What are a few Key Terms to know when
evaluating a Multifamily Syndication Investment?
There are so many factors to consider when evaluating a potential investment and at times it can be overwhelming, especially for those who may be investing in their first real estate opportunity. Investing in real estate is not rocket science and sometimes it’s just about gaining a little clarity on what you are looking for. Here are a few Key Terms you should be taking into consideration when breaking down a multifamily investment
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First off, what is a Multifamily Syndication?
Multifamily Syndication is where a group of people pool their resources to purchase
an apartment building which would otherwise be difficult or impossible to achieve on
their own. This typically involves the “General Partners” who organize the syndication, including
finding the property; the general partners are sometimes referred to as the “sponsors”.
The group of people who are providing the cash investment are often referred to as
“passive investors” or “limited partners”. In return for their investments, the limited
partners receive an equity share in the syndication along with cash flow distributions
Preferred Return (My Favorite)
A Preferred Return is a set return percentage to be paid to investors each year based on how much money they have invested. This is the minimum average annual return the investor can expect to receive. If the investment does not generate enough Net Profit to pay this Preferred Return in any given year, the amount of unpaid Preferred Return is rolled forward to the next year. Until all Preferred Returns are paid to investors, the GP team cannot take any Equity Distributions (meaning they don’t make any profit until the investors do).
Example: A 8% Preferred Return on a $100k investment equals a payment of $8,000 per year. If the investment can only pay that investor $4k in the first year due to renovation expenses, for example, the unpaid $4k is rolled forward and the GP owes the investor $12k the following year ($8k for the Year 2 Return + the unpaid $4k from Year 1).
Cash on Cash Return COC
A measurement of profitability often used in real estate transactions to assess short-term profitability, usually for a one-year period. The calculation determines the rate of investment income relative to the amount of money invested.
CoC Return can be increased either by increasing income received during the year or by reducing the number of dollars invested. A strong CoC comes from getting solid income from a small investment.
Net Operating Income
Net operating income in real estate is the money a property generates minus operating expenses. It is used to evaluate how much cash flow an investor can expect to earn from an investment property after operating expenses and vacancy losses.
There are certain costs that qualify as operating expenses and others that don’t. Operating expenses that should be deducted might include property tax, insurance, repairs and maintenance.
NOI doesn’t include depreciation, capital expenses, loan interest and loan payments, depreciation and amortization.
Internal Rate of Return (IRR)
The Internal Rate of Return (IRR) is a profitability metric used to asses the anticipated annualized return generated by an investment over time. IRR is a complex calculation that takes into account the amount invested, annual return distributions, and anticipated profit from the sale of the property in the future.
Importantly, IRR also incorporates the ‘time value of money’, meaning that it takes into account the increased
potential earning power investors enjoy due to 1) the early return of investment capital through refinancing and 2) earning annual income distributions rather than one lump sum payment at the end of the investment term. Receiving income or returned capital sooner means the investor has more time to use that money for other investments, which we call Opportunity Return.
Because IRR takes into account so many factors, it’s an easy way for investors to compare different kinds of
investments at a glance. The higher the IRR, the better.