wiDo you remember the 5 paragraph essay structure from elementary school? Having guidelines to introduce a central idea, provide 3 supportive paragraphs, and close with a strong conclusion provides freedom and structure all at once.
Similarly, each real estate syndication goes through a progression of stages with a clear beginning, middle, and end, which ensures individual investors operate as one, according to a clear business plan.
Phase #1 – Acquire
The first stage begins with sponsors getting a property under contract. Not only can finding a great property be difficult, but this phase also requires impeccable underwriting skills and solid projection calculations.
Once under contract, sponsors work diligently to discover the property’s needs, record estimated expenses, and update the business plan accordingly. After we and the sponsors are confident with the research, the deal, and the projections, we share the deal with investors like you, to gauge interest. Once all investors send in their funds, we then close on the property.
Phase #2 – Add Value
The term “value-add” means exactly what it sounds like; we’re adding value to the property, which is why renovations typically kick off upon closing.
All in accordance with the business plan, transitions begin with the property management team and renovations on any vacant units. This phase can last 12 to 18 months or longer, depending on the time it takes for all tenants’ leases to expire and for all old units to be renovated.
Exterior and common area renovations may also be made, such as updating or adding light fixtures, a dog park, covered parking, or landscaping.
Phase #3 – Refinance
Since commercial properties are valued according to the income they generate, the whole point of the renovation phase is to fetch rent premiums to increase revenue.
Most tenants will happily pay an additional $100 per month for the opportunity to move into an updated unit, and if the apartment complex has 100 units, that’s an additional $120,000 per year in rental income, which, at a conservative 10% cap rate, equates to $1,200,000 in additional equity ($120,000 divided by 10%).
A cap rate is the net operating income (NOI) divided by the purchase price. The cap rate helps you evaluate a real estate investment, and gives you an idea of the income potential of the real estate asset. The cap rate will vary by different markets and cities.
With that additional equity, a sponsor may attempt to refinance or, if the market is right, sell the property early. Although thrilling, neither of these is guaranteed. Through a refinance or supplemental loan, you would receive a portion of your initial investment back, while still cash flowing on the remaining investment amount. Investors still own the original pro rata shares after a refinance.
Let’s pretend you invested $100,000 into a value-add multifamily syndication with an 8% preferred return, After 36 months, the sponsors refinanced the property and returned 40 percent of your original capital. This means you get back $40,000, plus continuous cash flow distributions of 8% on the remaining $60,000. You are still in the deal with the pro rata shares of $100,000. When the sponsors sell, you will be paid out based on the original pro rata shares of $100,000.
Make sure to take a hard look at the investment documents, because every deal is structured differently. Some deals might provide cash flow distributions based on your remaining capital contribution.
Phase #4 – Hold
The next phase constitutes holding the asset while collecting cash-on-cash returns (aka, cash flow). Since the value-add phases are complete and the riskiest phases have passed, the focus shifts toward attracting great tenants and generating strong revenue.
Throughout the hold period, rent increases at a nominally low percentage each year, thus increasing revenue and contributing toward a steady appreciation of the property. The length of this phase, preferably 5 years or less, is based on the individual property, sponsor, and business plan.
Phase #5 – Sell
At this point, the property exhibits completed updates, increased revenues, and appreciation. So, the best use of investor capital is to sell the property so that they can seek their next investment project. During the disposition phase, sponsors prepare the asset for sale.
Sometimes the asset can be sold off-market, creating minimal disruption for tenants. Otherwise, sponsors muster through the whole listing and sale process. Occasionally, if investors agree, a 1031 exchange may be initiated. This allows investors to roll their capital and proceeds into another deal with the same sponsor.
Either way, once the sale is complete, you get your original capital back, plus a percentage of the profits. Time to pop those corks!
There you have it!
Just like a five-paragraph essay, you have structure, the exchange of information, and focus within each step. Remember, every deal is different and not all syndications go through all five phases
As a passive investor, you get to avoid the legwork, but you still want to thoroughly understand the typical phases of the value-add multifamily syndication process so you’re informed every step of the way.