There shouldn’t be a “versus” in there, i.e. “General Partner vs Limited Partner”
What’s all the Hubbub? Show me an Example of What Return on Investment is all About
Okay, okay, I hear you loud and clear. You want to see return on investment in action, eh? Let’s dive in with a personal example. I hope this will whet your appetite for ROI and financial freedom.
Last summer, we had guests staying with us. Steve and his wife, Kathy. We know Steve through the pharmaceutical company my husband, Henry, used to work for. Steve is a doctor and together they worked in the same department.
Let’s move on from the origin story and get to the good stuff. Over the course of their visit, we enjoyed sharing stories, usually over food. Okay, copious amounts of food, we’re all passionate about Italian cuisine. One evening while chatting about their kids, Kathy mentioned that they maxed out the kids' 529-plan for college. However, they anticipated that they’d need more as their combined salaries as a doctor and nurse place them in an upper tax bracket. Steve turned to me and asked: "What does the return on investment in real estate syndication look like?"
What does the Return on Investment in Real Estate Syndication look like?
Spaghetti and meatballs? Awesome. But to be asked to chat about my absolute favorite subject… real estate syndication? Oh man, you just know that little ‘ole me was excited!
After cleaning my plate, I suggested we make a Starbucks run to continue the discussion. I can talk for hours about real estate syndication, and I knew I needed to get my listeners caffeinated if they were going to stick around for the long haul.
Here’s the good news: in terms of return on investment, real estate has outperformed the stock market for the past 18 years. In fact, over the last century, housing has generated higher returns than the stock market at an almost two to one ratio.
Yep. That’s right!
Steve choked on his latte. Kathy took her napkin and deftly dabbed the bit of cream from her husband’s upper lip.
If they were a bit hesitant before, they were feeling a cosmic shift at this point that real estate may be a good option for their financial goals.
Just to temper your expectations now (in case you’re drinking a beverage), there are many factors that influence how a real estate syndication performs. However having said that, on average the housing market produces 12% returns and usually real estate syndication performs even better.
Kathy and Steve's faces looked considerably pleased with the news. Are your ears perking up too? Stay with us because it's about to get better.
Breaking Down the Metrics for Real Estate Syndication
There are a lot of details that come into play when projecting the rate of return for real estate syndication. Unless you happen to be a mathematician, you probably don't want to calculate all of the possibilities. You’re interested in at least having an idea just how much money you can earn from a successful investment, so let that be our focus.
The three main metrics that our friends, Kathy and Steve, and the rest of us need to be familiar with are:
Projected Hold Time
Projected Annual Cash-On-Cash Returns
Projected Profit On Sale
Before we delve deeper into these three main metrics, bear in mind that every single one of these metrics has the word PROJECTED in front of it. Investment always brings with it some degree of risk, so I made sure that Kathy and Steve were aware that the sample returns I gave them are projected.
These projections are not a guarantee that my friends Kathy and Steve - or my friends out there in the internet - will see the exact same return rate. However, the projected returns are close to what most of the investors we work with see. In my experience, these figures are a great guideline in which to base an investment strategy.
Now that we got all the small print and legalese out of the way, let's get down to potential profit projections and return on investment.
Expect a Hold Time of 5 to 7 Years for your Return on Investment
Kathy and Steve have a son and daughter, both of whom are in middle school. Their son, David, is in 6th grade and daughter, Catherine, is in 8th grade. When Kathy and Steve look at real estate syndications as beginners, a projected hold time of five years is a great starting point.
Real estate is not liquid, which means Kathy and Steve have to wait to get their cash return out of their investment. Five years is not an insignificant amount of time, but it is also not an unattainable amount of time. If you have a five-year plan like them, you can jot down doubling your investment into it right now if you choose real estate syndication.
Five years is also the sweet spot in the real estate market cycles. Five years allows time for the property to be updated, marketed, filled, and then passed onto the next interested investor before it is time to put more money into updating. Think of it like flipping a home, but for multi-family syndication. You want to get in and get out before you eat up your profits and have to wait longer for more.
If Kathy and Steve decide to hold for five years, David will be starting his senior year of high school and Catherine will be starting her sophomore year of college. That is perfect timing for an accumulated passive income collected over 5 years. Even more interesting and latte-choke inducing is the potential for a bump in cash distribution at sale thanks to value-add and appreciation.
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Cash on Cash Annual Returns Calculated for your Return on Investment
Your cash on cash annual returns is the actual cash flow you will see during the five years you are invested in a real estate syndication.
We call this your passive income.
This is the profit from the syndication that will be split among the investors once the mortgage, expenses, and vacancy costs are excluded.
A good estimate of cash-on-cash return for investors is about 8-10%. Kathy and Steve are comfortable investing $100,000 a year. This means they would see about $8,000 per year in cash-on-cash returns which would total up to $40,000 by the close of the 5-year hold.
Some syndications will payout quarterly cash-on-cash returns, so in this case, they could expect four payments of approximately $2,000 for a total of $8,000 per year.
The national average interest rate for savings accounts of at least $100,000 right now is .09% according to the FDIC. That means if you put your $100,000 into a savings account for the next five years you would make about $4,500.
Hmmm… not very impressive, is it?
Step back and look at your potential return on investment with a real estate syndication. Saving $100,000 for five years would earn a total of $104,500, but investing in real estate syndication would leave Kathy and Steve with $140,000. We aren't done yet though, because this is just the cash-on-cash return. They still have more profits to earn.
Projected Profits Upon Sale - your Return on Investment Looks even more Interesting
While the passive income is nice because who doesn't like earning money without doing any work, the best part is yet to come.
At the end of five years, all of the units in a real estate syndication have been updated, a strong tenant base has been cultivated, and rents have increased compared to when the asset was first acquired. We could also move up the property from Class C to Class A, or “luxury” apartment. This means that the asset is now generating a great revenue and is highly marketable.
Most real estate syndications at this point can sell with a projected profit of 40%-60%. So what does that mean for Kathy and Steve? It means that if they invested $100,000 into the syndication they would roughly receive anywhere from $140,000 to $160,000 back. That is a pretty good rate of return for not having to do or worry about a single thing.
It is important to note that this does not include appreciation in the market of the real estate syndication. It does factor in the improvement plan for the actual apartments, but if the area shows strong appreciation then we stand to profit even more. I choose to write conservatively, but there is always a potential for an even larger return.
So What is Your Entire Return on Investment?
You have seen a lot of great numbers, but let's break it down and make the choice a bit more cut and dry.
$40,000 cash-on-cash return + $60,000 profits from sale + $100,000 original principle
= $200,000 by the close of the five-year hold
If you had to read it twice you aren't alone. By the close of five years, Kathy and Steve could see their investment double if they invest in a real estate syndication. It will be hard for them to find something better than that for their five-year plan.
Since Kathy and Steve are interested in knowing more about the inner workings of real estate syndication, I told them they should get familiar with the Internal Rate of Return (IRR) as a next step.
Meet the IRR - Another Layer to your Return on Investment
IRR helps investors estimate how profitable an investment is likely to be. IRR is expressed as a percentage. For instance, an investment might be said to have a 10% IRR. This indicates that an investment will produce a 10% annual rate of return over its life. When everything is equal, an investment with a higher IRR is preferable to an investment with a lower IRR.
IRR takes cash flow distributions and proceeds from a refinance or sale into consideration as well as the net present value or NPV.
The use of "internal" refers to the omission of external factors such as the cost of capital or inflation from the calculation.
Coming Full Circle on Return on Investment
Do you see now just how you can get the most bang for your bucks going the real estate syndication route in terms of your return on investment? It’s my goal that investors like you get familiar with the possibilities, as well as understanding investing formulas such as IRR so that you can achieve stellar return on investment, and ultimately financial freedom so you can live a life of intention.
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Delphine Nguyen, Investor
Delphine Nguyen is a real estate investor and a licensed real estate broker in Illinois. She learned to be successful from a variety teachers, including her own mistakes. Real estate investing is her passion. Helping others to achieve their goals is another passion that she has. She does what she knows best, therefore, her focus is solely on multifamily and co-living investment types.
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