If you are new to real estate syndications, it can be exciting yet overwhelming when you receive an email on a new investment opportunity. There’s a lot of data to consider in an investment package and it’s easy to get lost and difficult to prioritize what data to focus on.
Here are a few tips on how to quickly determine whether a real estate syndication meets your goals and whether you want to move forward with the investment. If it’s a good fit, you can move forwarding by digging deeper into the deal and if not, you can pass and wait for another deal that fits your criteria.
Step 1: You’ll need to understand your goals and set some criteria.
Ask yourself these questions.
Once you’ve answered these questions, you can evaluate at a first glance the high-level investment summary and whether you’d like to continue looking into the numbers.
Step 2: Yay, your initial criteria pass these set of questions. Let’s focus on the numbers.
There will be a lot of information, but just looking at these 4 high-level metrics in the investment summary will steer you in the right direction on figuring out if you want to move to the next step and continue down the path of vetting the deal.
Keep in mind, what kind of returns are you looking for?
1. Preferred Return
Let’s say the preferred return is 9%, and you invest $50k into the deal. During the first year, the returns hit the expected 9% and the investors get paid their returns first. The general partners only receive returns after 9%, so this motivates them to work hard to get the returns beyond 9%.
Assuming that everything goes according to plan, with $50k invested, you would receive $4500 in cash flow each year – that’s $375 ($4500/12 months) per month of passive income if paid out monthly.
2. Cash on Cash Return
This metric shows you how hard your money is working for you and typically calculated on an annual basis. Let’s say this $50k investment has an average 10% annual cash on cash return (which is higher than the 9% preferred return). This investment is projected to pay out above 9% during the entire hold time. Which you can dive deeper if this meets your criteria.
Cash on Cash = return amount/invested capital
3. Internal Rate of Return (IRR)
Simply, the IRR is the average yearly return of a project taking into account the time value of money. It’s a useful metric because a dollar today is worth more than a dollar tomorrow and this calculation gives us a look into this. Let’s say the investment hold period is 5 years with 12% project IRR, you are not getting all your returns at one time. There are costs that come with a hold period since you can’t earn interest on those returns or invest them somewhere else.
4. Equity Multiple
The calculation of equity multiple is the total cash distributions received from an investment divided by the total equity invested. What does this mean? It’s the number that you multiply your initial investment by to predict the total amount you will have in your pocket, including the initial investment, by the end of the deal.
Let’s say the $50k invested into the deal with a 2x equity multiple, you would end up with twice your original investment after the asset is sold – $100k. This includes the cash flow distributions and the profits from the sale. So you have gained $50k minus your initial capital.
Step 3: Decisions, decisions….
Now it’s time to make a quick decision to see if it’s worth your time to continue to vet this opportunity. Looking at the high-level investment highlights and the expected returns from the 4 key metrics, decide if your goals are met.
At this point, you aren’t making the decision to wire your money over, but you are making the choice to further research the investment opportunity. Usually, you request the full investment summary or submit a soft reserve on the amount of investment from the sponsor. This allows you time to review the materials in depth.
Knowing your goals upfront and working from there can help you navigate quickly to whether syndication is worth looking into further or passing. Focusing on a few key metrics also helps with moving to the next step on validating whether the investment is worth digging into deeper. We hope this helps in sparking your path to passive investing!
-San Francisco Chapter Leader