As a passive investor, receiving an email alert for an open deal with Viking Capital can be an exciting moment. You start reading through the investment summary and the numbers look promising, but there may be some confusion around what those numbers actually mean for you and how much you can expect to receive in distributions.
Understanding the difference between income, accruals, and preferred returns is crucial when it comes to passive investing. It can be overwhelming to try and decipher these terms, especially for those who are new to the investment world.
At Viking Capital, we understand the importance of transparency and providing our investors with clear and concise information. That’s why we want to break down the returns a passive investor can expect and how quarterly distributions differ from accrued income.
Let’s start with the basics.
Income From The Sale Of a Syndication
Income refers to the actual cash flow generated by the investment property. This can come in the form of rent payments, interest from loans, or other sources of revenue. As a passive investor, your share of the income will be distributed to you on a regular basis, typically on a quarterly basis.
As a passive investor in a real estate syndication deal with Viking Capital, your potential income can come from both regular distributions throughout the hold time and a large payout at the end of the deal’s lifecycle when the property is sold, typically within 3-5 years.
It’s important to note that these distributions are subject to the actual cash flow generated by the property. If unexpected repairs or expenses arise, the funds may need to be diverted to cover these costs instead of being distributed as cash flow to investors.
In the event that the true cash flow of the property doesn’t allow for distributions to be made at a particular time, investors need not worry. The preferred return or distribution percentage is still being accrued, meaning that investors are still earning their income, which will be paid out at a later date. This is known as accrued income.
At Viking Capital, we understand that investing in real estate syndication can be complex and confusing, which is why we are committed to providing our investors with clear and transparent communication. We want to ensure that our investors have a complete understanding of the investment process and the potential income streams that can be generated.
What is Accrued Income?
Accruals, on the other hand, refer to the amount of income that has been earned but not yet distributed. This can occur when the property is generating income but not yet at a rate where distributions can be made. As a passive investor, you will still earn accruals, but they will not be distributed until there is enough cash flow to do so.
Accrued income is a term used to describe the earnings that you are generating from your investment, but which have not yet been paid out to your bank account. To put it simply:
Accrued Income = Earnings yet to be paid out Income = Earnings that have already been paid out to you, i.e., distributions received in your bank account
Suppose you have invested $100,000 in a deal with Viking Capital that offers an annual preferred return of 7%. If you hold the investment for five years, you can expect to earn $35,000 on your initial investment:
$100,000 initial investment x 7% preferred return = $7,000 annual return $7,000 annual return x 5 years = $35,000 total return
It’s important to note that the preferred return starts accruing from the time your money is allocated to the investment. The preferred return is non-compounding, which means that the accrual is also non-compounding, and it’s an annual return based on the preferred return of your invested capital. The appreciation that can come when selling the asset can be when the larger gains are realized.
At Viking Capital, we believe that it’s crucial to help our investors understand the different aspects of real estate syndication investing. We want to ensure that you have all the information you need to make informed investment decisions, and we are committed to providing you with clear and transparent communication throughout the investment process.
Example of Accrued Income:
In the world of real estate syndication deals, it’s important for passive investors to understand the difference between income, accruals, and preferred returns. Accrued income, specifically, is the money you’re earning on distributions that hasn’t hit your bank account just yet. Let’s break it down even further.
Imagine you invest $100k with Viking Capital, and the annual preferred return is 7%. If the investment is held for 5 years, you’ll earn $35k on your $100k. However, the true cash flow of the asset can only allow for a payout of $3,500 in the first year, leaving the remaining $3,500 to accrue and eventually get paid out to you. This is accrued income.
When you invest with Viking Capital or any other firm, your money is actively earning from the moment an asset is purchased. Whether the preferred return is paid out consistently or at another time period, as long as it’s accruing, you’re earning.
But what happens if the asset’s cash flow isn’t sufficient to pay out distributions at all during the hold period? This can happen for a variety of reasons, such as a global pandemic or a natural disaster. If this happens, it’s important for the sponsor to communicate with investors and explain the situation.
However, there is a silver lining to this worst case scenario. If a capital event occurs, such as the sale of the asset or a refinance, the accrued preferred return (in this example $35k) will be paid out as well as any other equity gain from the sale or refinance. This is the beauty of accruals and why it’s so important for investors to understand what’s happening with their investment.
In short, when investing in real estate syndication deals, it’s important to understand the different ways income is made, including distributions and proceeds from the sale of an asset. Accrued income is a valuable component of this equation, and can help investors continue to earn even if the full preferred return isn’t being paid out every month or quarter.
How Preferred Returns Work
As an investor, one of the key factors you consider when evaluating an investment opportunity is the potential returns you could earn. When it comes to real estate investing, preferred returns are a common way for investors to receive a fixed return on their investment before any profits are distributed to the sponsor or operator.
So, how do preferred returns work and why are they important to understand?
First, let’s define what a preferred return is. In essence, a preferred return is a guaranteed rate of return that investors receive before any other profits are distributed to the sponsor or operator of the investment. The preferred return is typically expressed as a percentage, such as 7%, and is based on the amount of capital the investor has invested.
For example, if an investor has invested $100,000 in a real estate deal that offers a 7% preferred return, they would receive $7,000 in annual payments (paid out quarterly or monthly) before any profits are distributed to the sponsor. This preferred return acts as a form of “interest” on the investor’s capital and provides a level of predictability and stability to their investment returns.
However, it’s important to note that a preferred return is not always guaranteed. In some cases, if the investment doesn’t perform as expected, the sponsor may not be able to meet the preferred return payments. In this case, the missed payments would accrue and be paid out to the investor at a later date, typically when the property is sold or refinanced.
So, why are preferred returns important to understand? For one, they provide a level of predictability and stability to an investor’s returns. By knowing that they will receive a fixed return on their investment before any profits are distributed to the sponsor, investors can more accurately project their cash flow and returns.
Additionally, preferred returns act as a way to align the interests of the sponsor and the investor. By offering a preferred return, sponsors are incentivized to prioritize the stability of the investment and work to ensure that it performs well enough to meet the preferred return payments. This alignment of interests can help to mitigate some of the risks associated with real estate investing.
Preferred returns are a form of incentive for investors, which allows them to receive a predetermined return before any other distributions are made. This can be a percentage or a fixed amount, and it helps to ensure that investors receive a return on their investment even if the property isn’t generating significant income yet.
How to Plan for Your Distributions When Investing in Syndication
The first step towards making an informed investment decision is to carefully evaluate the investment opportunity. If the investment summary indicates a 7% preferred return, but the projected cash flow is only 3-4% in the first two years, it’s likely that an automatic accrued return will be paid out at a later date.
Once you’ve confirmed that the investment plan includes an accrual, the next step is to determine the duration of the accrual. Will it last throughout the entire hold period, or just during the first two years before paying out the full preferred return in years 3-5?
With this information in hand, you can make a well-informed decision about your investment and project your personal income accordingly.
Suppose that in the first one or two years of receiving the anticipated quarterly distribution, it unexpectedly ceases. Should you promptly attempt to withdraw your investment? Absolutely not.
Our monthly investor updates should have conveyed any alterations to the distribution schedule. These updates contain relevant information that is relayed to the investor, such as the reason for the pause and the anticipated duration of the pause.
If any questions still persist, the recommended course of action is to contact Viking Capital’s investor relations team directly. They will be able to explain the situation and provide clarifications. Generally, there is a sound reason for pausing distributions, and we are always eager to hold a discussion about the matter.