determine whether the real estate investment trust is a good thing is exactly the same as in the case of the real estate syndication.

One final property ownership participation should be mentioned: the coopera­tive apartment. For years I puzzled as to how anyone in his right mind could afford to make a large down payment on a New York apartment, amounting to thousands of dollars, then make monthly payments of hundreds of dollars, sometimes as much as the rent on a comparable apartment. The answer lies in the advantage of ownership or part ownership of the apartment building, and the cooperative apartment owner is part owner of the whole building.

The owner of a single-family house deducts his property taxes and the interest on his mortgage from his income before applying the federal income tax. The owner of a cooperative apartment does the same thing for his proportionate ownership of the apartment house. Let us see how this works out in a specific case:
One of the newest and finest apartment houses in Washington, D. C. is offered on a cooperative basis. All apartments have two bedrooms and two baths. The purchase price of the cheapest apartment is $27,560. The down payment is $9,186. This is how the figures work out:

The brochure of the apartment house contains the following statement: "Real estate taxes and mortgage interest (included in monthly payments) are con­sidered by counsel deductible for federal income tax purposes under present laws."

Out of a total annual cost to the tenant of $2,556.10, $1,334.28 can be de­ducted from his income on his personal tax return before applying the federal income tax. Thus, if he is in the 50% tax bracket, Uncle Sam contributes one half of the $1,334.28 to help him out on his annual payment on his apartment— $667.14. His real annual charge is consequently not $2,556.10 but $2,556.10 less $667.14―$1,888.96, or $157.41 per month, a lower actual cost than the rental of a comparable apartment in the city- The higher the tenant's income, the lower is his real monthly payment and the more valuable the cooperative apartment as an investment.

How big a business is real estate syndication? At least $10,000,000,000 worth of property has been syndicated in the last decade, and if we were able to trace down all syndications in the smaller cities the total might be raised materially. In the year 1958 alone, possibly as much as $3,000,000,000 worth of property was syndicated.

The major syndication firms of the country are located in New York City and these are:

• Lawrence A. Wien, 60 East 42nd Street
• Marvin Kratter, 521 Fifth Avenue
• Louis J. Glickman, 501 Fifth Avenue
• Jerry M. Tenney, 20 East 41st Street

Two of the medium sized firms, also doing business in New York City are:

• Kaufman Management Corporation, 450 Seventh Avenue
• Harry G. Silverstein, 366 Broadway

Although real estate syndications are big business, and it is reported that Wien alone has syndicated over $500,000,000 worth of properties, there are relatively few brokers to whom the investor can sell his syndication units if he wants to convert them to cash—perhaps a dozen in all. Probably the leading syndication broker is A. George Golden Corporation in New York.

While the "13% return" on syndications is not based on accounting profits and is thus fictitious, it must be remembered that real estate has been rising in price tremendously in the last decade, so that properties built in 1950 might well sell for more than their cost when new. This appreciation in value is even more possible when it is realized that in this decade building material and labor costs have frequently doubled, so that to replace a $1,000,000 building constructed in 1950, might well cost over $2,000,000. A real estate syndication may turn out even more optimistically than anticipated in the brochures, but check it out fully. The anticipated return may be the ultimate in wishful thinking.