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Son of REIT: real estate syndicators have a sounder twist for small investors

A decade ago, investors large and small lost a fortune when the stock prices of real estate investment trusts (REITs) plunged. But another vehicle for land investment has been gaining in popularity.

It's real estate syndication. A new type, called public syndication, requires as little as $2,500 to $5,000 to make you at least a semi-magnate in real estate. It also requires a long-term outlook and a forgiving nature, says Eugene Rosen, vice-president for marketing of Southmark/Envicon Corporation, a major syndicator in New York.

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A syndicator raises money through a brokerage house that markets partnerships to clients, Mr. Rosen explains. The syndicator then buys some land with an income-producing structure already on it, or about to be put there, such as an office building or an apartment complex. As the tenants pay their rent, the syndicator or general partner takes a share, then distributes the rest to the investors or limited partners.

If that seems to bear an ominous resemblance to a REIT, Rosen notes that investors in syndication are one step closer to owning the skyscraper, and that makes a crucial difference. Whereas syndication partners hold a share of the assets, investors in REITs held shares of stock in a company, and at least initially, the company was a lender to the construction industry rather than an active participant.

Rosen says most REITs were the creations of banks. Southmark, for one, began as the REIT of Citizens & Southern Bank of Atlanta. ''Many of the major banks in this country found a vehicle through which they could roll money into the real estate industry without restrictions of banking laws that limited the percentage of their capital going into commercial loans and the percentage going beyond state boundaries,'' Rosen says. ''The bank could lend money to the trust and the trust could in turn lend almost all of its money to developers at whatever rates it could possibly get.''

The scenario played rather well until the 1973 Arab oil embargo dragged the stock market down and sent inflation spiraling upward. Construction loans were made at floating rates a few points above prime, so when the prime went from 5 percent to 12 percent, developers' rates rose from 8 percent to 15 percent. Many defaulted, and the banks that foreclosed found themselves in the real estate business, Rosen recalls.

The stock prices of some major banks' REITs lost 80 percent of their value between 1972 and 1974. Meanwhile, syndications were gaining favor, and by 1978 syndicators were raising $600 million in public sales. Last year they raised $6 billion, according to the Real Estate Securities and Syndication Institute, an affiliate of the National Association of Realtors. If memories of REITs are casting a shadow, it doesn't seem to be a long one, says Gregory Junkin, senior executive vice-president of Illinois syndicator Balcor/American Express.

Stockbrokers retailing partnerships were the prime movers in catching the public's interest, says Rosen. He says the vehicle's principal selling points are tax savings, because all partners share in depreciating property; cash flow, with the periodic sharing of rental income; and capital gains when the property is sold.

A common practice is to sell after five to seven years when the tax advantages diminish, but the potential gain in resale at another point often staggers the holding period. Although selling out of a syndication is much harder than getting out of REIT stock, the concomitant advantage is that stock market gyrations are irrelevant, Rosen says.

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Gyrations in the real estate market are relevant, however. With syndicators flush with so much cash, what's to stop real estate prices from being bid up beyond realistic levels and inviting a crash? Awareness of the possibility won't hurt.

Says Rosen, ''Many sponsors in their quest for property have paid far more for property than other people think it's worth.''

''Another mistake (some syndicators) are making is that they're looking for inflation to bail them out,'' says Mr. Junkin.

But William Dockser, chairman of CRI Inc., a Maryland syndicator, is ''absolutely not'' worried about syndicators having too much cash in hand, because ''the syndicators are a tiny portion of the marketplace compared with institutional investors,'' namely, insurance companies and pension funds, which have been very active in real estate for some time.

The more money, the better, Mr. Dockser contends, seeing a prosperous future for the richest syndicators, of which his company is one. ''You have to have a substantial capital base to be competitive for the top-grade real estate,'' he says.

Capital base is in the prospectus a syndicator provides each time public money is raised. So is the syndicator's track record in previous ventures.

Mr. Junkin sees ''staying power'' as essential for the syndicator and the limited partner. To the investor who frets over fluctuations in land values, he says, ''You should look at an investment in real estate the same way you look at any other business. How much can it make? Like any business, it will have its cycles. The people who don't have staying power don't belong in real estate.''

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