APARTMENT SYNDICATION?

An apartment syndication is a temporary professional financial services alliance formed for the purpose of handling a large apartment transaction that would be hard or impossible for the entities involved to handle individually, which allows companies to pool their resources and share risks and returns. In regards to apartments, a syndication is typically a partnership between general partners (i.e. the syndicator) and the limited partners (i.e. the investors) to acquire, manage and sell an apartment community while sharing in the profits.

General Partner (GP)

The general partner (GP) is an owner of a partnership who has unlimited liability. A general partner is also usually a managing partner and active in the day-to-day operations of the business. In apartment syndications, the GP is also referred to as the sponsor, syndicator, or operator. The GP is responsible for managing the entire apartment project.

Limited Partner (LP)

The limited partner (LP) is a partner whose liability is limited to the extent of the partner’s share of ownership. In apartment syndications, the LP is the passive investor and funds a portion of the equity investment.

Net Operating Income (NOI)

Net operating income (NOI) is all revenue from the property minus operating expenses, excluding capital expenditures and debt service.

For example, a 415 unit apartment community with a total income of $3,033,229 and total operating expenses of $1,032,109 has a NOI of $2,001,120.

Capitalization Rate

Capitalization rate, typically referred to as cap rate, is the rate of return based on the income that the property is expected to generate. The cap rate is calculated by dividing the property’s net operating income (NOI) by the current market value or purchase price of a property (NOI / Current market value = Cap Rate)

For example, a 415 unit property with an NOI of $2,001,120 that was purchased for $24,750,000 has a cap rate of 8.09%.

Cash Flow

Cash flow is the revenue remaining after paying all expenses. Cash flow is calculated by subtracting the operating expense and debt service from the collected revenue

For example:
    Total Income                   $1,859,729
    Total Operating Expense        $1,107,452
    Debt Service                   $571,080
    Asset Mgmt Fee                 $40,170
    Cash Flow                      $141,027

Equity Investment

The equity investment is the upfront costs for purchasing an apartment community, which includes the down payment for a loan, closing costs, financing fees, capital reserves account, and the various fees paid to the general partner for putting the deal together. May also be referred to as the total raise.

Sale Proceeds

The sales proceeds are the profit collected at the sale of the apartment community.

For example, here is a how the sales proceeds are calculated for a 415 unit apartment community purchased at $24,750,000 and sold after a five year value-add business plan:

Exit NOI             $2,670,812
Exit Cap Rate        7%
Exit Price           $38,154,455
Sales Expense       ($2,098,495)
Remaining Debt      ($19,800,000)
Sales Proceeds       $16,255,960

Internal Rate Of Return (IRR)

The internal rate of return (IRR) is the rate, expressed as a percentage, needed to convert the sum of all future uneven cash flow (cash flow, sales proceeds and principal pay down) to equal the equity investment. IRR is one of the main factors the passive investor should focus on when qualifying a deal.

A very simple example is let’s say that you invest $100. The investment has cash flow of $10 in year 1, and $40 in year 2. At the end of year 2, the investment is liquidated and the $100 is returned.

The total profit is $50 ($10 year 1 + $40 year 2).

Simple division would say that the return is 50% ($50/100). But since time value of money (two years in this example) impacts return, the IRR is actually only 23.43%.

If we had received the $50 cash flow and $100 investment returned all in year 1, then yes, the IRR would be 50%. But because we had to “spread” the cash flow over two years, the return percentage is negatively impacted.

The timing of when cash flow is received has a significant and direct impact on the calculated return. In other words, the sooner you receive the cash, the higher the IRR will be.

Cash-On-Cash (COC)

The cash-on-cash (CoC) return is the rate of return, expressed as a percentage, based on the cash flow and the equity investment. CoC return is calculated by dividing the cash flow by the initial investment.

For example, a 415 unit apartment community with a cash flow of $694,934 and an initial investment of $6,804,625 results in a CoC return of 10.21%

Equity Multiplier (EM)

Equity Multiplier (EM) is the rate of return based on the total net profit (cash flow plus sales proceeds) and the equity investment. EM is calculated by adding the sum of the total net profit and the gross cash flow and dividing it by the equity investment.

For example, if the limited partners invested $3,645,170 into an apartment community with a 5-year gross cash flow of $2,020,165 and total proceeds at sale of $6,003,028, the EM is ($2,020,165 +$ 6,003,028) / $3,645,170 = 2.2.

Gross Rent Multiplier (GRM)

The gross rent multiplier (GRM) is the number of years the apartment would take to pay for itself based on the gross potential rent (GPR). The GRM is calculated by dividing the purchase price by the annual GPR.

For example, a 415 unit apartment community purchased for $24,750,000 with a GPR of $3,958,680 has a GRM of 6.25.

Debt Service Coverage Ratio (DSCR)

The debt service coverage ratio (DSCR) is a ratio that is a measure of the cash flow available to pay the debt obligation. DSCR is calculated by dividing the net operating income by the total debt service. A DSCR of 1.0 means that there is enough net operating income to cover 100% of the debt service. Ideally, the ratio is 1.25 or higher. An apartment with a DSCR too close to 1.0 is vulnerable, and a minor decline in cash flow would result in the inability to service (i.e. pay) the debt.

Bridge Loan

A bridge loan is a mortgage loan used until a person or company secures permanent financing, which are short-term (6 months to three years with the option to purchase an additional 6 months to two years). They generally have a higher interest rate and are almost exclusively interest-only. Also referred to as interim financing, gap financing or swing loan. The loan is ideal for repositioning an apartment community.

Permanent Agency Loan

A permanent agency loan is a long-term mortgage loan secured from Fannie Mae or Freddie Mac and is longer-term with lower interest rates compared to bridge loans. Typical loan term lengths are 5, 7 or 10 years amortized over 20 to 30 years.

Refinance

A refinance is the replacing of an existing debt obligation with another debt obligation with different terms. In apartment syndication, a distressed or value-add general partner may refinance after increasing the value of a property, using the proceeds to return a portion of the limited partner’s equity investment.

Appreciation

Appreciation is an increase in the value of an asset over time. There are two main types of appreciation: natural and forced. Natural appreciation occurs when the market cap rate “naturally” decreases. Forced appreciation occurs when the net operating income is increased (either by increasing the revenue or decreasing the expenses).

Property And Neighborhood Classes

Property and neighborhood classes is a ranking system of A, B, C, or D given to a property or a neighborhood based on a variety of factors. These classes tend to be subjective, but the following are good guidelines:

Property Classes

• Class A: new construction, command highest rents in the area, high-end amenities
• Class B: 10 – 15 years old, well maintained, blue & white collar tenant
• Class C: built within the last 25 years, shows age, blue collar tenant
• Class D: over 30 years old, no amenity package, low occupancy, needs work

Neighborhood Class

• Class A: most affluent neighborhood, expensive homes nearby, maybe have a golf course
• Class B: middle class part of town, safe neighborhood
• Class C: low-to-moderate income neighborhood
• Class D: high crime, very bad neighborhood

Preferred Return

Preferred Return: the threshold return that limited partners are offered prior to the general partners receiving payment.

Distributions

Distributions are the limited partner’s portion of the profits, which are sent on a monthly, quarterly or annual basis, at refinance and/or at sale.

Underwriting

Underwriting is the process of financially evaluating an apartment community to determine the projected returns and an offer price.

Pro-Forma

A pro-forma is the projected budget of an apartment community with itemized line items for the income and expense for the next 12 months and 5 years, which is an output of the underwriting.

Acquisition Fee

The acquisition fee is the upfront fee paid by the new buying partnership entity to the general partner for finding, analyzing, evaluating, financing and closing the investment. Fees range from 2% to 4% of the purchase price, depending on the size and returns of the deal.

Asset Management Fee

The asset management fee is an ongoing annual fee from the property operations paid to the general partner for property oversight. Generally, the fee is 2% of the collected income.

Refinancing Fee

The refinancing fee is a fee paid for the work required to refinance the property. At closing of the new loan, a fee of 0.5% to 1.5% of the total loan amount is paid to the general partner.

Private Placement Memorandum (PPM)

The private placement memorandum (PPM) is a document that outlines the terms of the investment and the primary risk factors involved with making the investment. The four main sections are the introduction, which is a brief summary of the offering, the basic disclosures, which includes general partner information, asset description and risk factors, the legal agreement and the subscription agreement.

Subscription Agreement

A subscription agreement is an agreement between a company and investor(s) that sets out the price and terms of a purchase of shares in the company. The subscription agreement details the rights and obligations associated with the share purchase.