What is Real Estate Syndication?
Real Estate Syndication
Investing in real estate projects is a highly profitable business venture, however, doing so requires huge sums of capital. Typically, to bypass such limitations, groups of investors and an individual referred to as a “syndicator” or “sponsor”, form partnerships known as a Real Estate Syndication. In a Real Estate Syndication, the syndicator assumes the role of the scout and manager who simultaneously assesses, develops, and manages the properties while the investors act as the provider of necessary resources for the successful execution of the real estate investment.
How is it usually structured?
Real Estate Syndication is usually structured either as a Limited Liability Company (LLC) or a Real Estate Fund.
In a Limited Liability Company (LLC), real estate investors are pooled together by a General Partner or Sponsor to invest in a specific asset or property. The General Partner leads the acquisition of the property and manages the syndication business.
While in a Real Estate Fund, the General Partner also known as the Manager or Sponsor, pools capital from real estate investors to syndicate multiple properties. The fund is often pre-raised and deployed when enough capital is pooled to purchase different assets. In this setup, the investor acts as a Limited Partner with no property management responsibilities and relies on a “trust” system, where an experienced Manager directs the diversification of investment to various assets.
Regardless of whether an investor chooses to invest in an LLC or through a Real Estate Fund, the bottom line is that both structures serve as an avenue for investors with little to no experience in Real Estate Investing to effectively generate passive income.
What are its advantages?
- Provides superior opportunities
A Real Estate Syndication has a network of connections that enable them to swiftly determine which on-demand properties are available. It also gives you access to premium properties that are not typically found on the market providing you access to the deals which you would not have otherwise.
- Diversified investments resulting in reduced risks
Investing in a Real Estate Syndication enables you to gain multiple channels of income since your investment is distributed on multiple properties. This gives you the advantage of minimizing the inherent risk associated with a particular property as you diversify your portfolio across various investments.
- Makes your money work for you
A Real Estate Syndication allows you to make money passively. The sponsor shall handle all the responsibilities associated with ensuring that your investments are producing positive results.
- Tax Benefits
A Real Estate Syndication possesses certified professional accountants which enables you to legally minimize your taxes while maximizing the amount of income your investments are generating. This is done through cost segregation.
- Reliability and Best Practices
A Real Estate Syndication allows you to avoid risks that come with inexperience in Real Estate Investing. They are most likely well-versed with regards to deciphering which are opportunities and pitfalls thus enabling you to make the best out of your investments.
Terms you should be familiar with:
Discount Rate
The Discount Rate is the rate of return that investors expect and is used to determine Present Value.
Present Value
The Present Value is a figure which indicates the current value of future cash flows using a specific discount rate. To get the PV you would divide the future cash flow by 1 plus the discount rate in decimal form raised to the number of years of your investment.
For example, you invested $600 and in 1 year, you expect the investment to bring in $770. Assuming your discount rate is 8%, the computation would be presented like this 770/(1+0.08)^1 which then results to a Present Value of $712.963. This means that at an 8% discount rate, you would need to invest $712.963 to get a return of $770 in 1 year. Therefore, investing $600 was a good investment.
Net Present Value
The Net Present Value (NPV) is the sum of the present values for all cash flows and the initial investment. An NPV greater than 0 indicates a good investment while an NPV less than 0 would mean a loss. The NPV could be calculated using Excel through the formula =NPV (discount rate, series of cash flows which also includes initial investment). When calculating for the NPV, always bear in mind that the initial investment is a negative value since it is an outflow.
Internal Rate of Return
The Internal Rate of Return (IRR) is used to estimate the profitability of potential investments. Specifically, the IRR is the discount rate at which the net present value (NPV) of all cash flows is 0. To put it simply, the IRR indicates the point at which an investment is likely to breakeven. Therefore, an IRR that is higher than the discount rate would indicate that such investment would be profitable, while a lower IRR would indicate a loss.
To determine the IRR of an investment, you must identify at which discount rate does the NPV calculated from your investments turns into 0. This could be done in Excel through the formula =IRR (cells containing the initial investment and cash flows).
For example, you invested $10,000 and such investment is expected to bring in $2,000 in the 1st year, $4,000 in the 2nd year, $5,000 in the 3rd year, and $3,000 in the 4th year. Let’s assume that the discount rate is 10%. Using the figures mentioned and applying the NPV and IRR Formula in Excel you would get an NPV of $845.07 and an IRR of 14%.
Net Operating Income
The Net Operating Income determines the ability of real estate assets and properties to generate income. In calculating the NOI, the operating expenses must be deducted from the revenue generated by the property. Operating Expenses could be defined as the expenses required to keep the property or business operational and profitable. Such expenses range from common area maintenance costs, administrative expenses, property taxes, insurance, utilities, and other miscellaneous costs. Expenses such as income taxes and capital expenditures, which do not hamper the ability of the property to generate revenue, are excluded in the computation of NOI.
For example, you are running an apartment building, which in its 1st year generated rentals of $2,500,000, however, the operating expenses needed to keep the apartment complex running amounted to $1,000,000. By deducting $1,000,000 from $2,500,000 you determine that the NOI of the apartment building is $1,500,000.
Average Annual Return
Average Annual Return is used by investors to see the performance of investments over a specific period. The AAR serves as a gauge for investors in determining whether an investment, business, or property is profitable by comparing the most recent return with the AAR.
For example, Investment A experienced returns of 20%, 18%, 16%, 24%, and 22% over 5 years, to compute for the AAR we simply get the sum of the returns and divide it by 5 which would result in an AAR of 20%. Since the most recent return is 22% which is above the AAR, we can conclude that Investment A is currently performing well.
Equity Multiple
An Equity Multiple is a tool that determines the amount of return with the amount initially invested. To calculate for the equity multiple, the total cash distributions must be divided by the total equity invested.
For example, a group of investors invested $2,000,000 on a real estate project in which after a few years generated a return of $6,000,000.00. Using the formula, the equity multiple would be 3.0x.
In simpler terms, an equity multiple of 3.0x would mean that an investor would get 3 dollars back in return for every dollar he invested. Therefore, an equity multiple of less than 1.0x indicates a loss of investment while an equity multiple greater than 1.0x signifies gains.
Cap Rate
The Capitalization Rate is the ratio of the projected net operating income of a real estate investment property over its current market value and is represented by a percentage value. The Cap Rate provides investors with insight regarding the potential return of an investment. To compute the capitalization rate, the net operating income must be divided by the current market value of the property.
For example, a property with a current market value of $100,000 generates a net operating income of $20,000. By dividing the net operating income by the current market value provided, you obtain a Cap Rate of 20%.
References:
Real Estate Syndication
https://www.fool.com/millionacres/real-estate-basics/investing-basics/what-real-estate-syndication/
LLC vs Funds
Advantages
https://thinkrealty.com/9-reasons-invest-real-estate-syndication/
https://www.mckennacapital.com/post/lucrative-tax-benefits-of-real-estate-syndication
Discount Rate, PV, NPV and IRR
https://www.investopedia.com/terms/i/irr.asp#what-is-internal-rate-of-return-irr
https://www.jdsupra.com/legalnews/investing-through-a-private-real-estate-29837/
Net Operating Income
https://www.valuepenguin.com/small-business/what-is-net-operating-income
https://www.investopedia.com/terms/n/noi.asp
AAR
https://www.investopedia.com/terms/a/aar.asp
https://www.readyratios.com/reference/analysis/average_annual_return.html
Equity Multiple
https://cadre.com/insights/how-to-use-equity-multiple-to-evaluate-real-estate-investments/
Cap Rate