Landlording & Rental Properties

The Mega-Profit Potential of Apartment Syndication (Double Your Money!)

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Forty-four percent of millennials say it’s having children. Half say getting married and 72 percent want to own a home. But the single highest priority, at 80 percent, is being able to retire financially secure.

Although retirement is top of mind among millennials, most don’t really know what it takes to be able to retire—or even better, retire early.

Today, I’d like to share with you the secret to early retirement and wealth accumulation that few people ever speak about: building passive income through investments in an apartment value-add syndication.

How to Double Your Money in 5 to 6 Years

Investing in a syndication as a passive investor typically doubles your investment in five to six years. Additionally, it’s a method that requires relatively little work. What’s even better, the money you earn can qualify for special tax benefits, such as depreciation, capital gain tax, 1031 exchanges, capital expenditure, and tax deductible interest.

In this article, I’ll explain exactly what an apartment value-add syndication is, how to invest in it, and why it’s a better option than purchasing a home.

Related: What is Real Estate Syndication – Really?

What Is Apartment Value-Add Syndication?

An apartment value-add is the act of buying and renovating an old apartment to increase its occupancy and rental income. The rent you increase can vary from $50 to $500. For a 100-unit complex, the revenue can increase by as much as $50,000.

The amazing thing is that this additional revenue, assuming no additional expense, will increase your net operating income (NOI), allowing you to sell the apartment at a much higher price. The increase in selling price can be 10 to 20 times the increase in NOI, so a $50,000 increase in revenue can increase the selling price by as much as $1,000,000!

However, not all markets are priced the same. A hot market, like Los Angeles, typically has a higher selling price relative to a less popular city, like Tucson, Ariz., for the same NOI.

Now that we’ve covered what an apartment value-add is and how it generates money, let’s talk about what a syndication is. A syndication is a group of investors that raises equity and collaborates to execute a value-add deal. It involves two main parties: one called the general partner (GP) and the other called the limited partner (LP).

A typical GP consists of one to four people or LLCs, and a typical LP ranges from five to 50 people. The GP will source the deal, analyze it, create and execute a business plan, manage the apartment, and sell it based on the timing of the market—hopefully for a handsome profit.

This process typically takes four to six years. The LP’s responsibility is to find a trusted GP who knows what he or she is doing and has a successful track record. The LP should also understand the market condition of the property’s location. A general rule of thumb for selecting a market is to identify areas with high population and employment growth.

Related: Compelling Tax Benefits of Real Estate Syndication

The Ins & Outs of a Real-Life Apartment Syndication Deal

Let’s dive into an example of an apartment syndication deal in Tucson, Ariz., that I recently invested in. It’s projected to earn 15 percent IRR (Figure 1), a much more profitable return than that from buying a home.

Return on Investment

For this particular deal, the preferred return was 6 percent with an 80-20 split. This means that the GP promised me (the LP) at least 6 percent annual return.

If the property doesn’t generate enough cash flow to meet the 6 percent return, then the missing cash flow carries interest into the next year. It’s possible for an LP to earn low returns throughout this project and then receive a large payout at the end when the building is sold.

The 80-20 split means that the LP will get 80 percent of the cash distribution that exceeds the 6 percent preferred return, and the GP will receive the remaining 20 percent.

Figure 1. Projected Return for an LP in an Apartment Value-Add Syndication

The above chart shows an equity multiple of 1.9X, which means that I can expect to almost double my investment in a span of five years. An IRR of 15.2 percent means that I will be earning an average of 15.2 percent annual return.

The return gets better year-over-year as the units are renovated; however, it dips in the fourth year because the loan for the first three years is interest only. Principal payments start in year four.

Additionally, the 15.2 percent annual return here is far greater than a 15.2 percent return through stocks. This is due to the tax benefits associated with real estate—perhaps even greater than a 20 percent annual return in stocks.

ROI Varies Greatly by Market

Lastly, let’s instead look at the return for a three-bedroom house in Los Angeles. Here are the assumptions for the house:

  1. Purchase Price: $639,000
  2. Down Payment: 20% or $127,800
  3. Closing Cost at Year 0: $3,000
  4. Interest Rate: 4.25%
  5. Monthly Rent: $1,000/room (for all 3 bedrooms)
  6. Expense Ratio: 40%

Figure 2. Projected Return for a 3-BR House

This three-bedroom house investment will earn you 10.5 percent IRR but negative cash flow in years one to four. The negative cash flow is due to operating expenses and monthly mortgage. (Note that I am accounting rental income for all three bedrooms.)

A 10.5% IRR is not a bad return, but the negative cash flow makes buying a house in L.A. a risky investment because its return is mainly based on market appreciation. During a market downturn, an apartment value-add deal with positive cash flow is much more sustainable than a house with negative cash flow.

However, a house in a less expensive area may generate positive cash flow. A cost-efficient strategy some homeowners use is buying a duplex or triplex with six to nine total bedrooms and renting them out. Generating positive cash flow with this strategy is almost impossible in hot markets, like Los Angeles and San Francisco, where houses are very expensive.

Finally, I want to point out that REITs neither generate the same return as those of apartment value-add syndications nor give you the same tax treatments. REITs typically generate about 8 to 10 percent returns but do not offer you any of the tax benefits I mentioned earlier.

Would you ever invest in an apartment syndication deal? Why or why not? If not, what would you invest in instead? 

I’d love to hear your thoughts in a comment below. 

 

Jay, a civil engineering graduate from UCLA, is an active investor, developer, and writer. He is the President and Founder of Hestia Capital, which syndicates multifamily properties with value-add opportunities in Phoenix and Tucson. He is also working at CIM Group full-time as an Assistant Construction Manager/Analyst on the development team. His responsibilities include entitlements, cost management, and construction management for ground-up projects. Jay is also currently one of the leaders of a real estate investment group called the MultifamilyMasters.com, which grew to 1,000+ members within a year. Before working at CIM, Jay worked for Pankow Builders on large construction projects, such as the R3 Metropolis in DTLA and the EDITION Hotel in West Hollywood. Jay aspires to develop coliving projects in the future. When he has free time, he travels, plays basketball, snowboards, and golfs.

    Blake Lessard from Raleigh, NC
    Replied 5 months ago
    Great post! As a CPA, typically my clients have seen a passive loss for a year or two. Those losses then help offset the passive income for the following years until the apartment is sold. Seems to work out as long as you have a good syndication group.
    Jay Dang contractor from 92843, CA - California
    Replied 5 months ago
    Great read. Thank you for taking the time.
    James McCreary rental_property_investor from Diamond Bar, CA
    Replied 5 months ago
    Great post Jay. The single family play definitely has a place and fits a certain list of objectives, as does multifamily. Though the negative cash flow years you mentioned are difficult to stomach for a first-time investor. You have to love the tax benefits, which I believe many people underestimate in the power of compounding growth.
    John Bierly rental_property_investor from Bainbridge Island, WA
    Replied 3 months ago
    I find that most syndicated deals pay out about double the cash on cash return in IRR at exit, so 5% and 10%, etc. Not all the time, but often enough that it is a useful rule of thumb to set expectations. So if you are seeing a 6% COC then a 15%+ IRR may be unrealistic, or may be a sign of using high leverage to make the projected return. For instance, most DST deals that are targeted at 1031 exchangers who want out of active property management run about 5% COC and 10% IRR, but since they are conservative investments that cannot place additional capital from investors they are typically leveraged at only around 50%. Moving up the scale a bit, if you buy a stabilized (no deep value add) property at a 6.0 Cap and 65% LTV you should be able to hit 6/12. Getting up into the high teens on the IRR is going to be accomplished by either buying at a great price (high Cap rate), higher leverage, or a deep value add. My point isn't to disagree with the author, but rather to suggest you need to parse the numbers at a deep enough level to understand where the value creation is coming from and the associated risk - VA from getting a great Cap rate or loan rate going into a deal are examples of low and known risk; expecting to get much higher future rents through a remodel program coming in on budget or taking out a high LTV loan would be examples of a higher risk approach.
    Jay Chang developer from Los Angeles, CA
    Replied 3 months ago
    Hi John, Thanks for your valuable comment. You're correct, most deals are currently under 15% IRR unless it has a significant value-add and is bought at a great price. The multifamily property that I analyzed in this article was bought at less than $40,000/door and is located 2 blocks away from Wholefoods in Tucson, AZ. We are doing complete interior renovation and some exterior renovation, so the value-add is significant. The audience/reader should keep in mind that every deal is different, so please don't expect a 15% IRR on every apartment syndication, especially if it's a turnkey or stabilized property. I wonder what type of property do you focus on? And why?
    Shawn C. investor from Cedar Park, TX
    Replied 2 months ago
    Great article! The problem I find is learning about syndication. I am located in Austin, TX and I approached people that say they are experienced in syndicating apartment deal or pass them self off as "syndicators" and we talk about what value I can add to their business in exchange for their teachings and nothing happens or it turns out they are all talk. How does one truly learn about multifamily investing and or multifamily apartment syndication?
    David J Fleming
    Replied about 6 hours ago
    If you're in Austin check out Wildhorn Capital.