Ten Definitions You Should Know Before You Invest in Multifamily Real Estate By: Dr. Kristen Ray of Vital Investment Partners, LLC
Investing in multifamily real estate syndications can be a very lucrative opportunity for individuals looking to generate passive income with low risk exposure. Rents and other tenant fees generate steady cash flow that is distributed amongst the syndication partners. Additionally, since the property is owned by multiple partners, syndications are considered a low risk investment.
If you are new to multifamily investing, it is highly recommended that you spend some time researching the topic and learning as much as you can about the industry. A great place to start would be to familiarize yourself with the terminology of the business. Below you will find the definitions of some of the more commonly used terms in multifamily investing.
1. Apartment Syndication
An apartment syndication allows multiple individuals or companies to pool their financial resources in order to purchase and operate an apartment building together, while sharing the associated risk of ownership and returns in the form of rent and other tenant fees. A syndication is typically formed by a general partner, or syndicator, who runs the business operations, and limited partners, or investors, who supply the funds for the acquisition of the syndication property.
2. Accredited Investor
An accredited investor is a person, who meets certain income or net worth criteria as defined by the guidelines of the U.S. Securities and Exchange Commission. The current guidelines require an earned income of over $200,000 (or over $300,000 for married couples) in the past two years with a reasonable expectation of earning the same amount in the current year.
Alternatively, an investor is considered accredited if they have an individual or joint net worth of over $1 million, excluding the value of their primary residence. Only accredited investors are allowed to buy in certain securities such as apartment syndications in order to ensure that they are financially stable and can bear the risk of the investment.
3. Sophisticated Investor
An individual is considered a sophisticated investor if they have substantial understanding and experience with investments, financial markets, and business matters, which allows them to reasonably evaluate the risks and potential returns of new opportunities. Certain sophisticated investors may also be permitted to participate in private securities, even if they are not accredited as per the SEC definitions.
4. General Partner (GP)
A general partner, also known as syndicator or sponsor, is one of the parties involved in an apartment syndication. The GP handles all business operations for the syndication. They are responsible for locating suitable investment assets, recruiting qualified passive investors, and managing the syndicated property’s daily operations. The syndicator has unlimited liability as the owner of the partnership. While the GP is usually a team of individuals responsible for the various aspects of the syndication operations, it could also be a single person.
5. Limited Partner (LP)
Limited partners are the passive investors in an apartment syndication. They are the individuals or companies that provide the initial funds to purchase the real estate investment. Limited partners have no involvement in the day-to-day business operations of the syndication, hence the term “passive investors.” Unlike the general partner, their liability is limited to their proportionate ownership share. An apartment syndication can have one large investor who funds the entire acquisition, or multiple investors who pool their money to purchase the property.
6. Equity Investment
The term equity investment refers to the initial amount of funds needed by an apartment syndication to acquire its target investment property. It covers the down payment for the mortgage loan, the associated closing costs and financing fees, and the initial funding of the property’s operating expense account. It also includes funds collected by the general partner for their apartment syndication management services. The equity investment funds are provided by the initial pool of limited partners, also referred to as passive investors.
7. Internal Rate of Return (IRR)
The Internal Rate of Return is a measure of the potential profitability of investments such as apartment syndications. It is the percentage that equates the sum of all future cash flow funds (including the eventual sale proceeds) to the initial equity investment. A higher percentage indicates a better investment deal. While the calculation ignores external factors such as inflation, it takes into account the term of the investment.
For example, let’s assume you invest $1,000, receive $50 cash flow in year 1 and $150 cash flow in year 2, and then sell your share in the investment, receiving your $1,000 back. The total profit you earned is $200. If the $200 was earned in one year, the IRR would’ve been 20%, however because it was spread over 2 years, the percentage is lower (9.77%).
The formula for calculating the IRR is somewhat complex, however there are handy calculators [https://www.calculatestuff.com/financial/irr-calculator] available online that can help novice investors.
8. Cash-on-Cash Return (CoC Return)
CoC Return is another measure used to calculate the annual return on investment in apartment syndications. It is a percentage calculated by dividing the annual before-tax cash flow generated by a property by the initial equity investment.
For example, a property with a $1 million equity investment and annual cash flow of $150,000 has a cash-on-cash return rate of 15% ($150,000/$1,000,000).
9. Equity Multiplier (EM)
Equity Multiplier is the rate of return on an investment property that takes into consideration the entire cash flow and sale proceeds generated by the investment. It is calculated by dividing the sum of cash flow, sale proceeds, and equity investment by the initial equity investment amount.
For example, a property with a $1 million equity investment, total cash flow of $600,000 (earned over the life of the investment), and a total sale price of $2 million, will have an equity multiplier of 2.6. The calculation goes like this: ($600,000 + $2,000,000)/$1,000,000 = 2.6.
10. Preferred Return
The term Preferred Return refers to profits that are distributed to the limited partners of an apartment syndication prior to making any payments to the general partners.
We hope this has assisted you in understanding some of the syndication lingo. If you have any questions feel free to reach out. https://www.vitalinvestmentpartners.com https://www.vitalinvestmentpartners.com
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