For those that have determined that you are interested in pursuing asset classes or investments that are outside of the norm, you may have stumbled across real estate syndications.
A real estate syndication is when a group of investors pool their capital and resources (e.g., time, relationships, money, etc.) to acquire an asset that they cannot acquire individually.
While the syndicate can take on various special purpose entities, the overall goal is the same; to leverage the combined resources of several individuals and acquire an asset that would otherwise be difficult to acquire on an individual basis.
For simplicity, let’s assume that you determine to invest in a real estate syndication as a limited partner (i.e., as a passive investor) as opposed to as a general partner (i.e., taking on an active role) – how exactly would you get paid? The compensation structure, along with various other factors, is determined by the waterfall structure.
The Waterfall Structure
A waterfall structure describes how, when, and to whom funds are paid in a specific deal. When it comes to partnerships, the waterfall will determine the returns that will be allocated for the general partners and the limited partners.
The important thing to note is that the waterfall structure helps dictate the order of hierarchy through which funds will be allocated and distributed. Visually, one can view waterfall structures as various cups stacked on top of one another, whereby the cashflow first fills the top cup which eventually overflows into the other cups until there is no liquid left.
The way investment returns and capital gains are distributed among general partners and limited partners can be broken out into four different tiers. Primarily:
Tier 1 – Return on Capital: All of the distributions go to the investors until they recover their initial contribution.
Tier 2 – Preferred Return: All of the distributions go to the investors until they receive an agreed-upon preferred return on their investment (e.g., 8%).
Tier 3 – Catch-up Tranche: All of the distributions go to the general partnership until they receive a certain percentage of the profits.
Tier 4 – Carried Interest: The general partnership receives a certain percentage (usually a disproportionate amount) of the distributions until all of the returns are exhausted.
Catch-up Provision: In layman’s terms, a catch-up provision outlines that a limited partner will receive 100% of an investment’s preferred return until they realize a specific rate of return. Once that rate of return is achieved, the general partner will receive all proceeds until they meet their agreed upon return.
Preferred Return: In layman’s terms, this refers to the specific order in which investors (i.e., limited partners) are repaid their initial equity investment plus their respective share of the profits until a specific threshold is achieved.
Return Hurdles: In layman’s terms, return hurdles apply to the hierarchical nature of waterfalls. Return hurdles dictate the rate of return that must be realized before the cash flow can move onto the next tier in the waterfall. Two common return hurdles are the Internal Rate of Return (IRR) and Equity Multiple.
Internal Rate of Return (IRR): The IRR is the discount rate that makes the net present value (NPV) of all future cash flows from a particular project equal to zero. In layman’s terms, IRR is the average annual return over the lifetime of an investment and helps investors determine whether or not to pursue an investment and allows investors to compare multiple investment opportunities. This metric considers the time value of money i.e., a dollar today is worth more than a dollar tomorrow.
Equity Multiple (EM): In layman’s terms, the EM is a metric used to calculate the expected or achieved total return of an initial investment – effectively providing a snapshot of an investment’s overall profitability.
Cash-on-Cash (CoC) Return: In layman’s terms, the CoC is the rate of return that calculates the cash flow earned on the cash invested in a property. In other words, the CoC can be thought of as the “cash yield” of an investment.
At the end of the day, only you can determine whether real estate investing is right for you. As a starting point, think through your personal circumstances and the aforementioned considerations. Know that every investment strategy will be different, that each investment strategy has it’s own pros/cons, and that all investing carries a risk so as you continue to gauge whether you should invest in real estate, do your proper due diligence.
Investing in Real Estate comes with several advantages. Navigating the real estate investing process can be difficult, but you do not have to do it alone. We are here to help.
How You Can Get in On the Action
Cash Flow Champs is a privately held investment company that focuses on acquiring and managing opportunistic and value-add multifamily real estate properties. The company specializes in repositioning well-located assets in emerging markets surrounded by positive demand drivers such as population growth and job growth.
Cash Flow Champs partners with entrepreneurs and busy working professionals interested in investing in real estate but who lack the time to navigate the process. Alongside our partners, we aim to bridge purpose and profits in a manner that allows us to improve the lives of the residents in our communities and the neighborhoods where we operate.
In the words of Robert Kiyosaki, the poor and the middle-class work for money. The rich have money to work for them. If you are an individual that wants to build and maintain generational wealth through real estate, all while making a positive impact on the lives of residents and the communities where you invest, we’d love to explore opportunities for synergies.
Schedule a brief call with us so we can get to know you better, understand your life goals, and determine where synergies may exist.
This information presented on this site is for informational purposes only and does not constitute an offer or solicitation to sell shares or securities in the company or any related or associated company and is not a recommendation to pursue a specific investment opportunity. Any such offer or solicitation will be made only by means of the company’s confidential Offering Memorandum and in accordance with the terms of all applicable securities laws and other laws.