FAQs

Investment Definitions

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What is passive vs active investing?

Passive investing is the process of placing one's investment funds into a syndication (for example) and having all the work done by the General Partner. Active investing is where you personally do all the tasks for the investment; from planning, research, demographics, property selection and negotiation, due diligence, assembling the team, raising capital, applying for loans, managing the construction, marketing, lease up management, operations, maintenance, staff payroll, etc. It is a complicated and stressful process best done by a general partner team who do this full time. Active is hands on, passive is hands off.

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What are the benefits to passive investing in a syndication?

There are many benefits, including;

• passive investment - access to high returns without the work and stress

• syndication structure is designed to be a win-win for LP and GP investors

• LP investment has a much lower risk than GP as capital and profits are paid out ahead of GPs.

• cash flow - regular distributions directly into your bank account

• tax benefits - accelerated depreciation

• being able to access high returns at low risk with a relatively small amount of capital

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What are the downsides to investing in syndications?

Every investment has its downsides, here are some to consider;

• investing in a syndication is a passive investment by its structure, thus there is no control or decision making by the LP investor

• it is not a liquid investment, capital is committed and utilized together with the capital from all the other investors for a given period as defined in the PPM. I.e. usually until a capital event such as a refinance or sale.

• the need to be an accredited investor for certain offerings.

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MF Asset Class
MF assets (buildings and amenities) are classed by their age, location and rents. There are also + and - classes on the main classes below, which are slightly higher or lower classes. E.g. a B class property can be rehabbed to become a B+ property. CAP Rates vary per class.

• A+ class; newest with luxurious amenities (resort style pool, gym, business center, dog park, etc), high quality finishes, excellent locations.

• A class; newest with modern amenities, best location, highest rents. These properties are very stable, have low maintenance, and are generally bought by institutional investors - who are ok with lower returns as the risk is also low.

• B class; older with some facilities, generally in good locations, can be in good to moderate condition. Value-add potential in some cases, goal is to lift rents to A class.

• C class; old, low rents, usually minimal or no amenities, in average neighborhoods, often with problems (buildings, management, tenants). Demand is strong due to low rents. High potential for value-add (rehab) but also high risk.

• D class; very old, high vacancy, dangerous neighborhoods. High risk to rehab and as an investment.

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Build-to-rent (BTR)

BTR is a hybrid asset taking the scale, management and amenities of MF while offering the space and privacy of a single-family (SF) home. A BTR house will generally be larger than an apartment, have it's own garage, back yard, etc, thus command higher rent. Housing density is lower than MF thus asset income may be lower than with a MF property on the same size land. BTR is currently a favored asset post-CoVid, as many apartment renters want more space and the full home experience, but may not be able to afford to buy a SF house. For developers and investors, building BTR communities is relatively straight forward as there are only 3-4 floor plans in a project (vs a portfolio of SF houses will have many floor plans), it shortens the time to first revenue (vs waiting for the whole building in a MF development to be completed), and operations management is efficient which makes sale to institutional / long term buyers attractive.

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Multifamily Syndication
A multifamily syndication is an alliance in which multiple individuals pool together their equity and resources to purchase or construct a multifamily asset. Multifamily syndications generally have two parties: the multifamily syndicator (GP) and passive investors (LPs).

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Private Placement Memorandum
A Private Placement Memorandum (PPM) is a legal document given to prospective real estate investors (individual or LLC) who invest in a private syndication in order to explain the investment, risks, requirements, fees, etc, and comply with federal securities law (SEC). It will comprise of the following sections:

• Introduction; summary of the offer, property description, offering period, investment minimums, investment risks, suitability standards, and fees / commissions payable to the sponsor.

• Disclosures; this section outlines the capabilities of the sponsor, project costs, use of proceeds and gross sale revenues, and includes a projected budget (proforma). It also outlines the risks associated with the investment opportunity.

• Legal Agreement; this is the operating agreement for the entity (LLC, LP, or SPV) which owns the property (investors will own share in this entity). It will outline the management plan, rights of members, ability modify ownership, termination, and accounting rules.

• Subscription Agreement; agreement to the terms of the PPM, details the number of shares the investor will purchase. All investors will be required to submit funds at this time to close on the offer.

 

Limited Partner
A Limited Partner (LP) is a passive investor in a multifamily syndication. The passive investor's role is to bring equity. Once the multifamily complex has been acquired the passive investors will, in most cases, collect passive income from the property and receive a return upon the sale of the asset.

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General Partner
A General Partner (GP), also known as a Sponsor or Syndicator, is responsible for finding the multifamily opportunity or land, due diligence, underwriting the deal, sourcing equity, arranging the financing and streamlining the transaction process until the deal closes. The GP then manages the full multifamily construction process, including entitlements, civil engineering, permitting, architectural design, construction, legal, administrative, marketing and other functions. Once the complex has been acquired or construction is complete, the sponsorship team is responsible for marketing and operating the asset until refinance or exit (sale). The GP is also an investor contributing significant funds into the syndication alongside LP investors.

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Waterfall Structure
A waterfall is used to describe how LPs and GPs are repaid through a share of the multifamily asset equity distributions, from operating profits and refinance or sale. It is commonly based on a type of return hurdle that must be met in order to progress to the next part of the waterfall. In a basic waterfall structure passive investors (LPs) will receive for example up to an 8% preferred return, and once the preferred return has been met, the rest
of the profits will be restructured as shown in the example below. This structure is designed so that GPs are incentivized to maximize returns for the investor.

• 8% preferred return (100% to LPs, 0% to GP).

• Split remaining profits 80% LP - 20% GP until passive investors (LPs) receive a 10% internal rate of return (IRR).

• Then a 70% LP - 30% GP split until LP investors have reached a 12% IRR.

• Finally a 50% LP - 50% GP split of remaining profits.

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Capital Stack
Most MF projects / investments require loans to construct / purchase and operate. The investment return is paid out in order from the bottom of the stack. Risk is proportionate to return. For ground-up MF construction a typical capital stack is:

• Common equity; lenders usually require developers / sponsors to contribute some of their own funds as common equity in order to have 'skin in the game'. The sponsors who develop and operate the property hold this stock, and it is considered the riskiest yet potentially the most profitable portion of the capital stack.

• Preferred equity; similar to common equity but with superior payment rights. LP investors hold this equity.

• Mezzanine debt; this is secondary debt paid back after the senior debt. It is not always needed thus not present in every deal.

• Senior debt; usually comprises 75% of the total raise. Funds are from banks and institutions thus the lowest return (interest rate) along with the lowest risk. It has the first claim to funds in the event of a foreclosure and retains the property itself as collateral.

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Lease
A lease is a written agreement between the landlord and tenant to occupy / utilize an apartment for a certain period for a certain monthly payment. This is a legally binding contract detailing all terms and conditions. Leases are generally 12 months in duration, and can then renew or switch to month to month. 

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Who is an accredited investor?

An accredited investor (per SEC Rule 501 of Regulation D.2) is an individual who has an annual income exceeding $200,000 ($300,000 for joint income) for the last two years with the expectation of earning the same or a higher income in the current year. An individual must have earned income above the thresholds either alone or with a spouse over the last two years. A person is also considered an accredited investor if they have a net worth exceeding $1 million, either individually or jointly with their spouse. An entity is considered an accredited investor if it is a private business development company or an organization with assets exceeding $5 million. Also, if an entity consists of equity owners who are accredited investors, the entity itself is an accredited investor. Definition reference here.

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What are the common types of real estate offering types?
To allow real estate investors to raise capital without doing a full public offering through the SEC, Regulation D was added to the Securities Act in 1982. Rule 506 provides an alternative to prior methods of selling securities which were costly and had stringent requirements. The two important sub-regulations concerning private real estate offerings are:

• 506b - allows raise of unlimited capital from accredited investors and up to 35 sophisticated investors, but no public advertising

• 506c - allows raise of unlimited capital from accredited investors only (must verify), and allows public advertising​

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Net Operating Income
The Net Operating Income (NOI) or profit of a revenue generating property is the revenue minus expenses, but does not include debt service as an expense.

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CAP Rate
Capitalization Rate (CAP Rate) is the return on a property when there is no loan (all cash). CAP Rate = NOI / Sale Price or Value. E.g. if the property value or sales price is $10 M, and NOI is $500 k, then the CAP Rate = 5%. Usually CAP rates are known for an area and asset type, it can then be used to calculate the sale price.

 

Cash-on-Cash Return
Cash-on-Cash (CoC) Return is also known as the Return on Investment (ROI). It is equal to the annual cash flow divided by the down payment. E.g. annual cash flow is $10000, and the down payment is $40000, then the CoC return is 25%. The investment would be fully returned in 4 years in this example.

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Debt Coverage Ratio
Debt Coverage Ratio (DCR) is the amount of cash flow remaining after covering the mortgage. DCR = NOI / Annual debt. E.g. If NOI = $1 M and annual debt service is $800 k, then DCR is 1.25. This number is used by lenders to determine the strength of the deal and repayment ability, a higher DCR is better.

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Price per Unit and per Sq Ft
MF investments are often analyzed by looking at the price per unit. E.g. if the property has 20 units selling for $5 M, then the price per unit is $250 k. Price per Sq Ft is the total area (sf) of all units divided by the sales price. E.g. in this example if the units total 25000 sf (1250 sf per unit), then the price per sf = $20. These values allow for comparisons between deals. It is important to know these numbers for a submarket where an purchase offer is to be made.

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What is a preferred return and what is your rate?
A preferred return or 'pref' is a fixed percentage projected return paid to LP investors on their capital, paid from project operational or sale proceeds ahead of any returns paid to the GP sponsors. This lowers the risk on LP returns vs that of GP returns. As a general guide we project returns of 8% to Class A-1 shareholders and 9% to Class A-2 shareholders.

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Equity Multiple
An equity multiple is a measure of the total return for an investment over the total investment period. E.g. investing $100000 with a preferred return of 8% for 5 years and receiving a $60000 distribution from the asset sale gives 5 x $8000 + $60000 = $100000. The equity multiple here is 2X, as the investor doubled their money.

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Internal Rate of Return
IRR is defined as the discount rate that makes the Net Present Value (NPV) of all cash flow equal to zero. Another way to says this; it is the time-weighted, annualized return on equity invested. It is considered the best investment metric as it takes into account the time value of money. It incorporates both cash flows and sale proceeds.

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Basis Points
A basis point (bp) is 1/100 of a percent. For example 25 bp is 0.25%.

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What about single vs multi-family investing?
Single family (SF) investment (rental) can work well in high appreciation areas if the 1% rule is followed. In many population centers, including major cities in Texas, it is becoming very difficult to find a good deal to rehab. Cash flow in many cases only covers expenses and does not leave any profit. The main problem with SF investment comes with scaling up. The management and maintenance is very frustrating and time consuming once 10 or so houses are in a portfolio. A rental management company can be used however they are notorious for not caring, poor communications, and letting issues and bad tenants prolong. One vacancy of s SF house is a significant loss, whereas 1 vacant unit is not so impactful within a MF asset. Investing in a MF syndication removes any time and stress involved due to the efficiency and professional management of the operation.

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What makes a good market for new construction of a MF asset?
It is a combination of both asset performance factors and construction factors, as maximizing the sale is what drives investor returns.

• Population growth

• Job growth and job type diversity

• Projected future income growth

• Neighborhood median household income of $50k or above

• Poverty level well below 10%

• Unemployment no more than 2% above city average

• Landlord friendly state

• Reasonable cost and availability of construction materials and labor

The demographic hurdles help to minimize bad debt for the asset once in operation, thus making it more attractive for institutional buyers.