Multifamily syndications can be a great vehicle for investor looking to expand their portfolios into the world of commercial multifamily. Instead of needing to learn the business from A to Z, and investor can simply place his or her capital into an existing operator’s deal that has the experience and team to execute and perform. Though it can be a great vehicle, one of the most common questions I get from investors is how the returns on invested capital stack out over the life of the investment.
Though return structures can vary quite a bit from deal to deal (and operator to operator), there are general rules of thumb that are industry standard today for investors. So, let’s use these rules of thumb to map out the typical return structure for an equity investor. For the purposes of this example, I’ll use $100K invested equity into a value-add multi-family deal that has a 5-year hold period.
Let’s say the property already has some tenants paying market rents, but the business plan is to go in and improve a small percentage of the units. From day one, the operator may be able to pay out a preferred return that will be equivalent to a 5% return cash on cash on invested capital. If this initial period lasts two years, that means as an investor, you’ll receive $5,000 per year in cash-flow distributions ($5,000 annualized return on $100,000 invested equity leads to a 5% CoC).
Now, let’s say that by the third year, the operator was able to hit his goal and improve the cash flows of the building. So, for years three through five, now that the property generates more cash flow, let’s say you will start to receive $6,000 a year in cash flow distributions. Your cash-on-cash increases to 6%, and over the life of the investment, you’ll see that you receive $28,000 in total cash flow distributions. Not too bad.
Now, the bulk of your returns in this kind of deal are going to come during the exit. On a typical deal, assuming all went well with the operations and execution, an investor in this kind of deal would get his or initial equity back plus about ~$70,000 of proceeds in profit (these kinds of returns would be solid and not a unique case). What’s key to understand is that the bulk of the returns are made on the exit of the deal, and this is why I’m very passionate and often talk about the concept of not over-emphasizing cashflows in a multifamily deal, but rather the location and the equity upside.
So overall, with the $100,000 capital investment, the investor over the course of 5 years would have made about ~$198,000. Essentially, the investment has doubled, and on a IRR basis this would pencil out to be around a 15.7% return. Again, this is pretty typical in a deal like this and very much in-line with a proper operation. Note that this also all pre-tax profits, which would only improve the financial returns to the investor. Hopefully this sheds light on why investing in syndications has become such a popular investment vehicle for investors all over the country.
