Hello BP community of multifamily investors, owners, operators, syndicators and managers. 

I'm curious to see what everyone is seeing and your thoughts on where preferred returns offered to limited partners are headed into the future.

Yields across almost every income producing asset class from bonds to stocks have been declining for years, and 2020 has only accelerated this trend with real yields (risk free rate or 10YR TBILL minus inflation) currently being negative. While low interest rates in 2020 have helped real estate deals with yield/cash-on-cash, the reality is that as the spread between interest rates and cap rates will normalize and many real estate deals may struggle to deliver a preferred return of 8% in the first few years of operations.

From my experience 8% has been the most common preferred return with 7% being the next most common. The lowest I have seen is 5% and the highest is 10%.

However investors return exceptions do not always align with market forces and sponsors are often hesitant to change the structure of their deals if their investors have come to expect a certain structure. 

For LP investors - how important is the preferred return rate to you vs the pro-forma returns or other terms of a deal?

For Sponsors - what are your thoughts on what you're currently offering and have you considered offering a lower preferred return if we see thinner cash on cash going into the future?  

For those unfamiliar with the concept of a preferred return - 

A preferred return, while not present in every deal structure, is a common return hurdle and deal element that provides investors of a certain class with a preferred position in the order of cash flow that is described in the operating agreement for a project. With a preferred return structure, after all expenses and debt service are paid, the next hurdle in the order is cash flow is to pay an annualized return to investors based upon their current capital account, or a preferred return. Only after that return threshold has been exceeded does cash start to be distributed on the next hurdle, often a split between the LP/GP. If there is not enough cash flow from a project to deliver the preferred return for a given period that amount accrues and must be paid before paying the current preferred return or next hurdle in the waterfall. This is a generic description and each deal structure can be a little different with some deals having no preferred return. For example: If a deal has an 8% preferred return then an investment of $100,000 should receive a pref return of $8k/yr in addition to any other available cash-flow that can be distributed. If the deal cannot pay the 8%, that $8k will accrue to future periods until it is paid. 

Not that I like the market price of the Cohen & Steers REIT (RQI), but based on what you are calculating from the syndication world- how do you justify the risks accredited investors are exposed to in syndications (which they often don't understand, even if they think they do) with that level of return vs buying that REIT yielding 8%?

Again, I don't like the current price, but that REIT doesn't come with anywhere near the possibility of losing my entire principal the way syndications often do.

Edit- I damn near forgot to mention that while there are REITS that have been paying out steady dividends for decades, a preferred position in syndication only means you are in line to receive a distribution IF the deal works out enough to met a hurdle. 

@David A. It depends on what an investor is trying to achieve and how they weigh different features of the two different real estate investment vehicles (Syndication vs REIT).

For example, there are no tax benefits to an investor when investing in a REIT vs a private syndication where an LP is an actual owner of real property vs owning a share of a company that is in the business of owning real estate. So we if take tax benefits into account an 8% sheltered return isn't the same return as an 8% dividend that can be taxed at regular income rates.

Liquidity is both an advantage and a disadvantage when it comes to publicly traded REITs. It can be tactically advantageous for an investor to be able to buy and then sell a share of a REIT quickly, however that ability also leads to higher degrees of price volatility not necessarily directly correlated to the performance of the real estate. So while your principal may not be lost, it may decline by 30%+ like we saw in March while our investments in syndicated deals increased in value.

Some of what your talking about is more related to single asset risk vs a diversified portfolio and I would argue that one can achieve and mitigate single asset risk through investing in syndications by investing in multiple projects or even a private multi deal fund. 

I think REITs are a great way to add diversity to a portfolio of paper assets for an investor with a higher net worth looking to generate additional income and isn't as concerned with additional tax liability. If you're interested in investing in real estate to take advantages of all the benefits real estate typically offers, you have to invest in actual real estate whether that's through a syndication or other means. 

Also @David A. , and this is a common misconception, the preferred return doesn't necessarily have anything to do with the actual cash-on-cash return of a deal. The advantage of a preferred return is that it is essentially an annual coupon that the LP must receive before the next cash flow hurdle where typically the GP starts to make money. So a project with a 7% preferred could be distributing a 12% annual cash-on-cash return and end up with an 18% IRR over the entire project.

Originally posted by @David A. :

Not that I like the market price of the Cohen & Steers REIT (RQI), but based on what you are calculating from the syndication world- how do you justify the risks accredited investors are exposed to in syndications (which they often don't understand, even if they think they do) with that level of return vs buying that REIT yielding 8%?

Again, I don't like the current price, but that REIT doesn't come with anywhere near the possibility of losing my entire principal the way syndications often do.

Edit- I damn near forgot to mention that while there are REITS that have been paying out steady dividends for decades, a preferred position in syndication only means you are in line to receive a distribution IF the deal works out enough to met a hurdle. 

My biggest concern with that particular REIT is its long term price performance and that it seems not to have recovered from its Great Recession drop. Whereas real estate values generally are far higher than they were pre-GR, at least in most markets. It's the same with most REITs. They tend to produce awesome dividends, but a major price drop can last for a very long time and can take a decade to make up for in dividend returns. Personally I would rather own S&P index funds than most of the REITs out there.

There is absolutely risk when buying an individual piece of real estate, but we also have the ability to force value add and actively influence our return. Not the case with any REITs.

I actively syndicate, invest passively in syndications, and own REIT shares, just to be clear (not RQI though). REIT investing isn't the same as direct real estate investing, whether you're talking about buying single families or investing in syndicates.

Originally posted by @Taylor L. :

Originally posted by @David A.:

Not that I like the market price of the Cohen & Steers REIT (RQI), but based on what you are calculating from the syndication world- how do you justify the risks accredited investors are exposed to in syndications (which they often don't understand, even if they think they do) with that level of return vs buying that REIT yielding 8%?

Again, I don't like the current price, but that REIT doesn't come with anywhere near the possibility of losing my entire principal the way syndications often do.

Edit- I damn near forgot to mention that while there are REITS that have been paying out steady dividends for decades, a preferred position in syndication only means you are in line to receive a distribution IF the deal works out enough to met a hurdle. 

My biggest concern with that particular REIT is its long term price performance and that it seems not to have recovered from its Great Recession drop. Whereas real estate values generally are far higher than they were pre-GR, at least in most markets. It's the same with most REITs. They tend to produce awesome dividends, but a major price drop can last for a very long time and can take a decade to make up for in dividend returns. Personally I would rather own S&P index funds than most of the REITs out there.

There is absolutely risk when buying an individual piece of real estate, but we also have the ability to force value add and actively influence our return. Not the case with any REITs.

I actively syndicate, invest passively in syndications, and own REIT shares, just to be clear (not RQI though). REIT investing isn't the same as direct real estate investing, whether you're talking about buying single families or investing in syndicates.

 Understood, but the original post was about whether or not syndications will be able to continue to deliver returns at the present rate going forward. He cited an 8% rate. RQI isn't a favorite of mine either, and I don't own any shares of it, nor do I like it's current valuation. 

That said, if the OP's prognosis of yields shrinking in the already risky world of syndication investing, where you bear the best-of and worst-of aspects of both worlds in REI- REITS were starting to look more attractive by comparison. He also mentioned the volatility aspect (march 2020) which if you are able to take advantage of, give the REIT another shot in the arm and margin of safety. I did grab some deep discounts in March, and am wishing I would have grabbed some REITS at that time as well.

Originally posted by @David A. :

Originally posted by @Taylor L.:

Originally posted by @David A.:

Not that I like the market price of the Cohen & Steers REIT (RQI), but based on what you are calculating from the syndication world- how do you justify the risks accredited investors are exposed to in syndications (which they often don't understand, even if they think they do) with that level of return vs buying that REIT yielding 8%?

Again, I don't like the current price, but that REIT doesn't come with anywhere near the possibility of losing my entire principal the way syndications often do.

Edit- I damn near forgot to mention that while there are REITS that have been paying out steady dividends for decades, a preferred position in syndication only means you are in line to receive a distribution IF the deal works out enough to met a hurdle. 

My biggest concern with that particular REIT is its long term price performance and that it seems not to have recovered from its Great Recession drop. Whereas real estate values generally are far higher than they were pre-GR, at least in most markets. It's the same with most REITs. They tend to produce awesome dividends, but a major price drop can last for a very long time and can take a decade to make up for in dividend returns. Personally I would rather own S&P index funds than most of the REITs out there.

There is absolutely risk when buying an individual piece of real estate, but we also have the ability to force value add and actively influence our return. Not the case with any REITs.

I actively syndicate, invest passively in syndications, and own REIT shares, just to be clear (not RQI though). REIT investing isn't the same as direct real estate investing, whether you're talking about buying single families or investing in syndicates.

 Understood, but the original post was about whether or not syndications will be able to continue to deliver returns at the present rate going forward. He cited an 8% rate. RQI isn't a favorite of mine either, and I don't own any shares of it, nor do I like it's current valuation. 

That said, if the OP's prognosis of yields shrinking in the already risky world of syndication investing, where you bear the best-of and worst-of aspects of both worlds in REI- REITS were starting to look more attractive by comparison. He also mentioned the volatility aspect (march 2020) which if you are able to take advantage of, give the REIT another shot in the arm and margin of safety. I did grab some deep discounts in March, and am wishing I would have grabbed some REITS at that time as well.

That's when I bought the REIT that I own. It is absolutely possible for REITs to go bust. There are two I've found so far this year that have filed for bankruptcy, CBL and PEI. I think not a single soul on the planet would be shocked by the failure of big box retail property owners, either now or in the near future. They also don't offer the same tax advantages that syndications can, but that doesn't matter to every investor out there.

@Spencer Gray replying as an LP, the pref rate is obviously the first thing we're gonna see so there's some importance there but I'm personally OK seeing 7%, which I did indeed on a deal that just closed. Lower than that I would want to see a better split.

@Jesse M. Makes sense. How much do you weigh the pref % vs pro forma returns? For example, how would you view a deal with a 16% IRR with a 5% preferred return vs a deal projecting a 12% IRR with a 9% preferred return assuming a similar level of risk?

Also, what is your opinion on multiple waterfall splits such as moving from a 70/30 split to a 60/40 split after LPs receive a 15% IRR?

Appreciate your feedback!

I'd say that I want to see the best overall returns possible, in the long run. I'm not necessarily investing for monthly/quarterly cash flow but rather for total return for reinvestment after sale. So I'd probably go for higher IRR but my mindset may change as I get my hands in more deals. I don't like the idea of changing splits but would really have to see the numbers.