What beats apartment syndication returns for passive income?

23 Replies

Say I am an accredited investor and I want to allocate $500k for a type of investment that should be capital preserving; completely passive; and generates $100k annually in income.  In general that's a tough row to hoe, as the classic truly passive income flows almost never get near 20%.  But it does seem like even (relatively) conservative apartment syndication deals do hit that mark, over time.

Here's my thinking.  I take my $500k and I invest it into apartments in an investment ladder, with $100k invested each year.  That could be one property at $100k or two at $50k each.  Each year I invest $100k more until after year five, all of my cash is in between 5 and 10 apartments.

A typical deal, from what I've seen, may return 8% annually in dividends and 175% (including initial investment) during a sale in year 5.  That's a 2.1x multiplier.  This is what it looks like to me:

The 8% isn't a lot and it will increase to only $40k a year when all $500k is in play.  But on year 5, I get the original $100k back plus an extra $75k, leaving my annual return at $115k -- just above my target.  I then take my returned capital from year 1 and invest it again.

After this, there's always my one or two properties from 5 years earlier going up for sale, and so my annual return will stay at $115k (22%) indefinitely, until I finally stop the ladder.

When that happens, I will temporarily have an extra $100k each year for 5 years.

On the surface, this seems like it beats pretty much all other truly passive investments for annual income generation.   Therefore:

1. What am I missing?

and

2. What is better than this?

75% capital gain may or may not happen. Same is true for 8% annual dividend. Other than that, it's a perfect plan.

Wow sign me up for 500 k at 20% I can wire it over 

🤗

@Kurt Granroth It looks good on paper, but it is not easy to consistently find those deal.  Some may hit and some may miss.  You should also see better than 8% on the later years, but you may see less in the early years.

@Kurt Granroth , as you've laid it out, it really does sound like the perfect plan. Things will vary of course, but theoretically that plan would work. Also remember that often times these are conservative estimates. So, you may achieve much higher than 8% annual over the first year or two (and beyond), or you may even see disposition much earlier than year 5, ultimately allowing you to reinvest your original $100K much sooner. To play devils advocate, surely you could lose your entire investment or realize returns much lower than expected, but vetting your Sponsor thoroughly should put you in a good position.

Something to consider is finding multiple Sponsors who operate across a number of MSAs as a way to further diversify and minimize risk. Most Sponsors, or those who raise capital for Sponsors, would be glad to have even just one of your $50K or $100K investment.

@Jeff Greenberg - the availability of this class of a deal is definitely an outstanding question for me.  A distinct requirement of the ladder I describe is that I could consistently find one or two every single year.  The thing is, the information I've currently come across, both in aggregate and in specific, suggests that 8% annual dividends and 2-2.1x multiples are typical estimates -- but is that so, only if "typical" means "rarely"?

@Michael Bishop - I'm absolutely in the process of vetting multiple potential sponsors now, and certainly invite more.  I've been so far very impressed with the detail provided by one sponsor, including dealing with various "worse case" scenarios.  But... I can be paranoid AF and so I need to find equally compelling alternative options.

@Kurt Granroth as has been said this is all on paper. A good deal could return you much more than this and a bad deal could return much less. Look for deals and companies that are conservative and have multiple exit strategies. Some syndications use a cash out refi to get them to their projected 15-20% IRR, which I find to be very aggressive, as a lot of things can change to disrupt that strategy.

I would also be cautious around syndicators that are showing too high of returns. 

Try running your numbers if the market slows or goes negative for awhile.....it happens.

Like @Jeff Greenberg said, some will exceed and some will fail to hit those numbers over multiple investments.  When you "find" deals that hit these criteria you have to remember that they are projections.  Things can and do go wrong and markets do shift.  

I also agree with finding the right sponsors.  You should invest first in the syndicator and then find the deals that he/she presents to you to find the ones that fit your model best.  If you are investing with a seasoned and successful sponsor they should be able to navigate the waters of an unforeseen event if and when it arises due to their experience.  

Having said this I still believe that MF investments are the best vehicle I have found and most will hit the numbers you expressed provided you invest with experienced and successful syndicators.

At some point you will have to make a decision and trust the process and sponsor.  You can never have a contingency for EVERY scenario that may pop up.  We've all heard of analysis paralysis and it is a real problem for some.

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@Kurt Granroth don't apologize for being paranoid. Only the paranoid survive. 

Only flaw I see in your plan is the assumption that these properties will sell in year five on the mark and make you the projected return. 

If the market turns between the purchase point and year 5 your sponsors might need to extend the holding period or sell and take much lower returns. 

Other thing that you don't have in your plan is a solid tax plan. You will pay a lot of taxes while having $500K to invest could be leveraged in a way that might be more tax efficient. 

Are there other things that could yield more returns than apartments and be truly passive?

Sure. 

Bitcoin, gold, oil & gas, the stock market...

However they are ALL far more risky than apartments in my opinion. 

Good luck!

Your basing future returns on past performance.

I think you may be a little late in the multi space . to be laying out a 5 year program going forward.. I think there are still fine deals to be had.. but the market is highly competitive right now with cap rates being were they are at for prime properties. . and who knows what will happen at the exit..

think of those that invested in 2002 thinking in 5 to 7 years they were going to exit.. they did exit through Sherriff sales or deeds in lui..  So that's an extreme of course.

@Ivan Barratt   and I had a nice conversation this week.. and we both agreed that to hit those numbers some folks will substitute risk for reward.. and reward is almost always related to risk..

find those top flight sponsors and be realistic in your return goals..  other wise go do it yourself.. like Ivan was saying.. those of us in the business can do this no problem but we create our income.. and our investors come along for the ride.

Kurt,

While MF apartments managed by proven operators over many years has been a great core holding in alternative real estate investments you may want to continue to evaluate if you should put all your investments into one niche.  I find most investors like MF as a main core holding as folks have to live somewhere (almost everyone reading this probably lived in one) so they are comfortable with it. Other attractive niches like self storage (one out of ten people use one) and mobile home parks where many folks have never lived in one are often overlooked investment niches.  So you may want to research a few more areas with similar return characteristics that have positive future outlooks (see a few of these ideas in below blogs).  

I like the systematic approach you are laying out.....dollar cost "averaging in" approach to reduce market timing risks and what I internally call a "cooling off period".....minimizing putting a lot of money at work at once to give the rationale mind a chance to catch up.  I do like investing with multiple experienced partners in different geographic areas.  

https://www.biggerpockets.com/blogs/9145/54155-sel...

https://www.biggerpockets.com/blogs/9145/62927-6-r...

@Kurt Granroth

It's a great plan and I'd like to add a little more insight.

I'm doing the same thing but have come to the conclusion that I need to average my return on equity (NOT CoC) to ~12%. So... if I want 1.2m in passive income (I'm a 10x kind of guy) I need to work hard to earn $10,000,000 (1.2m divided by 12%) in equity. How do I do this?

1: Grow an operating business or income stream that generates excess cash flow (for me it's a property management and syndication business). For you it might be a day job, new biz venture, etc. 2: Invest the cash into income producing assets that generate the best risk adjusted return while greatly protecting hard earned principal (for me it's workforce apartments in great locations, with long term, fixed rate debt). 3. Reinvest distributions and refinance liquidity events from these projects into new income producing assets. Simple formula that takes a lot of discipline and a ton of perspiration to execute.

Looking forward to connecting. 

@Joseph Gozlan - the tax aspect of apartment syndication is something I'm having difficultly nailing down past the high level concepts.  That is, using cost segregation to achieve accelerated depreciation is apparently a common strategy. In that case, I'd get a K-1 at the end of the year showing that my investment was a loss, even with my dividends.  But... exactly how much of a loss are those K-1s showing, on average?  I haven't found that out yet.

As far as alternatives go:

Bitcoin - Feels more like gambling or playing the lottery than any actual investing, over the long haul

Gold/Oil/Gas - I'm not all that familiar with the various commodities.  My impression is that they rarely out-perform the stock market over the long haul, and I'm not aware of them being considered a capital preserving income generator.

Stock Market - That's what 100% of my investments are currently in, so that's definitely my comfort zone.  I do want to diversify, though.  Plus, the best consistent capital preserving income source would be various high-dividend stocks.  Those maybe will pay out just under 10%, conservatively?   I would make that or more investing in private notes and potentially quite a bit more investing in apartments.

@Kurt Granroth

I would like to know how you will find enough quality syndicates to accomplish the goal? 

is someone rating/ listing them?

Thanks 

@Kurt Granroth , there are 2 big issues with your spreadsheet plan:

1) It assumes we're not having  a business cycle recession for the next 10 years. While anything is possible,  the United States has never seen an expansion go that long in its history.  So it's pretty unlikely. if that happens, your 8% yield is going to go down as turnover will increase, vacancies will increase and rent will go down.

2) It assumes that there's not going to be a commercial real estate pricing recession anytime in the next 10 years (which is completely different than a business cycle recession, and may or may not coincide). If we do, it will wipe out all of those 175% returns in those years and turn them into negatives.

Originally posted by @Ian Ippolito :

@Kurt Granroth , there are 2 big issues with your spreadsheet plan:

1) It assumes we're not having  a business cycle recession for the next 10 years. While anything is possible,  the United States has never seen an expansion go that long in its history.  So it's pretty unlikely. if that happens, your 8% yield is going to go down as turnover will increase, vacancies will increase and rent will go down.

2) It assumes that there's not going to be a commercial real estate pricing recession anytime in the next 10 years (which is completely different than a business cycle recession, and may or may not coincide). If we do, it will wipe out all of those 175% returns in those years and turn them into negatives.

 Ian, that is going to depend on the investment and the underwriting.  On our apartment purchases we are underwriting very conservatively and we are assuming that the market will go down. We are also projected much higher than an 8% cash on cash return for investors so even if out conservative approach is not conservative enough there still room for positive returns.  We also plan on selling 1.5% higher that the current market cap the property is located in. The other thing we do is make sure investors understand that if the cycle does change prior to selling we will keep the property.  There  are several other things that would do to try to mitigate future losses. 

 There are plenty of other companies like mine that utilize a very conservative approach 

@Jay Hinrichs I usually find myself agreeing with what you say, but I have to question your statement, "other wise go do it yourself."  Are you really implying that an inexperienced investor could safely get near the returns that most of us can get for our investors.

These times are certainly challenging, but as @Todd Dexheimer has stated, it is important to be conservative and keep an eye on the downside.  We are looking at 10 year terms, while our expected hold may be 3-5 on a value add deal.  We are also expecting to sell at a higher cap than we are buying at.  No one has a crystal ball, but if we plan on a correction and it doesn't come, our deals will be that much better.

It's a good plan.  You will find that the path is not linear though and that the market will dictate disposition timing and true returns more than the property plan and proforma.

Many sponsors are also not as conservative with their assumptions as they think they are, especially in the later years.

I'd recommend considering other asset classes in addition to multifamily.  Not all asset classes move together and one of the benefits of passive investing is being able to take advantage of those cycles.

@Jeff Greenberg   good point I was not inferring this fellow could do this or not.. as I don't know his experience level.. however its just a general comment.. just like those that think they will make more money not using a turn key company to aquire their sfr's./

A rising stock market makes your UBER man look like a genius.    Are we not seeing the same thing happen in RE right now.

Those who bought houses in Vegas @ at bottom look like geniuses- they were.  Those buying now getting .6 %rent to purchase price ratios look like UTTER fools.

I notice many of Del s people he interviews got in the game right after the crash.

@Kurt Granroth mfh seem to the gateway for syndications because most investors graduate from sfhs and small mfhs and realize that they are not equipped to be a large scale operator.

You can find higher returns in development and non real estate syndications like life settlements but I personally think mfhs class c and b has the lowest risk and reward in terms of the sharpe index.

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