Part 1
Passive Income
Buying large apartment complexes is first and foremost a business. When you invest in syndication, you are investing in a business, real estate is just the vehicle, and living space for rent is the product.
We buy apartments because they produce income. When tenants pay their rent, they are creating income. On the other end of the spectrum, large commercial real estate properties cost money to run and keep up.
There are basic expenses like maintenance, capital expenditures, (think roofs, parking lots, upgrades, etc.) management of the property, utilities, and other business expenses like printing, legal support, (think evictions) insurance, and taxes. Another huge expense is the mortgage. After subtracting expenses from the income, what you have leftover is profit, or in this case, passive income or cash flow.
The income gets paid out in dividends to the General Partners and Limited Partners in accordance with their percentage ownership of the company. Dividends are paid monthly, some are paid quarterly, and on the rare occasion it may be bi-annually or annually, it just depends on the project. Quarterly is pretty standard. For passive investors, this income is very passive. All you have to do is check your email when the General Partners send an update (or don’t, this is optional), and make sure you are receiving your ACH transfer (or don’t, but it is a good idea, kind of like balancing your checkbook, who does that?) How much more passive can it get than that?
Appreciation
Appreciation is the laziest and most intensive benefit of real estate. Let me explain. Market appreciation happens naturally. As you own an asset, it naturally appreciates as the population grows and jobs move into a market. Some markets have a higher market appreciation rate, but those markets come with risk and volatility (California, New York, Las Vegas circa 2008). Buying for appreciation is speculative and it is risky, though millions have been made, just the same, millions have been lost on speculation.
We don’t buy for market appreciation, but we do make sure it is trending on the up, not the other way, and we like to see the market economy projecting modest appreciation.
The best real estate syndications rely heavily on cash flow and have a plan to force appreciation. Forced appreciation is what happens when a property is improved physically or economically.
Physically forced appreciation means we make repairs or update units and the exterior with an expectation that we can demand higher rents for improved property. Economically forced appreciation is when we manage the building better by lowering expenses and increasing income by getting trouble tenants out who aren’t paying their rent and increasing rents to market rent rates.
Market appreciation is the cherry on top while forced appreciation is the business strategy for the project. Again, buying and managing apartments is a business, so there must be a business plan and professional execution of that plan.
Equity
Over the life of the project, the equity in the property increases, so at the sale, the equity is profit, and it gets split among the Limited Partners and the General Partners in accordance with their ownership percentage. Remember, owning and managing an apartment complex is a business, except in this business strategy, you build equity in a physical asset.
Leverage
When leverage, also called debt, is used to purchase a commercial property, you are able to buy something much larger in price and size than you would if you were paying cash. Currently, there is a lot of capital that needs to get deployed, so lenders are chomping at the bit to finance stable real estate purchases such as apartments–stable meaning they produce income.
Interest rates are competitive and loans are pretty easy to come by as long as the underwriting of the project pencils out to the bank’s standards. There are some amazing loan opportunities with non-recourse financing from government-backed lenders such as Freddie Mac and Fannie Mae.
What I love about leveraged properties is that you get another set of eyes on the underwriting. A bank won’t lend on a bad deal.
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