When does a passive investor get their money back?

If you’re here on our blog, you probably already know that the biggest benefit to being a passive investor in a real estate syndication is that once you invest capital in a deal, you will potentially receive returns on that investment over time without so much as lifting a finger. But how does a passive investor get their original money back?

This is a common question among new passive investors. While each syndication handles their finances and returns a little differently, this article will provide a broad idea of the different ways that each passive investor will receive any returns of their initial investment back to their bank account.

How passive investors receive returns on their investments

Investing in a multifamily syndication is much like buying a house: you’ll build up equity over time, but it’s on the condition that you made an initial down payment, which remains tied up in the equity of that property.

Now picture a syndication, where several different investors have put in different amounts of capital to fund the initial investment. The returns that you make over time are dependent on how much of your capital remains in the project in the form of a percentage.

If the investment performs well over time, you’ll receive returns regularly. But what about getting back your original capital? You’ll receive your original down payment back in one of two scenarios: the sale or refinancing of the property.

Sale vs. Refinancing

When your sponsor decides that selling the property is in the best interest of the investors, then you will receive money from the sales proceeds. Ideally, the property sells for more than the original purchase price, so that each of the investors receives their original capital back in full. However, if the sponsor has to sell the property at a loss, you will probably not receive the full amount you originally invested.

Another option is a refinance, in which investors might get a portion of their money back (like 50%) while still maintaining their initial share of the property. This allows you to free up some of your capital for another investment or for personal use while continuing to receive the same percentage of distributions that you had before. You would receive the rest of your capital when the sponsor eventually sells the property, once again assuming the property sells for a profit.

Timeline for sale or refinance

When you first invest in a deal, it’s a good idea to expect your capital to be tied up for about 5-7 years. However, each deal works differently, and the timing of a sale or refinance will be impacted by market trends and by how well or poorly the investment is performing. Some deals might be refinanced in three years; others might be sold in 10.

“Returns on” vs. “Returns of”

When you receive monthly or quarterly distributions, that money is typically a return on capital and not a return of capital. This is an important distinction when a deal has a preferred return. A return on capital does not change your equity in the property, so your preferred return distributions should remain constant, if the cash flows support them, until there is a capital event like a sale or refinance. A return of capital, on the other hand, decreases your equity in the property by returning your original capital. This will diminish your amount of preferred returns since your preferred return is a percentage of a decreasing amount of equity.

Be careful and read all legal documents thoroughly to make sure you have a clear view on how returns are classified before you invest in a deal. Some sponsors treat distributions as a return of capital, which will lower your profit split in a deal.

Understanding risks

When you invest capital in a real estate deal, understand that no matter how promising it sounds, there is a risk that the investment won’t perform well. Not only would you not receive good returns; there’s a chance that you wouldn’t get any of your capital back.

That being said, real estate provides better stability than many other forms of investment. Because it is backed by a physical asset (the building itself), it’s highly unlikely that your investment would bottom out at zero, like it could with higher-risk investments like stocks.

Understanding risk and researching deals before deciding to invest won’t eliminate losses altogether, but it will help you feel confident about choosing to invest with sponsors that will handle your investment wisely.

Interested in investing?

I provide opportunities to passively invest in larger multifamily properties. To learn more, visit www.jheckrei.com. If you want to get started, join our investor club.