I got an interesting question from someone I know pretty well the other week that stumped me for a moment. As an active multifamily investor and syndicator, I consider myself to be well versed in most questions as it relates to raising capital and investor returns. Yet, this one took a second; “Lior, is it better to invest in a syndication of a multi-family or should I just buy my own property that’s turnkey and ready to go”.
It was a great question that I didn’t have an immediate answer for, and the more I thought about it, the more I realized it was a great point for someone considering investing in real estate. You can invest into someone’s syndication (where an operator raises capital for his or her deal that they are sponsoring), or you could consider buying something turn-key that should in theory be easier to manage. So, I decided to run some hypothetical numbers to see what the comparison between the two strategies would be.
So, in this experiment, I ran an analysis of two scenarios that is most relevant for Boston multi-family. I looked at the opportunity of investing in a value-add multi-family syndication that is being run by a professional sponsor such as myself (using a small 3-unit value-add project as a basis that I typically sponsor) versus buying a small turnkey multifamily at a similar price point (~$900K 3-unit multi-family). I looked at three metrics, IRR, cash on cash, and equity multiple, to get a general sense of what the return profile looks like.
Before sharing the results, there are a few assumptions that I made that I think are important to disclose. First, on the turn-key acquisition, I assumed the purchase was performing at top dollar rents from day one and did not need any renovation work. Second, I assumed the expense structure between the purchases would be the same, including property management in both analyses. Finally, as in most of my modeling, I assumed a low 3% yearly appreciation rate in property value and 2% income and expense annual growth. Both scenarios were modeling out 3-year hold periods.
Here’s how the numbers panned out for turn-key investing: when buying a turnkey property, the results were:
- IRR: ~14%
- Cash on Cash: ~5-6%
- Equity multiple: ~1.4
Not too shabby for a turn-key purchase. I will say this is a common return profile for an investment property in Boston. The cash on cash is what you typically see around the city, and the IRR is not too bad for something that is ready to go.
Now, on my typical syndications that I have done where I have a value-add project, my typical deal profile for a capital partner is typically about:
- IRR: ~18-19% + (for light value add deals for heavier ones push 20%+)
- CoC: ~5%
- Equity multiple: ~1.6-1.7 up to 2+
So, what are the key take-aways from running numbers on these scenarios? First, though the return profile is lower, buying your own deal turnkey is not always necessarily a bad move. If you wanted to learn the business hands on, then this could be a great idea; you’ll see directly what it takes to run a building and some of the typical issues that come up.
Additionally, depending on the deal structure, you may have a shot at better cash on cash returns buying a building yourself. With a syndication, you’ll need to evaluate the structure of the offering, including how cash flow is distributed, if there is any preferred return, and other factors to see where you can maximize consistent distributions assuming that’s a priority for your investment strategy.
What is clear, however, is that when investing in a value-add syndication where equity gets created through renovations/stabilization, there is more meat on the bone for your investment. Therefore, you’ll see your IRR and equity multiple much higher on the syndication side, which can be important metrics for those looking at increasing net-worth and their balance sheets.
Now, from a risk assessment perspective, there is obviously some more risk that comes with renovations and stabilization as compared to turnkey investing. There’s always some risk that projects take longer than expected or go over budget, but this is why judging the quality of the operator is crucial. Part of the diligence is assessing how good you think the operator is in executing and hitting benchmarks or mitigating storms when external factors influence construction and other operations.
Finally, from a higher-level investment strategy, investing in syndications is something that is more scalable and allows for diversification. There is a reason syndications have been so popular for folks with capital to invest in; you don’t need to save the full 25% down saved up to get real estate exposure in your portfolio, and you can invest in smaller chunks across a broad range of properties and markets.
