This edition of Wealth in Afterburner is going to focus more on the Limited Partner (LP) side of things, specifically, questions that you can ask before you get into any deal. There's no doubt that in this current market investment deals are harder to come by, but when that deal does pop up, you'll be glad you read this. This is a good one you can come back to you re-read as well. Alright, that being said, let's jump right in!
1. Who is eligible to invest in an apartment syndication?
Short answer: anybody.
Long answer: you'll need to pay attention to the type of investment offering. There are two types that are offered:
506(B): is offered to accredited investors and up to 35 non-accredited investors (definitions below). If you are not an accredited investor, you will need to ensure you are a "sophisticated" investor who has a reasonable understanding of investments and the risks associated. With a 506B offering, the sponsor in charge of offering the deal cannot do so publicly. So, that means when I sell a security, I cannot use any means of general solicitation or advertising to promote the offering. As such, I would need to demonstrate that I had a substantial prior relationship with an investor before making any investment offerings.
506(C): is offered to accredited investors only, and this can be publicly offered as solicitation. With the 506C route, accredited investors will need to corroborate their accredited status, often times done through a third party.
Clear as mud yet? Bottom line is this: if you are going to invest, do your research and look up Securities Exchange Commission (SEC) guidelines on these differences before you pull the trigger. Ensure you are provided an agreement or a Private Placement Memorandum (PPM) and ask all the questions that come to mind!
2. What types of returns can I expect?
There are multiple investments out there that you can invest in. Short-Term Rentals (STRs), Mobile Home Parks (MHPs), General Commercial Multi-Family (apartments), Storage, just to name a few. And while each investment may differ, many of these are similar but can be structured differently to accommodate for an investor's true interest. A general apartment syndication deal might offer an LP a 7% preferred return (first 7% of all net income proceeds go to the LP) with a 70/30 equity split, or any number above 7% would then get split with 70% going to the LP and 30% going to the GP, or the sponsor(s) in the deal. This incentivizes the GP to make more money for everyone involved. At the back end of the deal, or the disposition, you should pay attention to the equity multiple, or ultimate end number you can expect to get back from the investment. I typically see a lot of deals that will run the course of 5 years as a hold, or sometimes even up to 10 years, with a 2.2X to a 2.9X equity multiple, meaning the amount you get back from your initial investment. For example, if you are being offered a 2.5X equity multiple and your original investment is $100K, by the end of that hold period, you can expect to get back $250K, which generally includes the amount of money you have made in preferred returns up until that point. Sometimes you will see a higher cash flow but for less equity, and vice versa. Pay attention to the offering material, specifically the investor returns portion for more data here.
3. What's the risk involved?
At the very extreme end, you lose all your money. Pretty extreme. Most people you talk to who bought any real estate 20 years ago and actually kept the real estate have profited significantly.
A more realistic and far from extreme risk, would be that the deal you invested in doesn't meet the mark on the projected investor returns. There can be a number of factors that contribute to this. As an investor, you want to review the numbers yourself prior to investing, to ensure it passes your litmus test. Things like how the deal is financed (fixed debt vs floating), interest rates, pre-payment penalties, leverage and whether enough money is being raised to cover working capital and unexpected expenses are all good questions you need to ask. Once you feel comfortable with this, then pivot to the person who is offering you the investment. In my opinion, this is the most important factor in the deal: who you are investing with is arguably more important that what you are investing in. I will pass on a 7% preferred return from a stranger or on a GP that is after a get rich quick scheme and accept a 5% return from a person with integrity who does what they say they'll do, maintains transparency, is open with failures and successes, who is reachable and who I know will work their ass off to reposition an asset and stop at nothing to ensure investors are taken care of. You'll want to have confidence in who you're investing in. Don't be afraid to ask the GP questions like "what is on the line for you with this deal?" or "do you have any of your own money in the deal?"
4. How often are distributions sent, & when can I expect payment?
Half of our deals are paid out to investors every quarter, and the other half every month. It's a safe bet that you'll fall into one of these categories. There are a number of real estate software syndication platforms available to GPs and LPs, such as: InvestNext, Syndication Pro or Juniper Square to name a few. The process should be clear, and laid out before your funds are wired to the GPs to close the loan. You are generally set up with credentials for one of the above mentioned websites, and once logged in you have the opportunity to set up your ACH deposit, so distributions are direct deposited to you on the set date your GP has communicated.
In addition, you can log in at anytime to view updates, track performance and retrieve important documents. If your GP has multiple opportunities, you can also find them listed on your portal so you can peruse at your own leisure.
You should receive investor returns and projections in an Offering Memorandum (OM) when the deal is presented to you, and there you should find expected first distributions, which can vary, but generally, LPs are paid out 3 to 5 months after close of the loan. This accounts for the GP to ensure takeover with the new property management company is complete, accounting is set up, and any challenges are cleared up. When in doubt, you should feel confident in asking any questions regarding timing, money and the general plan.
5. Can I pull my money out of the deal before the prescribed hold period?
Generally speaking, no. To be smart about this and not prematurely commit, you should have a good idea of how long the hold period is going to be before you invest. This should help guide your tolerance for how long you are able to stay in the deal before getting paid your initial investment back. General hold periods will last between 2 and 10 years on average, and often times will come with a proposed plan for an additional capital event (refinance) at the mid-way point. This ensures you as an LP are getting back your initial capital as soon as possible, which gives you the wiggle room to continue to invest while still receiving earnings from the current deal.
The term Limited Partner suggests that you are limited in risk, should the deal go south, you can expect to not lose more than your investment. Whereas, with a General Partner, he or she is at risk for losing more, and in certain cases are considered the personal guarantors of the loan, suggesting that if it defaults, the bank can go after their assets. This is most definitely a worst case scenario, but still good to know. Finally, the limited nature of an LPs investment means that if he or she wants out of a deal, it is up to the GP as to whether or not that's possible, and if it is, it's typically done in a buyout of that LPs investment.
6. What's the difference between a REIT and a Syndication?
REIT: Real Estate Investment Trust
Syndication: the transfer of something for control or management by a group of individuals or organizations.
Six big differences between REITs and Syndications: a. Number of Assets b. Ownership c. Investment Minimums d. Liquidity e. Tax Benefits f. Returns a. Number of assets: when you invest in a REIT, it is as if you are buying stock in a company, and that company holds a portfolio of properties across multiple markets. When you invest in a syndication, you are investing in a particular asset (apartment complex). b. Ownership: when you invest in a REIT, you are investing in a company that owns the asset, so you will not own the underlying property, you are simply purchasing a share of a company. When you invest in a syndication, your investment amount is commensurate with a percentage of ownership in the asset. For example: the GP informs you that the down payment or the raise for a $5M apartment complex is $1M. You invest $250K towards that $1M, and the LP/GP split is 70/30. You will end up owning 17.5% of that apartment complex. Math: $250K / $1M = 25%. 25% of 70% = 17.5%. c. Investment Minimums: when you invest in a REIT, you can buy a share at a really low price, sometimes sub $100. When you invest in a syndication, you will likely need to meet a minimum threshold of at least $10,000. d. Liquidity: when you invest in a REIT, just as you can sell your Tesla stock, you can also sell your share in a REIT, thus making it easier to get liquid. When you invest in a syndication, you cannot do this. You do; however, have the steady flow of cash from a syndication upon which to use.
e. Tax Benefits: when you invest in a REIT, because you’re investing in the company and not directly in the real estate, the tax benefits are a bit less exciting. You do get the benefits of depreciation, but those are factored in before you get your dividends, so you don’t get any tax breaks on top of that, and you can’t use that depreciation to offset any of your other income. When you invest in a syndication, you get the benefit of depreciation to lower your taxable income.
f. Returns: these can vary significantly, however, generally speaking REITs will come in at less of a ROI than a syndication will. Historical data over the last 40 years demonstrate REITs averaging a $12.5% ROI, whereas syndications on average will boast a 20% ROI, when both cash flow and equity return is factored in. There are benefits to both, so you'll need to choose which makes more sense for you.
Our aim is to provide you the resources, tools and knowledge needed to make a sound investment that produces competitive cash flow for you and your family. We have a lot of exciting opportunities coming up, and are excited to partner with like minded investors. Please reach out if you have any questions, or if you'd like to discuss a topic more in depth.