If you’ve decided that incorporating real estate into your investment portfolio is a no-brainer and realize that you don’t have the time or desire to be an active investor (another great choice!), then investing in a no-hassle, hands-off, Real Estate Syndication is the best option. These investments enable multiple participants to pool capital together to purchase a real estate property that delivers passive income and appreciation to the investor.
Within the world of Real Estate Syndications, there are a number of terms used when describing an investment. In this blog post we will review the most common terminology with the goal of demystifying some of the confusing industry jargon:
Accredited Investor
At its most basic level, an accredited investor is a person who the Security and Exchange Commission (SEC) deems financially sophisticated enough to participate in non-registered security transactions such as hedge funds, venture capital funds and for our purpose, certain multi-family real estate syndications.
An accredited investor must meet one of two criteria:
Earn an income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same or higher for the current year
OR
Have a net worth of $1,000,000, excluding the equity in your personal residence
Related: What is an Accredited Investor?
Acquisition Fee
Compensation earned by the general partner in a syndication for sourcing, screening, arranging financing, and closing on an investment asset.
Active Investing
This is the opposite of passive investing. An active investor does all the work of finding, structuring, managing, and exiting investments.
Asset Management Fee
Typically a recurring fee paid from property revenues to the general partner for asset management.
Average Annual Return
This is the return on investment divided by the number of years the investment is held.
Bridge Loan
Typically short-term loans enabling investors to leverage equity in one property to finance another or access cash for a down payment on a new acquisition.
Capital Expenditures
These expenses are funds used by the managing company or partners to acquire, improve, or maintain a property. Also referred to as CapEx. It specifically applies to when these funds improve the useful life of a property.
Capitalization Rate (Cap Rate)
Calculated by dividing net operating income by current market value of a property to determine an expected rate of return.
Cash Flow
Remaining liquid profit after deducting operating expenses and any debt service payments.
Cash-on-Cash (CoC) Returns
A rate of return calculated by dividing the cash flow being produced by a property by the initial cash investment.
Cost Segregation
This is the process of identifying assets and costs, and their classification for tax purposes. Applies for reducing current tax liability and deferring taxes.
Closing Costs
Costs required to close on a real estate or financing transaction. May include origination, application, processing, underwriting, appraisal, and recording fees.
Debt Service
The amount of loan payments required to be paid back to a lender. Also used to calculate the DSCR for qualifying for commercial real estate financing.
Debt Service Coverage Ratio (DSCR)
The DSCR is the ratio commercial mortgage lenders use to evaluate and qualify a deal for financing. The DSCR measures how much cash flow will be available to cover debt service. A DSCR ratio of 1 means the cash flow should cover the debt payments. Lenders typically expect a minimum DSCR of 1.2 in order to get a loan. A better ratio may qualify the borrower for better terms.
Disposition
The term disposition refers to the sale of an asset (property).
Distributions
These are the funds paid out to investors. These profits may be paid monthly or quarterly or upon a successful exit.
Due Diligence
Due diligence describes a group of tasks to screen and evaluate a property and to satisfy lender underwriting requirements. May include appraisals, surveys, inspections, and title work.
Earnest Money
An earnest-money deposit is placed into escrow by the buyer of an apartment building to demonstrate their commitment to execute on the purchase contract. Will be credited toward the acquisition cost at closing.
Effective Gross Income
The EGI is the effective income derived by subtracting losses due to vacancy, concessions, employees, model units, and any bad debt.
Equity Investment
The cash put into an investment. In an apartment building syndication this capital may be used toward the down payment, closing costs, borrowing costs, funding an operating account funding, along with any compensation earned by the general partners.
Equity Multiple
The EM is a way to calculate a rate of return on commercial investment property. This is calculated by dividing the total cash distributions (cash flow and cash on exit) by the equity investment made. An equity multiple less than 1x means you are getting back less cash than you invested. An equity multiple greater than 1x means you are getting back more cash than you invested.
Exit Strategy
This is how the syndicator plans to cash investors out of their investment in the future. This may be by selling the property, purchasing their shares, or refinancing them out.
Floating Interest Rate
This is the same as a variable or adjustable interest rate loan. The interest rate—and typically the payments—will float and change with the market.
Forced Appreciation
This is the increase in market value through an increase in NOI, which is forced by an increase in income or a decrease in expenses.
Gross Potential Rent (GPR)
The hypothetical amount of revenue if the apartment community was leased at 100 percent occupancy year-round at market rental rates.
Gross Potential Income
The potential income a multifamily property could produce if it had no vacancies and all leases were signed at market rates—plus any other revenue.
Gross Rent Multiplier
This calculation shows the number of years it would take for the property to pay for itself based upon the gross potential rent. This is calculated by dividing the property purchase price by the annual gross potential rent.
Holding Period
The holding period is the amount of time the sponsor plans to hold the property.
Interest Rate
The cost charged by a lender for using their funds to finance a deal.
Interest-Only Payment
A monthly mortgage payment that only requires interest, not the principal balance, to be paid. The balance may be due on sale, refinancing, or at the maturity of the loan.
Internal Rate of Return (IRR)
The Internal Rate of Return is the expected compound annual rate of return that will be earned on a project or investment. The higher an IRR the more desirable a project is to undertake which allows investors to easily compare multiple investment opportunities.
Joint Venture
A “JV” is a partnership between two or more investment partners who collaborate on a deal.
K-1 Tax Form
Allows a company to utilize pass-through taxation, which shifts the income tax liability from the entity earning the income to those who have a beneficial interest in it.
Key Principal
A key principal in an apartment syndication is a vital person to the ongoing success of the investment. It is someone who should be insured to compensate for any interruptions if something happens to them.
Letter of Intent
An LOI is a non-binding agreement drafted by the buyer proposing their purchase terms. Typically used as a faster method to make an offer, without being tied into the deal.
Limited Partner
In contrast to the general partner, a limited partner’s liability is limited to the extent of their share of ownership. In a typical real estate syndication, a limited partner is a passive investor who puts in capital.
London Interbank Offered Rate
The LIBOR is a benchmark interest rate that is often used to calculate loan rates and interest rate adjustments on a variable rate loan.
Loan-to-Cost Ratio
The LTC ratio shows the value of the anticipated loan amount against the total costs (acquisition and renovations).
Loan-to-Value Ratio
The LTV calculates the ratio of the loan amount divided by the apartment building’s appraised value.
Market Rent
The market rent refers to the market value of a rental unit for lease based upon comparable rental rates for similar units in close proximity to the subject.
Metropolitan Statistical Area (MSA)
A MSA is a geographic region with a substantial population. These are cities pooled together with neighboring communities that have high degrees of integration. An example is the Miami Metropolitan Area. This MSA actually encompasses Miami, Fort Lauderdale, and West Palm Beach, three counties, dozens of cities, and even more neighborhoods.
Net Operating Income (NOI)
Net Operating Income is a calculation used to determine the value of an income-producing real estate property by taking the revenue from the property and subtracting the operating expenses.
Non-Recourse Loan
A non-recourse loan is a loan on which the borrower is not personally signing a guarantee. The lender generally has no recourse to pursue the borrower in a default, beyond the pledged real estate collateral the loan was made on.
Operating Expenses
Operating expenses are what it costs to run and maintain an investment property. In apartment syndications, these operating expenses usually include payroll, maintenance, repairs, contractors, marketing, admin, utilities, management fees, property taxes, insurance, and capital reserves.
Passive Investing
The strategy of placing your capital into a real estate syndication that is managed for you.
Permanent Agency Loan
This is a long-term mortgage loan guaranteed by government-sponsored agencies Fannie Mae or Freddie Mac. Loans may be amortized for as many as 30 years.
Preferred Return (Pref)
Investors with preferred shares or preferred returns receive their distributions and returns up to an agreed upon percentage before the sponsor. This holds them accountable and ensures interests are aligned.
Prepayment Penalty
A penalty for paying off a loan balance early. These clauses can be especially complicated calculations in commercial mortgage lending.
Price Per Unit
The price per unit of an apartment building. For example, a 100-unit building for sale at $10,000,000 would have a price per unit of $100,000. It is a method of comparing competing properties, assessing value, and weighing returns between investments.
Private Placement Memorandum (PPM)
Sometimes referred to as the offering memorandum, the PPM is a legal document that is provided to prospective investors that details the offering; the description of the company and how it will be managed, the use of proceeds, the risks of the investment, and the subscription terms.
Pro-forma
A projected financial statement for estimated revenues and expenses. Often detailed for one and five years.
Property Management Fee
A recurring cost for having a professional property management company manage day-to-day operations of a property.
Ratio Utility Billing System (RUBS)
A RUBS system is a way to bill tenants back for utility costs and increase the NOI of the property. Can be based on occupancy or square footage leased.
Recourse
In contrast to a non-recourse loan, this is the right of a lender/creditor to pursue the debt owed to them. A full recourse loan can expose liability to personal assets beyond the collateral in the case of a default on the loan.
Refinance
Replacing a debt obligation on a property with a new loan, often with different terms.
Rent Premium
A rent premium can be earned upon completing upgrades and renovations.
Rent Roll
The spreadsheet or document detailing each of the units in an apartment community. A good rent roll will include unit numbers, unit types, square feet, tenant names, market rents versus actual rent, deposit amounts held, move-in dates, lease-start and lease-end dates, and current status.
Reposition
To reposition a property is a strategy in which the owner, or general partner, of a property aims to change the position of the asset in a market through adding value and/or rebranding the property.
Return Hurdle
A return hurdle is the rate of return that, when achieved, triggers a disproportionate profit split. Common return hurdles are pref, IRR, and equity multiple.
Return On Equity (ROE)
The ROE is the amount of net income returned as a percentage of shareholders equity.
Return On Investment (ROI)
The ROI is the cumulative cash flow plus net resale proceeds divided by the Members’ equity contribution.
Reversion Cap
The reversion cap is the expected CAP rate at the end of an investment (or disposition of a property). It is the benefit that an investor expects to receive at the time of sale.
Sales Comparison Approach
The typical method for estimating a property’s value based on recent similar sales in the area.
Self-Directed IRA (SD-IRA)
A Self-Directed IRA is technically not any different than other IRAs (or 401ks). The government created the IRA to allow investments to grow tax-free or tax-deferred compounded over time to maximize growth. The IRA can also qualify for yearly tax-deductions (depending on the account type), provide asset protection, and assets may be passed to future generations for qualifying accounts.
A self-directed IRA is unique due to the available investment options and because it puts the IRA owner in control.
Most IRA custodians only allow approved stocks, bonds, mutual funds and CDs. A truly self-directed IRA custodian allows this type of investing in addition to real estate, notes, private placements, tax lien certificates and much more.
Sensitivity Analysis
A sensitivity analysis, also referred to as what-if or simulation analysis, is a way to model different outcomes given a number of variables. This is often used to show returns in the event of a market downturn (often proving that large, value-add multifamily apartments expose investors to less risk than other traditional investments).
Sophisticated Investor
An individual “determined” to have enough experience and knowledge to assess the risks and merits of an investment opportunity for themselves.
Split
A split is the percentage of distributions from operations and profits from capital events that are split between the limited partner (investor) and the general partner in the syndicate deal. Splits are common in the syndication business. Typical split would be 70% payout to limited partners (investors) and 30% to the general partners after the 8% preferred return is paid to investors.
Syndication
Apartment syndications are essentially real estate partnerships pairing passive investors, capital, and a syndicator (sponsor or active partner and promoter) who organizes the deal, puts it together, and manages it.
Subscription Agreement
A document that is a promise by the LLC that owns the property to sell a specific number of shares to a limited partner at a specified price—and a promise by the limited partner to pay that price.
T-12
A T12 is a profit and loss statement showing the actual reported numbers for the last 12 months.
The Promote
The promote refers to a ‘bonus’ of sorts used to motivate the sponsor to exceed return expectations and reward them for their work in finding, managing and adding value to the property.
Underwriting
A process of evaluating an apartment building community to determine the status, value, risks, and potential.
Vacancy Loss
How much potential revenue and cash flow is lost due to vacant units.
Vacancy Rate
The percentage of vacant units in a multifamily community.
Value-Add
The term value-add is used to describe a property that offers the opportunity to increase NOI through renovations, rebranding, or increased operational efficiencies.
Waterfall
The waterfall structure is a method for splitting profits among partners in a business deal that allows for said profits to follow an uneven distribution. In a waterfall model, payouts change when previously agreed upon return hurdles are met.
Workforce Housing
Workforce housing is a term that is being increasingly used to describe housing that is affordable for households with an earned income that is insufficient to secure quality housing within a reasonable proximity to a workplace.
1031 Exchange
A properly structured 1031 exchange allows an investor to sell a property, to reinvest the proceeds in a new property and to defer all capital gain taxes.
Conclusion
As we can see from the details above, most of the concepts are relatively straightforward when you have an understanding of the specific terminology. This is why our team here at Limitless Investing focuses heavily on educating our audience so they are confident when making investments into our high-quality, pre-vetted opportunities.
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