All Forum Posts by: Randy Smith

You’ll find very quickly that there are about as many types of metrics to measure the returns of an investment as there are investment opportunities available to you. It’s important to know what the metrics are telling you, and which ones measure the results you are looking for your specific situation. We’ll outline the three main metrics you should pay attention to when investing in your first or subsequent passive investing opportunities below.

Cash on Cash Return (COC)

The cash-on-cash metric is really important for the cash flow investor that is trying to replace their W-2 income in order to leave their job or for those that have already retired and need to have consistent and steady income. The COC calculation measures the annual returns for a given period which is usually one year. To understand this calculation, assume you have a $100,000 investment, and it produces $4,000 in cash flow in the first year of the investment. You're COC returns would be 4% ($4,000/$100,000).

Average Rate of Return (ARR)

The ARR is the average annual returns that is generated over the duration of the investment. It is calculated by adding up COC returns of each year and then dividing by the total number of years. Let's assume the same $100,000 investment above produces $4,000 year one, $6,000 year two, $8,000 year three and $10,000 year four. The total returns are $28,000 over four years so your average returns are 7% ($28,000/4/$100,000).

Internal Rate of Return (IRR)

The internal rate of return metric is likely the single most important metric to look at when considering the overall performance of an investment and is probably the most important metric for the growth investor that is simply trying to grow their nest egg as fast as possible. The IRR metric helps to measure not only how much returns you get from an investment but also how fast you get the returns. As they say, a dollar earned today is more important than a dollar earned tomorrow.

The calculation on this metric is a little too complicated for the purposes of this article, but the basic premise is that the sooner you get your invested dollars back, the more valuable they are to you as the investor. To show a very high-level example, the IRR on a $100,000 investment that returns $10,000 per year for 5 years is higher than an investment that returns nothing for the first 4 years and then provides a $50,000 return in year 5. By getting the $10,000 back each year, an investor can reinvest those dollars to help the total returns on those dollars increase faster over time.

Be careful that you are using the same metrics when you are comparing investments across different operators or asset classes. And more importantly, be sure you are using the right metrics for your specific investment needs. The cash flow investor will want to pay more attention to the cash-on-cash returns and the growth investor will likely want to pay more attention to the internal rate of return.

@Chris Seveney

@Chase Hoover

Thank you both for your comments.  I agree that fee structures and prefs needs to be alined, but it's also important to pay the operators for the work they are doing.  It's unreasonable to expect the GPs to significantly come out of pocket on the front end of deals as there are plenty of expenses involved in acquisitions, due diligence, asset management etc.

After the excitement has set in once you’ve discovered the amazing returns passive investing through syndication can provide, you’ll want to dig in and get a better understanding of how you will get paid. In this brief article, we’ll discuss the Preferred Return and the infamous Waterfall which accounts for the two main areas where you can expect to receive returns in this space.

Preferred Return

Most operators will provide a Preferred Return to their investors. This means that the investor will receive a certain return on their investment before the operator receives any of the profits from the business operations. This will generally fall in the 7-8% range. So, what does this mean exactly? Let’s say that you invested $100,000 in a deal with a 7% Preferred Return. In this scenario, you would receive $7,000/year (usually monthly or quarterly distributions) before the operator gets any share of the profits.

It's important to note that a Preferred Return is not a guaranteed return so you won’t necessarily earn the Preferred Return in the first or subsequent years. You can expect to see first year returns in the value-add space around 3.5-6% for the first year.

Waterfalls

Once the operators have started to complete the business plan, the profits of the investment will start to improve resulting in returns that exceed the Preferred Return. In most cases, the passive investor will receive additional payments from a waterfall structure. Some common waterfall structures are 80/20 or 70/30 where the larger of the two numbers is usually paid to the passive investors.

Let’s use the same example we used earlier with a $100,000 investment with a 7% Preferred Return, and let’s consider a 70/30 waterfall. Let’s also assume that there is a total of 10, $100,000 passive investors. If the overall profit from the business operations is $1,000,000, the passive investors would receive a total of $70,000 (7% Preferred Return on $100,000), and then the remaining $930,000 would be split into $651,000 (70%) for the passive investors and $279,000 (30%) for the operators. Each passive investor would receive $65,100 from the waterfall for a total of $72,100 ($65,100 for the waterfall + $7,000 for the Preferred Return).

Spend the time to understand the structure of the specific deal you are looking at and be sure to ask as many questions as you like to make sure you are comfortable with everything. An educated investor is a confident investor which makes you a great partner for the many amazing operators in this space.

When I first started investing passively in real estate through the syndication model, I was asked if I was an accredited investor or just a sophisticated investor. At first, I was confused and intimidated by the jargon, and I wondered if I should just keep feeding the 401K and index funds like everyone I knew. Instead, I decided to dig in and educate myself further to make sure I could “talk the talk” in this new and exciting space.

The topic of sophisticated or accredited investors comes up in this space as you need to meet certain requirements to invest in private placement investments like apartment syndications. Ultimately, the more sophisticated and wealthier you are, the more options you have to invest your hard-earned money.

Let’s add to your education in the space today with a simple definition:

Accredited investors need to satisfy one of the following criteria:

1. An individual with income more than $200,000 for a least a couple of years or a couple with income more than $300,000

2. A household with more than $1MM in net worth excluding their personal residence

There are some other options and more details, but if you can check either of the items above, you are safe to call yourself an accredited investor.

The more complicated designation is the Sophisticated Investor. Sophisticated Investors are not necessarily accredited investors, but they generally have significant financial wealth and must be sophisticated enough in financial and business matters to be able to understand the risks of an investment. Accountants, bankers, and business owners can usually meet the requirements to fall under the sophisticated investor designation as can others with significant financial and business acumen.

Once you’ve identified what type of investor you are, you can now start to look for operators and investments that you are qualified to work with. There are several sources that you can leverage to find those investments, but we’ll leave that for another day. With this information, you’ve added another tool to your investor’s tool belt that will help you to decrease your dependance on your W-2.

@Account Closed

@Sean Willette

Yes, I was referencing odcfund.com, but it's also important to note that you can still invest passively if you are not accredited ($200,000/year single or $300,000/year married or $1MM in net worth excluding your home).  There are plenty of deals out there that are 506B which accept sophisticated investors with as little as $25,000.

Many of your larger syndicators only accept accredited investors because they want to have the ability to advertise their deals to the general public.  506B deals can not be advertised so they can be a little harder to find, but you'll be able to find plenty of them if you start networking in the space. Of my 18 LP positions, only 5 of them are 506C (for accredited investors only).

Feel free to reach out if you want to discuss further or in more detail.

@Vincent Plant.  Boy, that's a big question, and likely too much to put here in one post.

Ultimately, here are the high level steps you'll want to go through in order to move forward with passive investing:

1.  Understand what you want to accomplish with your investing.  Wealth generation, monthly cash flow, time freedom, etc.

2.  Research and pick an asset class and business model that can help you reach those goals

3.  Research and pick a geography where you want to invest in order to achieve your goals

4.  Find an expert operator in the asset class and region from above

5. Decide which offering you want to invest in from the operator you found above

You can also choose to invest in a great operator that uses the fund model to diversify your investment across multiple assets and geographies.

I love talking about this stuff, so feel free to DM me and we can hop on a call as well.

@Billy Daniel. Yes, you can definitely stretch your dollars further if you are limited on cash. I used a number of different sources when I first started passive investing. First, I used money from an old 401k that I transferred into a Self Directed IRA. That was money that was already sitting in the stock market, and it gave me a bucket to pull from to get started. My thought was that it was somewhat "fun money" because it was just sitting in mutual funds getting eaten alive by fees. Second, I was in a great W-2 job with big quarterly bonuses so I could move those bonuses into individual passive investments each time I received them. Sure, you might be limited to one or two deals a year if you are cash flowing them, but they will grow very quickly once you start to see the snowball effect of your monthly/quarterly returns combined with your deals that start to go full cycle. Lastly, I ended up selling all of my single family homes as well and took that capital and placed it in multiple deals across various asset classes, operators, and geographic regions. Now, I'm looking at the equity I have in my house as well. If my monthly/quarter distributions can cover the monthly cost of the heloc, it might make sense for me to leverage some of that too. Bottom line: At the time, I had more money than time, so it was/is a great place to hold my capital. Now, I have more time on my hands, and I'm starting to get involved again on the active side while watching my passive income grow and grow.

If you hang around the real estate investing community for any amount of time, you are going to hear a lot about investing through syndications. For those of us that have been doing this for any amount of time, this terminology is about as normal as discussing the news, weather, and sports. But for those that are new to real estate investing, it can be a little overwhelming and intimidating at best. In this article I’ll discuss what passive investing through syndication is and why it can be a great tool to have in your investing tool belt.

Active Vs. Passive Investing

First, let’s discuss the difference between active and passive investing. Active investing in real estate is what most people think of when they think about real estate investing. Imagine HGTV’s many, many shows that show the very glamorous life of buying the “ugly house on the street” and then turning it into the “prettiest house on the street” in just a few short weeks with a couple of funny interactions with the construction crew the TV personality just happened to find walking the isles of Home Depot.

There are many different versions or variations of active investing (wholesaling, buy and hold, BRRR, short term rentals, and many others), but what the reality TV shows do not share are the razor thin margins, the cutthroat world of acquisitions, and the many unglamorous aspects of the business that make it very tough for the average active investor with a W-2 to be successful with this as a side hustle. As someone who has played the active investing game while trying to show up and perform 100% in a W-2 job, it's not really all that it's cracked up to be.

Passive investing by design is very boring compared to the high energy, high stakes, and perceived high rewards that are portrayed by the active investor community. On a normal day as a Passive Investor, you might receive some updates via email on your investments, receive some solicitations from new operators that are trying to earn their way into your passive investment portfolio, and you’ll likely want to confirm that the disbursement deposits are hitting the correct bank account on the predetermined date.

Passive investing is simply, picking the right “jockey,” and then watching the jockey run around the track. Sometimes your jockey finishes in first place, and other times she comes in 2nd or 3rd, but if she doesn’t break her leg, you’ll both move on to race another day and she will only get stronger and faster.

What is a Syndication

Now, let’s define what a real estate syndication is. A real estate syndication is an investment structure that allows you to bring a group of investors together to invest in a specific real estate opportunity. This type of structure can be used to invest in almost anything, and some of the most common real estate syndications include apartments, mobile homes, self-storage, land, development, ATM machines, and even bit-coin mining.

Roles in Syndications

Next, let’s discuss the two main roles in syndications: General Partners and Limited Partners

The General Partner is the “jockey” that is in control of the day-to-day operations of the business. They are responsible for finding the deals, doing the due diligence, setting up the financing, raising the capital, creating and executing the business plan, dealing with the operational challenges that come up 24 hours a day, managing the cash flow, and ultimately distributing the profits to all of the partners throughout the hold period.

Good General Partners have been involved in the business for years, and they have perfected their business procedures to make sure the business plan is executed as effectively as possible. The success of the syndication will often rely on the skills and experience the General Partners bring to the deal.

The Limited Partner is the individual or the individuals that are bringing the liquid capital to the syndication deal, and these funds are usually used for the down payment or the rehab of the real estate being purchased. In return, the Limited Partner generally receives some type of quarterly or monthly distribution as well as an additional return when the business plan is successfully completed at some point in the future. The Limited Partner is not involved in the day-to-day activities of the business plan, and they don’t have to deal with the issues that arise throughout the period that the business plan is being executed.

The main responsibilities of the Limited Partner are to complete due diligence on the General Partners (the “jockey”) and the specific deal, review the regular communications from the General Partners that provide updates throughout the hold period, tell everyone you know every time you get a deposit into your account without doing any active real estate activities, and continue to earn good money from your W-2 or other business activities to keep feeding the passive investing machine you are creating.

Whether you determine that Active Investing or the Passive Investing is the best route for you and your needs, syndications are a great model to consider if you are interested in maximizing your returns while also taking advantage of scaling faster by combining your efforts with other investors and professionals in the space.

To wrap this up, my wife and I were able to 10x our monthly passive income through the syndication model in about the same amount of time as it took to build a small single family rental portfolio. As a result, our focus will be to continue investing in real estate through the passive investment model with syndications.

 @Sean Willette I invest in Phoenix (my backyard), Tucson, TN, and other various states through multiple funds I invest with (Open Door Capital, Ashcroft, Spartan Investment Group etc.  I'm always looking to partner and help in any way in this space.

Thanks @Arn Cenedella.  Yes, leave the operations to the experts as a passive investor and focus on your super power in the W-2.