Fundamental Real Estate Syndication Terms You Need to Know

Investing in multifamily syndications includes many terms that may be unfamiliar. Here we break down the most frequently used terms so you can better understand how commercial real estate syndications work and how you make money if you invest.

Frequently Used Real Estate Syndication Terms

Real estate syndications establish a partnership between active and passive investors to hold and manage a property. Once the syndication closes, the sponsor creates a company to hold the asset and establish the role of sponsors and investors.

General Partner (GP) is the sponsor or managing partner who does the work and makes day-to-day decisions. They find, buy, manage, and sell or refinance the property.

Limited Partners (LP) are passive investors who contribute to the down payment of the property but have no decision-making authority in the business.

An Accredited Investor meets the SEC guidelines for sophisticated investors. To qualify, you must earn $200,000 or more annually (or $300,000 with a spouse) or own over a million in assets, not including your primary residence. You must be an accredited investor to participate in most real estate syndications.

Frequently Used Investment Return Terms

CAP Rate or capitalization rate provides insight into the value of the investment. To calculate the Cap rate, divide operating income by the current market value to establish an estimated annual rate of return. Cap rates for multifamily housing tend to range from 6 to 8%.

Annualized Return is calculated by dividing the return on investment by the hold period and describes the anticipated average return you will receive each year.

IRR, or Internal Rate of Return, considers the time value of money in its calculation by considering anticipated cash flow, the cost of servicing debt, and the proceeds expected at the time of the exit.

Cash on Cash Returns forecasts investment yield. To calculate, divide the annual pre-tax net revenue by the initial cash investment.

Preferred Return describes the rate of return investors receive before the sponsor takes their share. A cumulative preferred return means the amount accrues from the date of purchase.

Total Return describes the total return you receive over the entire hold period.

Frequently Used Investment Terms Related to Real Estate

The Vacancy Rate compares the number of rented units with the number of unoccupied units.

Value-adds are projects the management team completes to increase the property’s value and raise rents during the ownership period. Value add projects might include upgrading individual units or adding amenities to the public space.

Capital Expenditures involve expenses used to buy, upgrade, and maintain the property. Value-add projects include capital expenditures designed to increase rents and raise the property value,  increasing returns for investors. However, if capital expenditures exceed estimates, it can reduce profitability.

Underwriting is the process of evaluating the property. The sponsor uses underwriting to determine the profitability of the project. Lenders underwrite loans by vetting the asset and borrowers before extending a loan. The quality of the underwriting is essential to estimating profits and securing financing.

Debt Service describes the amount of loans required to buy the property. The loans becomes part of operating expenses and impact risk. Properties with higher leverage could become riskier than those with more equity if the economy or regional market faces a downturn.