Apartment Building Syndication

[Mitchell Handley]

I have what seems like a very simple question about Real Estate Syndication's that I am having a hard time finding an answer for.

If I was to invest $200,000 in a real estate syndication. After 2 years the syndication refinances the property and pays back my $200,000 investment. If the company continues to own the property and the property continues to receive a positive cash flow. Would I receive a percentage of that cash flow until the property is sold? 

[Brian Burke]

@Mitchell Handley if the deal is structured such that you no longer receive cash flow after receiving a return of your capital, run, do not walk, as far as you can from that deal.  Those are not market terms.  Yes, you see plenty of syndicators doing this, but there is no reason why investors should accept such terms.

In essence what the syndicator is saying with this structure is, "I don't have the money to buy this deal, so I want you to buy it for me.  You take all of the risk, and I get all of the upside.  I can pay you back your $200,000 and own the deal for myself."  No way in heck should you accept that.

@Scott Morongell was absolutely correct that syndications can be structured however the parties agree.  If you are new to investing in syndications, you might be lured into investing in something that you don't fully understand.  So agreeing, and knowing what you are agreeing to are two different things.  Study the language in the operating agreement very carefully because waterfall terms in operating agreements can be confusing and it isn't difficult for sponsors to hide onerous terms among the fluff.

The way the waterfall calculations should work is that you receive 100% of all distributable cash (divided among you and the other investors pro-rata) until you reach the preferred return hurdle.  For sake of example let's say that's 8%.  Once that hurdle has been met you would receive the portion of distributable cash as specified in the operating agreement, usually somewhere between 50% and 80%.  

If you get some of your capital returned, the amount of dollars added to the accumulation of preferred return goes down, which means that satisfying the distributions required to get you to an 8% return on your unreturned capital takes fewer dollars. 

Let's walk through an example.  Let's say that in the first year you have $200,000 committed.  It takes $16,000 to satisfy the preferred return hurdle.

In year 2 you have $100,000 committed because the sponsor refinanced and sent you $100,000 back.  For year 2, your preferred return hurdle is $8,000.  At the end of year 2 the sponsor refinances and returns another $100,000 so now you have no capital left in the deal.  Your preferred return hurdle for year 3 is $0.

Now let's say that the operating distributions total $10,000 for year 1.  You get all of it, because the sponsor owes you $16,000 in preferred return.  The other $6,000 carries over.

In year 2 there is also $10,000 to distribute.  You get all of it, because to satisfy the preferred return the sponsor owes you $6,000 from last year and $8,000 from this year, so $14,000.  The remaining $4,000 carries over to year 3.

In year 3 there is $10,000 to distribute.  You get $4,000 of it to satisfy the remaining preferred return left over from previous years.  Since you had no money in the deal in year 3 there is no preferred return added to the accumulation.  The remaining $6,000 is split between you and the sponsor according to the terms of the hurdles in the operating agreement.  So for example, if the next tier is a 70/30 split, you get 70% of $6,000, or $4,200.

In year 4 there is $10,000 to distribute.  You have no remaining unpaid preferred return and because you got all of your money back there is no preferred return added.  If the next tier is 70/30, you get $7,000.  And so on.

But let me re-state, the operating agreement can say whatever the sponsor wants it to say.  You have to study carefully.  What I described is how I do it and is generally considered market terms by sophisticated investors.  But plenty of sponsors look for unsophisticated investors that don't know any better and slip in all kinds of stuff that are not in your best interest.

There should never be an alteration of your ownership percentage whether you have your capital back or not.  Unless you agree to it, but why would you?