Passive Investor Resources
If you are an accredited passive investor looking at investing in multifamily syndication deals then I created this just for you. The reason why is because I was recently on call with an investor and he asked me where he could go to learn more about investing in multifamily syndication deals.
There was an awkward pause...I didn’t have a good answer for him. There’s simply wasn’t one place for him to go that had info to help him know the questions to ask, research to do and things to think about. Until now.
This page’s only purpose is to arm you with info you need to make informed decisions when investing passively in multifamily syndication deals. I have hundreds of investors and have had thousands of investor conversations. The information below was created based on that experience.
Knowing Yourself and Your Goals
Before looking at deals or syndicators, it’s important to know yourself, what type of role you’d like to have in the investment and what your goals are. This starts by determining if you want to be passive or active.
Active vs. Passive Investing
- Active Investing: the acquisition of real estate (whether it is single-family residences (SFRs), apartments or other commercial real estate) with the goal of leasing it to a tenant and turning over the ongoing management to a third-party property management company.
- Passive Investing: placing one’s capital into a real estate syndication – more specifically, an apartment syndication – that is managed in its entirety by a sponsor
-To determine if passive investing is the ideal strategy for you, answer yes or no to the following seven questions:
- Do you not have the time to be an active investor but still want to invest in real estate?
- Do you want to be involved in a larger apartment deal, but don’t have the capital to acquire one by yourself?
- Do you not have experience as an apartment investor but still want to invest in apartments?
- Do you want a higher level of certainty in your returns as opposed to a riskier investment with a higher upside potential?
- Is capital preservation an important factor in your investment decision?
- Do you want a higher than average return from what is offered by the stock market, bonds, savings account, etc.?
- Do you want a hassle-free investment more than you want to control the business plan?
-The more “yes” responses you provided, the more passively investing in apartment syndications aligns with your investment goals.
-Overall, passive investing required a lower time commitment, has less risk and comes with less control than actively investing. For more information on these three distinctions, click here.
What is Your Ideal Passive Investment?
Assuming that passively investing in apartment syndications aligns with your investment goals, the next step is to determine the type of apartment syndication you will invest in.
-There are two main types of apartment syndications in which you can invest: distressed and value-add
- Distressed property: a non-stabilized apartment community, which means the economic occupancy rate is below 90% and likely much lower, due to poor operations, tenant problems, outdated interiors or amenities, mismanagement, deferred maintenance, etc.
- Value-add property: a stabilized apartment community with an economic occupancy rate above 90% and has an opportunity to be improved by adding value, which means making improvements to the operations and the physical property through exterior and interior renovations in order to increase the income and/or decrease the expenses. For more information on how syndicators add value to apartment communities, click here.
- Your ideal passive investment is distressed if you are content with tying up your capital for a year or two with minimal to no cash flow and willing to risk losing it all in order to potential double your initial investment
- Your ideal passive investment is value-add if you are attracted to the prospect of receiving an 6% to 8% (or higher) cash-on-cash return each year and a sizable lump sum profit after five years
- Apartment Syndication
- Accredited Investor
- Sophisticated Investor
- General Partner (GP)
- Limited Partner (LP)
- Capital Expenditures (CapEx)
- Operating Expenses
- Debt Service
- Net Operating Income (NOI)
- Capitalization Rate (Cap Rate)
- Price per Unit
- Cash Flow
- Closing Costs
- Financing Fees
- Operating Account Funding
- Equity Investment
an apartment syndication is a temporary professional financial services alliance formed for the purpose of handling a large apartment transaction that would be hard or impossible for the entities involved to handle individually, which allows companies to pool their resources and share risks. In regards to apartments, a syndication is a partnership between general partners (i.e. the syndicator) and the limited partners (i.e. the investors) to acquire, manage and sell an apartment community while sharing in the profits
an accredited investor is a person that can deal with securities not registered with financial authorities by satisfying one of the requirements regarding income or net worth. The current requirements to qualify are an annual income of $200,000 or $300,000 for joint income for the last two years with expectation of earning the same or higher or a net worth exceeding $1 million either individually or jointly with a spouse.
a sophisticated investor is a person who is deemed to have sufficient investing experience and knowledge to weigh the risks and merits of an investment opportunity
the general partner is an owner of a partnership who has unlimited liability. A general partner is also usually a managing partner and active in the day-to-day operations of the business. In apartment syndications, the GP is also referred to as the sponsor or syndicator. The GP is responsible for managing the entire apartment project.
the limited partners is a partner in a partnership whose liability is limited to the extent of the partner’s share of ownership. In apartment syndications, the LP is the passive investor. The LP funds the entirety or the majority of the apartment syndication.
capital expenditures are the funds used by a company to acquire, upgrade and maintain an apartment community. An expense is considered to be a capital expenditure when it improves the useful life of an apartment and is capitalized – spreading the cost of the expenditure over the useful life of the asset.
- Capital Expenditures include both interior and exterior renovations
- Examples of exterior capex are repairing or replacing a parking lot, repairing or replacing a roof, repairing, replacing or installing balconies or patios, installing carports, large landscaping projects, rebranding the community, new paint, new siding, repairing or replacing HVAC, and renovating a clubhouse
- Examples of interior capex are new cabinetry, new countertops, new appliances, new flooring, installing fireplaces, opening up or enclosing a kitchen, new light fixtures, interior paint, plumbing projects, new blinds and new hardware (i.e. door knobs, cabinet handles, outlet covers, faucets, etc.)
the costs of running and maintaining the property and its grounds
debt service is the annual mortgage paid to the lender, which includes principal and interest. Principal is the original sum lent and the interest is the charge for the privilege of borrowing the principal amount.
- Example: a 24-month $11,505,500 loan with 5.28% interest amortized over 30 years results in a debt service of $60,977 per month.
net operating income is all revenue from the property minus operating expenses, excluding capital expenditures and debt service.
- Example: an apartment community with a total income of $1,879,669 and total operating expenses of $1,137,424 has a NOI of $742,245
capitalization rate is the rate of return based on the income that the property is expected to generate. The cap rate is calculated by dividing the property’s net operating income (NOI) by the current market value or acquisition cost of a property (Cap rate = NOI / Current market value)
- Example: an apartment community with a NOI of $742,245 that was purchased for $12,200,000 has a cap rate of 6.1%.
price per unit is the cost of purchasing an apartment community based on the purchase price and the number of units. The price (or cost) per unit is calculated by dividing the purchase price by the number of units.
- the revenue remaining after paying all expenses. Cash flow is calculated by subtracting the operating expense and debt service from the collected revenue
|Total Operating Expense||$1,137,424|
|Asset Mgmt Fee||$40,195|
closing costs are the expenses, over and above the price of the property, that buyers and sellers normally incur to complete a real estate transaction
financing fee are the one-time, upfront fees charged by the lender for providing the debt service. Also referred to as a finance charge.
the operating account funding are the expenses, over and above the price of the property, to cover things like unexpected dips in occupancy, lump sum insurance or tax payments, or higher than expected capital expenditures. The operating account fund is created by raising extra money from the LP. Also referred to as contingency.
the equity investment are the upfront costs for purchasing an apartment community, which includes the down payment for a loan, closing costs, financing fees, operating account funding, and the various fees paid to the GP for putting the deal together. May also be referred to as the initial cash outlay or the down payment.
the sales proceeds are the profit collected at the sale of the apartment community.
the internal rate of return is the rate, expressed as a percentage, needed to convert the sum of all future uneven cash flow (cash flow, sales proceeds and principal pay down) to equal the equity investment. IRR is one of the main factors the passive investor should focus on when qualifying a deal.
- Example: A very simple example is let’s say that you invest $50. The investment has cash flow of $5 in year 1, and $20 in year 2. At the end of year 2, the investment is liquidated and the $50 is returned
- The total profit is $25 ($5 year 1 + $20 year 2)
- Simple division would say that the return is 50% ($25/50). But since time value of money (two years in this example) impacts return, the IRR is actually only 23.43%
- If we had received the $25 cash flow and $50 investment returned all in year 1, then yes, the IRR would be 50%. But because we had to "spread" the cash flow over two years, the return percentage is negatively impacted.
- The timing of when cash flow is received has a significant and direct impact on the calculated return. In other words, the sooner you receive the cash, the higher the IRR will be.
the cash-on-cash return is the rate of return, expressed as a percentage, based on the cash flow and the equity investment. CoC return is calculated by dividing the cash flow by the initial investment.
- Example: an apartment community with a NOI of $330,383 and an initial investment of $3,843,270 results in a CoC return of 8.6%
the rate of return based on the total net profit (cash flow plus sales proceeds) and the equity investment. EM is calculated by dividing the sum of the total net profit and the equity investment by the equity investment.
- Example: the LP that invested $3,843,270 into an apartment community with a 5-year gross cash flow of $2,030,172 and total proceeds at sale of $6,002,116 has an EM of 2.09
the market rent is the rent amount a willing landlord might reasonable expect to receiving, and a willing tenant might reasonable expect to pay for a tenancy, which is based on the rent charged at similar apartment communities in the area.
the gross potential rent is the hypothetical amount of revenue if the apartment community was 100% leased year-round at market rates.
|Unit Type||# of Units||Bed/Bath||Market Rent|
the gross potential income is the hypothetical amount of revenue if the apartment community was 100% leased year-round at market rates plus all other income.
the loss to lease is the revenue lost based on the market rent and the actual rent. LtL is calculated by subtracting the gross potential market rent by the gross potential rent.
- Example: an apartment community with a GPR of $183,072 and with an actual rent of $157,270 has a LtL of 14%
the loss to lease is
bad debt is the amount of uncollected money a former tenant owes after move-out or any other cost incurred that does not bring in revenue.
concessions are the credits (dollars) given to offset rent, application fees move in fees and any other revenue line time, which are generally given to tenants at move in.
a model unit is a representative apartment unit used as a sales tool to show prospective tenants how the actual unit rented will appear once occupied.
an employee unit is a unit rented to an employee at a discount.
the rate of unoccupied units. The vacancy rate is calculated by dividing the total number of occupied units by the total number of units.
- Example: an 216-unit apartment community that has 17 vacant units has a vacancy rate of 7.9%
vacancy loss is the amount of revenue lost due to unoccupied units.
- Example: an 216-unit apartment community that has 17 vacant units that rent for an average of $777 per unit per month has a vacancy loss of $158,454 per year.
effective gross income is the true positive cash flow of an apartment community. EGI is calculated by the sum of the gross potential rent and the other income minus the income lost due to vacancy, loss-to-lease, concessions, employee units, model units and bad debt
- Example: if total potential rent for the property is $2,263,624, the property losses $158,454 due to vacancy (7% vacancy rate) and $159,362 in credit costs (loss-to-lease, concessions, employee units, model unit, bad debt, etc.), and other income is $177,462, then EGI is $2,123,235
the economic occupancy rate is the rate of paying tenants based on the total possible revenue and the actual revenue collected. The economic occupancy rate is calculated by dividing the actual revenue collected by the gross potential income
- Example: a 216-unit property charges, on average, $847.11 per month per unit. Each month, a total of $3,025.50 is lost due to various concessions. There are 17 vacant units which could be rented for a total of $13,204.50 per month. Monthly bad debt is $4,595.58.
- The physical occupancy rate is 92%: 199 occupied units / 216 total units
- The economic occupancy rate is 86%
- Current revenue = $1,945,808 = [($847.11 * 216) – $3,025.50 concessions – $13,204.50 vacancy loss - $4,595.58 bad debt] * 12 months
- Current revenue / total possible revenue = $1,945,808 / (216 units * 847.11 * 12 months) = 86%
- Breakeven Occupancy
- Physical Occupancy Rate
- Gross Rent Multiplier (GRM)
- Rent Premium
- Debt Service Coverage Ratio (DSCR)
- Interest Rate
- London Interbank Offered Rate (LIBOR)
- Bridge Loan
- Permanent Loan
- Prepayment Penalty
- Ration Utility Billing System (RUBS)
- Property and Neighborhood Classes
- Preferred Return
the occupancy rate required to cover the total expense of an apartment community. The breakeven occupancy rate is calculated by dividing the sum of the operating expenses and debt service by the gross potential income.
- Example: a property with $1,166,489 in operating expenses, $581,090 in debt service and $2,263,624 in gross potential income has a breakeven occupancy of 77.2%
the physical occupancy rate is the rate of occupied units. The physical vacancy rate is calculated by dividing the total number of occupied units by the total number of units.
the gross rent multiplier is the number of years the apartment would take to pay for itself based on the gross potential rent. The GRM is calculated by dividing the purchase price by the annual gross potential rent
- Example: An apartment community purchased for $12,200,000 with a GPR of $183,072 per month has a GRM of 5.6
a rent premium is the increase in rent after performing renovations to the interior or exterior of an apartment community. The rent premium is an assumption made by the syndicator during the underwriting process based on the rental rates of similar units in the area or previously renovated units.
the debt service coverage ratio is a ratio that is a measure of the cash flow available to pay the debt obligation. DSCR is calculated by dividing the net operating income by the total debt service. A DSCR of 1.0 means that there is enough net operating income to cover 100% of the debt service. Ideally, the ratio is 1.25 or higher. An apartment with a DSCR too close to 1.0 is vulnerable, and a minor decline in cash flow would result in the inability to service (i.e. pay) the debt.
- Example: an apartment community with an annual debt service of $581,090 and a NOI of $960,029 has a DSCR of 1.65
the interest rate is the amount charged, expressed as a percentage of principal, by a lender to a borrower for the use of their funds.
LIBOR is the breakeven occupancy is a benchmark rate that some of the world’s leading banks charge each other for short-term loans. LIBOR serves as the first step to calculating interest rates on various loans, including commercial loans, throughout the world.
a bridge loan is a mortgage loan used until a person or company secures permanent financing, which are short-term (usually up to 1 years) and have a higher interest rate. Also referred to as interim financing, gap financing or swing loan. The loan is typically secured on a project that requires renovations.
a permanent loan is a long-term mortgage loan obtained after completing renovations on an apartment community, which usually repays the bridge loan.
a prepayment penalty is a clause in a mortgage contract stating that a penalty will be assessed if the mortgage is paid down or paid off within a certain period.
a refinance is the replacing of an existing debt obligation with another debt obligation with different terms. In apartment syndication, a distressed or value-add syndicator may refinance after increasing the value of a property, using the proceeds to return a portion of the LP’s equity investment.
appreciation is an increase in the value of an asset over time. There are two main types of appreciation: natural and forced. Natural appreciation occurs when the market cap rate “naturally” decreases. Forced appreciation occurs when the net operating income is increased (either by increasing the revenue or decreasing the expense.
RUBS is a method of calculating a tenant’s utility bill based on occupancy, apartment square footage or a combination of both. Once calculated, the amount if billed back to the resident, which results in an increase in revenue.
property and neighborhood classes is a ranking system of A, B, C, or D given to a property or a neighborhood based on a variety of factors. These classes tend to be subjective, but the following are good guidelines
- Property Classes
- Class A: new construction, command highest rents in the area, high-end amenities
- Class B: 10 – 15 years old, well maintained, little differed maintenance
- Class C: built within the last 30 years, shows age, some deferred maintenance
- Class D: over 30 years old, no amenity package, low occupancy, needs work
- Neighborhood Class
- Class A: most affluent neighborhood, expensive homes nearby, maybe have a golf course
- Class B: middle class part of town, safe neighborhood
- Class C: low-to-moderate income neighborhood
- Class D: high crime, very bad neighborhood
the preferred return is the threshold return that LPs are offered prior to the GPs receiving payment.
distributions are the LPs portion of the profits, which are sent on a monthly, quarterly or annual basis, at refinance and/or at sale.
underwriting is the process of financially evaluating an apartment community to determine the projected returns and an offer price.
a pro-forma is the projected budget of an apartment community with itemized line items for the income and expense for the next 12 months and 5 years, which is an output of the underwriting
the exit strategy is the plan of action for selling the apartment community at the end of the business plan.
the subject property is the apartment the syndicator intends on purchasing.
the rent comparable analysis is the process of analyzing similar apartment communities in the area to determine market rents of the subject apartment community.
the submarket is a geographic subdivision of a market.
an MSA is a geographical region containing a substantial population nucleus, together with adjacent communities having a high degree of economic and social integration with that core, which are determined by the United States Office of Management and Budget (OMB).
the acquisition fee is the upfront fee paid by the new buying partnership entity to the syndicator for finding, analyzing, evaluating, financing and closing the investment. Fees range from 0.5% to 5% of the purchase price, depending on the size of the deal.
the asset management fee is an ongoing annual fee from the property operations paid to the syndicator for property oversight. Generally, the fee is 2% of the collected income.
the property management fee is an ongoing monthly fee paid to the property management company for managing the day-to-day operating of the property. This fee ranges from 2% to 8% of the total monthly collected revenues of the property, depending on the size of the deal.
the refinancing fee is a fee paid for the work required to refinancing the property. At closing of the new loan, a fee of 0.5% to 2% of the total loan amount is paid to the syndicator.
the guaranty fee is a fee paid to a loan guarantor at closing. The loan guarantor guarantees the loan. At closing of the loan, a fee of 0.25% to 1% of the principal balance of the mortgage loan is paid to the loan guarantor.
the rent roll is a document or spreadsheet containing detailed information on each of the units at the apartment community, along with a variety of data tables with summarized income.
the profit and loss statement is a document of spreadsheet containing detailed information about the revenue and expenses of the apartment community over the last 12 months. Also referred to as a trailing 12-month profit and loss statement or a T12.
the PPM is a document that outlines the terms of the investment and the primary risk factors involved with making the investment. The four main sections are the introduction, which is a brief summary of the offering, the basic disclosures, which include sponsor information, asset description and risk factors, the legal agreement and the subscription agreement.
Questions to Ask the General Partner
Investment Strategy FAQs
Some passive investors will invest in their own name, while others will create an LLC and invest through that. From my experience, the breakdown is 50/50. I recommend asking your CPA for the best approach that fits your particular situation.
- Once the deal is closed, the GP should send consistent updates on the status of the deal. You may receive updates once a month, which is what my company does. However, some GPs provide quarterly updates. Others provide annual updates. And some don’t provide updates at all. The best update frequency will depend on your preference
- In regards to the information included in the update, this varies from GP to GP. Our monthly reports include occupancy rates, updates on the number of renovated units, details on our rental premiums and how they compare to our projections, capital improvement updates, relevant updates on the market and resident events. Each quarter, we provide a link to the apartment’s financial statements, which include the T12 and the rent roll.
- Overall, you want to know the status of the business plan and how the rents compare to the projections
- Blog post on investor reporting
GPs should NEVER guarantee a return. If they do, run! Any return offered should be a projection, never a promise.
- Ideally, the GPs projected returns exceed the preferred return offered. That way, if they don’t achieve the projected returns, they still distribute the full preferred return. If the actual returns end up being lower than the preferred return, the process is that which was agreed to in the PPM. Generally, there is a provision where the GP will “catch-up” with the payments to the LP before collecting their asset management fee.
- Make sure that the GP has a process and that you are clear on the process.
- Similar to the question about “what happens if the project fails,” if the GP says there are no risks, they are either lying or unexperienced.
- The three risk areas associated with apartments are the deal, the market and the team. Therefore, ask the GP what about the risks associated with these three areas and what they are doing to mitigate them.
Before investing in a deal, the GP should provide you with the projected timeline of the project. Generally, that is 5 years, and the GP will require you to keep your capital in the deal until the end of the business plan.
This varies. But if there is a process for pulling your money out of the deal, it will be outlined in the PPM. The process usually entails you selling your shares to another party with the written consent of the GP.
- Generally, the GP will make money via the acquisition fee, ongoing asset management, equity ownership in the deal and whatever else they decide to charge. All of the fees they charge should be listed in the PPM.
- After determining which fees they charge, ask them why. They should only charge fees based on the value they provide to the deal. If they can’t explain what value they are providing for each fee, then they shouldn’t be charging that fee.
- Blog post on how a syndicator makes money
- The distribution frequency varies and depends on your preference.
- The typical frequencies are monthly, quarterly or annually. My company found that the majority of our investors preferred monthly distributions, so that’s what we decided to do.
- Most GPs will have a minimum investment. The more experience they GP has and the larger the project, the higher the minimum.
- You want to know what the minimum investment is so that you can determine if you are financially capable of investing in the deal.
- If the syndication is a 506b offering, you don’t need to submit your financials. If it is a 506c offering, you will. But you can get around submitting financials by working with a financial advisor.
- Blog post on 506b vs. 506c (based on the podcast interview Joe did)
- Usually, the GP will put you on their private email list.
- If they already have a deal under contract, you can ask them for an investment summary, for the information to the conference call or a recording of the conference call.
Ideally, the general partner has their own funds in the deal because there is an extra level of alignment of interests. If you lose money, the GP loses money. If the GP doesn’t invest in the deal, they aren’t exposed to the same risks as you. Additionally, the GP investing in the deal signals to you that they are confident in the deal and the projected returns.How many of your investors have invested in multiple assets?
Determine what percentage of their investors have come back to invest in a second deal. A GP’s retention rate is a great indicator of the GP’s track record of meeting and/or exceeding the projected returns.
As a passive investor, you need to have a high level of confidence with the individuals that make up the GP, as you are entrusting them with your capital. One way to determine the character of the GP is to determine if their family and friends invest in their deals.
- On all tax related questions, always consult with your accountant. But generally, passive investors are attracted to real estate because of depreciation. Most likely, the depreciation will be greater than the distributions paid out each year. When this is the case, you won’t pay taxes until you receive the proceeds from sale.
- Determine if the GP passes the depreciation on to the passive investors, because not all do.
- Also, ask the GP if the performs a cost segregation on their apartment communities. Cost segregation is a tax strategy that results in even greater tax benefits
- The answer is no. However, you are able to 1031 exchange your proceeds at sale into another investment if the GP allows.
- Ask them if they allow you to 1031 exchange your proceeds at sale into another investment and what the process is for doing so. Generally, the GP will need to know well in advance of sale.
- The type of financing is determined on a case-by-case basis. But generally, if the GP will perform renovations, they will get a short-term, preferably interest only loan, and then refinance into a permanent loan once the renovations are completed.
- The advantages of this financing structure is the interest only payments, which will allow the GP to distribute returns during the renovation period, and the refinance, which will allow the GP to return a sizable amount of initial equity.
- Generally, there are two ways to find apartment deals, on-market and off-market. Ideally, the GP is sourcing off-market deals, as there are a variety of benefits to finding apartment deals off-market compared to on-market. Off-market deals are less competitive with more opportunity for negotiation, which means better purchase terms, which means better return projections.
- On-market vs. off-market deals blog post
- As long as the GP performed adequate due diligence on the asset, the project shouldn’t fail. And by fail, I mean that you don’t receive your preferred returns and/or initial equity at the end of the business plan. However, like any investment, failure is always a possibility. Therefore, the purpose of this question is to determine 1) their plan of action of returns dip below projections and 2) what they are doing to address the three risks (deal, team and market) associated with apartment syndication.
- If the GP responds with “well that’s just not going to happen,” then that is a sign that they aren’t taking the real risks seriously.
- The GP should have a contingency or operating fund to cover shortfalls. If the project requires renovations, ask the GP how much they’ve budgeted as a contingency. A good rule of them is 10% to 20% of the renovation budget.
- Ask them how much upfront money they’ve budgeted to cover potential shortfall like unexpected dips in occupancy, unexpected maintenance issues, lump sum tax or insurance payments, etc. A good rule of thumb is 1% to 3% of the purchase price.
- Finally, ask them how much money they are budgeting annually to a reserves account. A good rule of thumb is $250 to $300 per unit per year (i.e. a 100-unit apartment community should save $25,000 to $30,000 as reserves for ongoing shortfalls).
- If the GP does not budget for these contingencies, they may have to come back to you asking for additional capital, which will reduce your return on investment.
The money you invest in the deal goes towards a variety of costs associated with purchasing an apartment community. These include the down payment for the loan, financing fees, renovation costs, GP fees charged for putting the deal together, contingency or operating account funds and costs associated with performing due diligence.
- This process will vary from GP to GP. For my company, we will notify you of a new opportunity and invite you to a conference call in order to provide you with the specifics on the deal. If you are unable to attend the conference call, no problem. We always record the calls and send the audio file out the next day.
- After the conference call, if the deal meets your investing goals, you will verbally commit to the deal.
- Then, you will be required to sign documents to finalize your commitment, which include a private placement memorandum (outlines structure of and the risks associated with the deal), an operating agreement (outlines the GP and LP responsibilities and ownership percentage), a subscription agreement (outlines the number of shares you own of the LLC that owns the apartment community) and an accredited investor qualifier form (where you state that you meet the accredited investor qualifications). We will also have you fill out a direct deposit form so that you will automatically receive your distributions.
- Once you’ve finalized your commitment, you just wait for us to close the deal.
- This is our process, but other GPs may have a different process.
- Blog post on what happens after an investment is found
Some GPs will notify all of their passive investors at the same time, while others may notify their “preferred investors” first. Ideally, all investors are notified at the same time and commitments are taken on a “first-come, first-serve” basis.
Specific Deal FAQs
The majority of owners are selling because they’ve reached the end of their business plan. But, some owners may sell because they are distressed in some form. These are the types of deals you want to invest in because they have the most upside potential. A distressed owner will usually except a lower purchase price or better purchase terms than an owner who isn’t.
- The combination of the costs associated with purchasing the property and the renovation costs should be lower than the value of comparable properties in the area. That difference is free equity, which will increase the profit you receive at sale
- If the acquisition plus renovation costs are equal to or higher than comparable properties in the area, the GP is paying too much for the property and your profits at sale or equity returned at refinance will be reduced.
- The in-place cap rate is based on the purchase price and the current net operating income. You want to know the going in cap rate so you can compare it to the cap rate in the market. A going in cap rate that is higher than the market cap rate is a good sign, because that means the property is purchased below market value.
- If the GP’s business plan is distressed or value-add, the cap rate isn’t as important because the net operating income is lower than what it should be a purchase. If that is the case, you want to know the stabilized cap rate and how it compares to the market cap rate, with the former being higher than the latter as the ideal scenario.
- Understanding the quality of the major systems is important for the GP to determine an exterior renovation budget. Additionally, if the major systems are in bad shape, this is a risk factor and should be addressed with a contingency budget
Ask them if they or someone on their team inspected these major systems themselves. The only way to know the true state of the major systems is to see them with your own eyes, as opposed to trusting the owner, broker or offering memorandum
The target hold period will let you know how long your capital will be locked into the deal.
- The GP shouldn’t just provide you with an overall capex budget. You want to know how much money is budgeted to each project.
- Also, you want to know how they calculated the capex budget. More specifically, you want to know if the GP assumed the capex costs or if they are based on bids from contractors who inspected the property. The latter is more accurate than the former.
- Finally, you want to know what portion of the capex goes towards a contingency fund. As I explained earlier, the contingency should be 10% to 20% of the total capex costs.
- If the year 1 income projections are different than the actual trailing 12-month financials, you want to know why.
- As I explained earlier, the revenue is based on market rents, loss-to-lease, vacancy, bad debt, concessions, employee and model units and other income. So, if any of these line items differ from the T12, you want to know what the GP based those assumptions on and whether or not those assumptions were approved by the property management company.
- A conservative annual rent growth factor is between 2% to 3%. This factor is the projected natural growth in revenue
- Some GPs will base this factor on historical rent growth, which may be lower or higher than 2%. Rent growth factors higher than 2% are aggressive and if you run into such a case, the GP should have ample evidence to prove why they’ve assumed a higher number.
If the year 1 expense projections are different than the actual trailing 12-month financials, you want to know why the GP made those assumptions and if they confirmed them with their property management company.
- You want to know if the annual tax assumption is based on what the current owner is paying or if it is based on the purchase price. The latter is the correct approach.
- The tax assumption can be calculated by finding the tax rate on the county’s auditor site and multiplying it by the projected purchase price.
A conservative annual expense growth factor is between 2% and 3%. This factor is the projected natural growth in expenses and should be relatively similar to the annual rent growth factor.
As I mentioned before, a GP should save $250 to $300 per unit per year in reserves. This is to cover ongoing shortfalls or unexpected capex projects. If they don’t have a reserves budget and a shortfall occurs, they may be coming to you for extra capital.
- First and foremost, you want to know if they have already secured debt financing or if they are still working on assumptions. If it is the latter, the projected returns may change once debt is secured.
- Next, you want information on the interest rate. Is it locked in or is it floating (meaning it could change)? If it is the latter, the returns will change if the interest rates rise or fall.
- Finally, you want to know if it is a short-term loan or a permanent loan. If it is the former, ask them what refinance assumptions they used (i.e. interest rate, loan amount, etc.) and why they made those assumptions.
- For distressed and value-add deals, your largest profit will be realized at the sale of the apartment at the end of the business plan. So, you need to know what assumptions are being made about the sale of the property.
- These assumptions include the exit NOI, exit taxes, exit cap rate (is it higher or lower than the purchase cap rate, with the former being the conservative approach), the closing costs and the remaining debt.
The relevant return factor is based on your investing preferences. The GP should calculate returns using factors like cash-on-cash return, internal rate of return and equity multiple. You may have return goals for one, two or all three of these return factors. You’ve already determined all of the assumptions the GP made when calculating these returns, and your decision to invest is based on these assumptions and the projected returns.
You want to know what market factors the GP look at when qualifying a market. Important factors include unemployment change, population growth, population age, job diversity, the top employers and supply and demand.
Blog post on evaluating a market
- One of the factors a prospective tenant will take into account when moving to an area is the quality of the school district. Even if your target tenant demographic are not small families, a quick way to gauge the overall quality of a market is the school district. Look at the elementary, middle and high schools and see how they rank.
- No one wants to live in a high crime area. Look at the crime stats for the market. If there is a specific deal, look at the crime stats of the neighborhood.
- More specifically, look at the crime trend. Even if it is relatively high, a downward trend is a good sign.
- You want to know the median income of the area in order to determine if the demographics income levels support the rent projections. Generally, people spend 25% to 35% of their annual income on home expenses. Therefore, confirm that the median income is at least 3-4 times higher than the annual projected rent.
- The market vacancy rate is essentially the average multifamily vacancy rate in the market. However, a more accurate market vacancy rate is based on a handful of recent sales.
- Ask them what the market vacancy rate is and how it was calculated, and then compare that rate to the assumed vacancy rate.
- You want to know what percentage of the passive investors are professionals and what percentage are first-timers
- Because professional investors have passively invested in many deals across many GPs, having a large percentage of professional investors signals that you are dealing with a high-quality apartment syndicator.
- Determine how many deals they have completed and how those deals actually performed when compared to the projected returns.
- If the GPs has had past deals that underperformed when compared to the projections, it isn’t necessarily a deal breaker. A good follow up question would be “what processes have you put in place to reduce the likelihood of an underperforming deal?”
- As I mentioned in a previous section, I would advise against investing with a GP that hasn’t successfully taken a deal full cycle. While this can be offset by an experienced team, there is still less risk when going with a GP without a proven track record
- This is a question you would want to ask during your first conversation with a GP. If they have a deal under contract, ask them some of the questions I outlined in the “Specific Deal FAQ” section. You will have a better understanding of their business plan when they explain it for an actual deal than for a hypothetical deal.
- Also, if they currently have a deal under contract, ask them how much capital they have left to raise. Maybe, this can be your first passive investment.
- A satisfactory response to this question will vary for investor to investor.
- Based on my experience with passive investors, the reason they decide to invest in my deals are because of alignment of interest, transparency and trust.
- We show alignment of interest by placing our asset management fee in second position to the preferred return, which means we don’t get paid until our investors get paid. Additionally, we invest our own capital in the deal
- We are very transparent with our passive investors, providing detailed monthly email recaps on the status of our business plan. We also pride ourselves on our responsiveness. When an investor sends us an email, we reply within hours, not days
- Finally, we build trust with our passive investors through a thought leadership platform. I host a daily real estate podcast, and whenever I jump on a call with a prospective investor, most of them tell me that they feel like they’ve already talked to me because of the podcast
- These are a few examples of how syndicators differentiate themselves but the reasons why you invest with one syndicator over another (assuming the projected returns are equal) are based on your personal preferences
- You want to know that your money is in good hands, and the syndicator is one of many people that are responsible for the success of the deal.
- Usually, the “syndicator” is actually more than one person. There are multiple partners who have different responsibilities. So, you want to know who all the business partners are, how they met, what unique skillsets they bring and how each partner complements the other.
- Another important team member is the property management company. Their responsibility is to manage the operations on a day-to-day basis. The property management company should have prior experience managing apartment communities. In fact, they should be actively managing apartment communities that are, preferably, in the same submarket. Ask for the historical information of the property management company (i.e. how many units do they manage, how long have they been in business, have the syndicators worked with this company in the past, etc.)
- The syndicators and the property management company are the most important members of the team, so gaining an understanding of their background and experience is a must prior to entrusting them with your money.
- Most apartment syndicators will create a LLC and purchase the property with the LLC. As a LP, you will then purchase shares of that LLC.
- The apartment will be managed by a professional property management company that is either a 3rd party or owned by the apartment syndicator.
- Regardless of who the property management company is, you want to know about their past experience. Determine how many properties they manage overall and how many properties they manage in the GP’s target market.
- If it is a 3rd party management company, determine how many of the GP’s previous deals were managed by them and the success of those deals (i.e. how did the actual returns compare to the projected returns?)
- As the LP, your sole duty involves the funding of the deal. After that, the process should be hands off except when reviewing the investor reports and doing your taxes at the end of the year
- The GP is responsible for everything else. Generally, they will find the deal, review and qualify the deal, make and negotiate the offer, coordinate with professional property inspectors, find the best financing options, coordinate with attorneys to create the LLC and partnership agreements, travel to the property to perform due diligence and market research, hire and oversee the property management company and perform ongoing asset management, which includes lender conversation, overseeing the business plan and ongoing communication
- Blog post on the GP duties
- Some GPs will focus solely on apartment syndications, while others may also focus on other asset classes, whether it be single family homes, mobile homes, self-storage, retail, development, etc.
- Ideally, their main focus is on apartment syndications. If it is just a side business, that is a red flag
- There are three main part of an apartment syndication: acquisition, management and sale. Each part has its unique action items and challenges. Even if a GP has previously acquired and managed a deal, you still don’t know if they are capable of finalizing the business plan with a sale. Keep that in mind when screening GPs. If they haven’t taken a deal full cycle, they are lacking in the full apartment syndication experience
- The point person is the individual in the GP that you reach out to if you have any questions or concerns about the deal. You want to know who this person is and what their GP responsibilities are. Ideally, they are actively involved in the deal and are one of the experienced team member as opposed to their sole responsibility being the point person.