The lifecycle of a multifamily syndication deal typically involves several stages, starting with the acquisition of the property and ending with the sale of the asset.
The specific steps may vary depending on the deal and the syndicator, but generally, the stages are as follows:
- Acquisition: The first stage involves finding and acquiring a property that meets the investment criteria of the syndicator and their investors. This stage involves due diligence, negotiations, and closing the purchase.
- Asset Management: Once the property is acquired, the syndicator takes over the management of the asset. This stage involves implementing the business plan for the property, which could include making improvements, increasing occupancy, and reducing expenses. The goal is to maximize the cash flow and value of the property.
- Cash Distributions: As the property generates cash flow, the syndicator distributes the profits to the investors according to the terms of the deal. This could be on a monthly, quarterly, or annual basis, depending on the syndicator’s policies.
- Refinancing: If the syndicator can increase the value of the property through improvements or increased cash flow, they may choose to refinance the property to pull out equity and distribute it to the investors. This allows the investors to realize some of their profits without selling the property.
- Sale: The final stage is the sale of the property, which could happen after a few years or several decades, depending on the syndicator’s strategy. When the property is sold, the profits are distributed to the investors according to the terms of the deal, and the syndication is dissolved.
Overall, the lifecycle of a multifamily syndication deal can take several years, and it involves multiple stages of management, cash flow, and potential profit. Syndicators aim to create value for their investors by acquiring, improving, and selling properties at a profit, while also providing regular cash distributions along the way.
Distributions offer Passive Income
Passively investing in syndication has a unique advantage – it allows limited partners to enjoy regular income distributions without any significant effort on their part. This feature is one of the appealing aspects of passive investing, but it’s crucial to understand the mechanics of how these distributions are accrued and paid out over the lifecycle of the investment. Therefore, it’s essential to gain a comprehensive understanding of the process before deciding to invest.
First, let’s start with what passive investing is:
In the context of multifamily syndication, passive investing refers to investing in a real estate deal as a limited partner (LP), without actively participating in the day-to-day management of the property or the syndication itself.
Multifamily syndication is a real estate investment structure where a group of investors pools their capital together to purchase and manage a multifamily property, such as an apartment complex. The syndication is typically led by a general partner (GP) who is responsible for sourcing the deal, managing the property, and overseeing the syndication’s operations.
As a passive investor in multifamily syndication, you provide the capital needed to invest in the purchase of the property (for Viking Capital the minimum investment is $50,000), but you do not actively participate in the management of the property or the syndication. Instead, you receive regular income distributions and a share of the profits generated by the syndication based on your ownership percentage.
Passive investing in multifamily syndications can be an attractive option for investors looking to diversify their portfolios and generate regular passive income from real estate investments without the challenges of managing the property themselves.
Cash Distributions vs. Accrued Income
To understand multifamily syndication investments, it’s essential to start with the basics. One important aspect is the concept of cash distributions and accrued income.
Cash distribution is the portion of the preferred return that’s paid out monthly or quarterly to limited partners (LPs) based on the actual cash flow at the asset, such as rent collected. It’s a direct result of the realized cash flow at the property.
Accrued income is the remaining portion of the preferred return that isn’t paid out on a regular basis. Instead, it’s accumulated over time and paid out later, either when cash flow allows it or during a capital event like the sale of the property.
Example:
To better understand how cash distributions and accrued income work in multifamily syndication, let’s consider an example scenario. Suppose you have invested $100k at a 7% preferred return, based on the projected proforma. In the first year of owning the property, the realized cash flow at the asset allows for a 3% preferred return to be paid out as a cash distribution, which is directly credited to your account.
The remaining 4% of the preferred return will be accrued, meaning it will be accumulated over time and paid out later. This may occur when the asset generates enough cash flow or when a capital event, such as a sale of the property, takes place.
Now let’s say that at the end of the first year, you receive $3k in cash distributions and have accrued $4k. Moving into Year 2, there are no distributions paid out due to various reasons, such as a natural disaster or building up reserves for an upcoming uncertain economy. By the end of Year 2, you have accrued an additional $7k, adding up to a total accrued income of $11k along with $3k in cash distributions for the first two years.
This pattern of accruing income and receiving cash distributions will continue throughout the lifespan of the deal until a capital event, such as the sale of the asset, occurs. When this happens, the accrued income in your account will be paid out first, followed by the return of the original capital, and finally, the profits will be distributed according to the agreed split between the LP and the ownership group.
Cash Reserves and Asset Cash Flow | How Viking Capital Distributes
At Viking Capital, we take a conservative approach to raising funds for our real estate investments. We only raise the amount needed to purchase the property and cover the necessary capital expenditures and reserves. This ensures that we are paying out cash distributions solely from the direct cash flow of the property, rather than relying on additional funds from investors.
When we invest in properties with a value-add component, we anticipate that the cash flow will increase over time as we lower expenses and make improvements. While this may result in lower cash distributions in the first year or two, the potential for higher payouts in years three through five is significant. Ideally, the preferred return will be paid out in full over these years, along with any accrued income.
However, it’s important to note that there is always a possibility that the preferred return will accrue over the entire lifecycle of a deal and only be paid out at a capital event, such as the sale of the property. In any case, we focus on maintaining cash reserves at both the fund and asset level. This provides us with a safety net should unforeseen circumstances arise or interest rates increase.
At Viking Capital, we prioritize financial stability and security for our investors. By carefully managing our cash reserves and utilizing a conservative approach to raising funds, we are able to offer our investors consistent and reliable cash distributions over the lifecycle of each investment.
What is a preferred return mean?
At its simplest, the preferred return is the return that the limited partner (LP) will receive on their invested capital for the period of time that their money is held. For example, if the preferred return is 7%, it means that over the lifecycle of the hold period of that deal, the LP can expect to make that percentage. So, if someone invested $100k at a 7% preferred return, they would receive 7% each year that the asset is held.
However, it’s important to note that the preferred return is different from cash distribution. Cash distributions are based on the actual cash flow of the asset itself, at that present moment in time. If there’s enough cash flow at that time, the full preferred return amount would be paid out. If there isn’t presently enough cash flow, it would then be a percentage of the preferred return and the remaining amount would accrue over time.
So, while the preferred return is a promise to pay a certain percentage of return over the hold period, cash distribution is the actual payment of money to investors based on the property’s cash flow.
It’s also important to understand that the limited partners will get their preferred return before any profits are split with the general partners. This is why it’s called a preferred return. Once the preferred return is paid to the LPs, any remaining profits are then split according to the terms of the deal.
For example, if someone invested $100k at a 7% preferred return, and the hold period of the deal was five years, they would earn $35k on their investment ($100k x 7% x 5 years). If there are cash distributions during that time, the preferred return will be paid out first, and any remaining profits will be split between the LPs and general partners according to the agreed-upon terms.
Cash on Cash Distributions
One common misconception is around cash distributions. Many investors assume that they will receive cash distributions every quarter, but that is not always the case. Cash distributions are based on the true cash flow of the property after all operating expenses have been paid out. So, if there isn’t enough cash flow to support distributions, investors may not receive any payments for a period of time.
If you aren’t getting distributions, don’t panic just yet. While it may seem like a red flag, it doesn’t necessarily mean you’re in a bad deal. However, it does mean you should start asking questions.
The first thing you should consider is whether the operator is being conservative with their payout strategy. Sometimes, operators will hold back distributions in the short term to ensure the long-term health of the investment. This can be a positive thing if it means the long-term returns and valuations are protected. In this case, the operator is taking a prudent approach to ensure the sustainability of the investment.
On the other hand, if the operator didn’t plan properly and is unable to make distributions, then you should continue asking more questions. It’s important to understand why the operator is unable to pay out distributions. Are they experiencing unexpected expenses or did they underestimate the cost of the project? Are they simply mismanaging the investment?
Asking these questions can help you determine whether you should continue to hold your investment or look for a way out. If the operator is taking a conservative approach, then you may want to stay invested for the long term. However, if they are mismanaging the investment, it may be time to consider cutting your losses.
In any case, it’s important to do your due diligence and ask questions when an operator isn’t paying out distributions. This will help you make informed decisions about your investment and ensure that your money is being used in the best way possible.
Is My 7% Preferred Return Guaranteed?
Real estate investment comes with a certain level of risk. As an investor, it’s important to take the time to understand and assess that risk before committing your capital to any deal. However, there are some aspects of real estate investing that come as close to a guarantee as possible, and one of those is the preferred return.
The preferred return is the return that investors will receive on their capital for the period of time that their money is invested in the deal. This percentage is typically agreed upon at the outset of the investment and serves as a benchmark for the returns that investors can expect to receive.
It’s important to note that the preferred return is not the same as cash distributions. While cash distributions are based on the actual cash flow of the property at any given time, the preferred return is a guaranteed percentage that will accrue over the lifecycle of the investment. This means that even if cash distributions are not paid out in a given period, the preferred return will still be accruing and will be paid out at some point in the future.
At Viking Capital, we believe that investing in real estate is a smart move for those who are willing to take on some risk. However, we also believe that it’s important to be transparent about the risks and rewards associated with any investment. When an operator is not paying out distributions, it’s important to start asking questions. Is it because they’re being conservative and focusing on the long-term health of the investment, or is it because they didn’t plan properly? By asking these questions and digging deeper into the details of the investment, investors can make informed decisions about their portfolios and investments.
In short, while there are no guarantees in real estate (or in life), the preferred return is as close to a guarantee as investors can get. By working with a reputable operator and asking the right questions, investors can mitigate risk and maximize returns in their real estate investments.
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