Syndication: How Valuable is the Time Value of Money?

[Shafi Noss]

Hello everyone,

  I'm trying to get a sense for just how valuable tax deferment through depreciation is to the multifamily passive investor. Suppose passive investor Isabel invests 100k in a syndication. The syndication pays a 10% pref and has a hold period of 5 years, and imagine she's in a 25% tax bracket. Her cash flows would look like this.

Year 0) -100k (-100k from principle investment)

1) 7.5k = (10k from cash flow - 2.5k from taxes)

2) 7.5k = (10k from cash flow - 2.5k from taxes)

3) 7.5k = (10k from cash flow - 2.5k from taxes)

4) 7.5k = (10k from cash flow - 2.5k from taxes)

5) 125.5k = (100k from return of principle + 30k from equity - 4.5k from 15% capital gains)

Total Return: 55.5k

IRR: 10.4%

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  Now suppose she uses depreciation, and is able to depreciate all of her cashflow. She is not using a 1031 on sale, so she will pay full recapture. Now her cash flows look like this.

Year 0) -100k (-100k from principle investment)

1) 10k = (10k from cash flow, 2.5k depreciated)

2) 10k = (10k from cash flow, 2.5k depreciated)

3) 10k = (10k from cash flow, 2.5k depreciated)

4) 10k = (10k from cash flow, 2.5k depreciated)

5) 115.5k = (100k from return of principle + 30k from equity - 4.5k from 15% capital gains - 10k paid as recapture)

Total Return: 55.5k

or if she reinvests that extra 2.5k every year at 10%

Total Return: 56.6k

IRR: 10.8%

Isabel only sees an improvement of 0.4% to her IRR or an extra 1.6k if she invests the extra cashflow. And if the hold period is doubled to 10 years, and the equity return is doubled to 60k. Her IRRs change to 10.2% and 11.1%, or a 0.9% improvement, and she gets an 11.4k difference in total return.

Now that's not zero, but it seems like a small bonus at best. Would Isabel be right to consider her investments in a syndication this way, or is there more to the picture?