By James Furlo on
Clear and Concise Real Estate Syndication Terms and Definitions
Like any industry, there are special terms that are helpful to know. Here are some of the most common ones in plain English. You can bookmark this resource to reference later.
Here's each term in alphabetical order. Click the word to go to its definition.
Accredited Investor
Agency Debt/Loan
Annual Percent Rate (APR)
Average Annual Return (AAR), aka Annualized Return
Break-Even Occupancy
Bridge Loan
Capital Call
Capital Expenditures (CapEx)
Capitalization Rate (Cap Rate)
Cash-on-Cash Return (COC)
Commercial Real Estate Loan
Cost Segregation
Depreciation
Development Spread and Lift
Distribution Waterfall
Equity Multiple (EM)
General Partner (GP), aka The Operator or The Sponsor
Income Statement, aka Annual Property Operating Data (APOD)
Internal Rate of Return (IRR)
Limited Partner (LP)
LLC Operating Agreement
Net Operating Income (NOI)
Private Placement Memorandum (PPM)
Property Class
Recourse Loan
Rent Roll
Repositioning
Return on Investment (ROI)
Rule 506(b) and Rule 506(c) of Regulation D
Subscription Agreement
Syndication
Value-Add
Yield on Cost (YOC)
Syndication
A temporary group of people (or businesses) who pool their resources to purchase an apartment building that would otherwise be difficult or impossible to buy on their own. You might sometimes hear this referred to as fractional ownership. Learn more
People / Roles
General Partner (GP), aka The Operator or The Sponsor
They organize the syndication and assume a day-to-day role in managing it. They find the property, secure financing, manage the property, provide tax reports, and share key performance metrics with investors.
There's some nuance between the three names, but for the most part, they're interchangeable. Having more than one GP in a deal is common, called co-GPs. Learn more
Limited Partner (LP)
They provide the cash and receive an equity share, cash flow distributions, and profits in return for their investment. They have restricted voting power and no day-to-day involvement in the business. Their liability for the property's debts cannot exceed the amount they invested. Learn more
Accredited Investor
"A person who meets certain standards of wealth and sophistication." There are two primary ways to qualify as an accredited investor:
- Net worth over $1 million, excluding your primary residence (individually or with spouse or partner).
- Income over $200,000 (individually) or $300,000 (with spouse or partner) in each of the prior two years and reasonably expects the same for the current year.
Legal
Rule 506(b) and Rule 506(c) of Regulation D
An SEC regulation that allows two distinct private placements of securities:
- 506(b): No general solicitation or advertising is allowed (i.e., we must have a prior relationship). Securities may not be sold to more than 35 non-accredited investors, but to an unlimited number of accredited investors.
- 506(c): Issuers can broadly solicit and advertise. All investors must be accredited, and everyone needs to be verified.
In other words, when you invest in a syndication, you're not buying the property directly. Instead, you're buying a private share of an LLC that owns the property. Learn more: Rule 506 of Regulation D , (b) and (c)
LLC Operating Agreement
A document that specifies the terms of a limited liability company according to the needs of its members. It also outlines financial and functional decision-making. Learn more
Private Placement Memorandum (PPM)
A legal document that states an investment's objectives, risks, and terms. It includes a company's financial statements, management biographies, a detailed description of the business operations, and more. It serves to provide buyers with information on the offering and to protect the sellers from the liability associated with selling unregistered securities. Learn more
Subscription Agreement
An investor's application to join a limited partnership (LP). It's also a two-way guarantee between a company and a new shareholder (subscriber). The company agrees to sell a certain number of shares at a specific price, and, in return, the subscriber promises to buy the shares at the predetermined price. Learn more
Financial
Income Statement, aka Annual Property Operating Data (APOD)
A 1-year financial statement showing a property's income and expenses by item. At a minimum, it shows the Net Operating Income, and sometimes it will also show debt payments and reserves. This is a detailed picture of a property's financial performance. There are four ways it's calculated:
- T-12: A trailing 12 months of historical income and expenses. It's usually broken down by month with a total so you can see anomalies in the income stream.
- T-3: A trailing 3 months multiplied by 4 to create an annual run-rate. This is often useful for gross income since operations tend to trend in one direction or another. Many people use the T-3 for income and a T-12 for expenses when underwriting deals.
- T-1: Often used by lenders to gauge the trend of the income.
- Pro Forma: A forward-looking Income Statement using projections and assumptions. If the seller's broker provides it, it's usually optimistic.
Net Operating Income (NOI)
This equals all revenue from the property minus all reasonably necessary operating expenses. The NOI is a before-tax figure on a property's income and cash flow statement, excluding principal and interest payments on loans, capital expenditures, depreciation, and amortization. In other industries, this metric is called EBIT, meaning "earnings before interest and taxes." Learn more
Rent Roll
A simple table that breaks down the income by unit. It typically includes the unit number, the tenant's name, when they moved in, when their lease ends, their monthly rent, deposit, and any past due balances. It might also contain unit details like the number of bedrooms and bathrooms, the square footage, and the possible market rent.
While the document is simple, it's critical when evaluating a property's financial performance and potential. Learn more
Depreciation
An accounting method used to allocate a physical asset's cost over its useful life. It allows real estate investors to write off 3.6% of the value of the building each year as an expense, even though there is no out-of-pocket cost for this expense. Learn more
Cost Segregation
A technical process (that we manage) where short-life items are separated from long-life items and depreciated rapidly over 5-7 years. This typically doubles or triples depreciation during the first five years of ownership. Learn more
Capital Call
This is when we collect funds from Limited Partners when the need arises - to make a new investment or pay expenses. When you sign a subscription agreement, you're committed to that amount.
The order of operations is the opposite: once your funds transfer, we countersign the subscription agreement. This avoids any awkward calls and gives preference to investors who act first. If the deal becomes oversubscribed - we have more funds than needed - we'll return the principal of investors who transferred last.
Sometimes during the hold period, expenses are higher than expected, and the operating reserves become too low. If that happens, there could be a second capital call proportional to your ownership. It's rare, and we'll communicate A LOT before it happens, but you should be aware of it. Learn more
Capital Expenditures (CapEx)
These are funds used to upgrade and maintain the property. Examples include repairing a roof, replacing windows, or painting. They're above and beyond daily operational repair and maintenance costs. In addition to raising funds for the downpayment, we'll also raise funds to complete value-add improvements to reposition the property (see property terms below). Learn more
Distribution Waterfall
Found in the Private Placement Memorandum, this describes how to allocate investment returns among a group of investors. Here's one common distribution structure:
- Acquisition fee: 2% of the purchase price.
- Asset management fee: 2% of revenue.
- Preferred return: compounding 8% plus 100% return of original investment.
- Profit split: 70% to investors up to 15% IRR, 50% to investors above 15% IRR.
This priority of distributions remains consistent across cash flow, refinance proceeds, and sale proceeds. Furthermore, our investor's ownership is never diluted. Even if 100% of their capital is returned to investors, they still own the same percentage of the deal. Learn more
Loans
Recourse Loan
The lender can go after the debtor's other assets not used as loan collateral or take legal action in case of default to pay off any remaining debt. A recourse loan only affects the General Partners. Learn more
Commercial Real Estate Loan
This is similar to a mortgage on a home. Usually, the term is shorter (20-25 years), the rate might only be fixed for the first few years (~5 years), and there's a balloon payment in the middle of the term (~10 years). The loan-to-value (LTV) is also lower (70-75%) than a home. Learn more
Agency Debt/Loan
Government-backed loans (Freddie Mac and Fannie Mae) that are non-recourse, offer 30-year fixed financing, and can be up to 80% LTV. Loan sizes start at $3 million, so these are for larger properties. Learn more
Bridge Loan
These short-term loans (12-24 months) help investors quickly buy a property, do a significant rehab, stabilize the operations, and refinance with a longer-term loan. Learn more
Property
Repositioning
The strategic use of renovations and capital improvements on properties to change their place in the marketplace. There are three ways you can reposition a multifamily property:
- Cosmetic: considered light value-add. These include landscaping, painting, flooring, and appliances.
- Structural: considered heavy value-add. These include changing the layout or adding new amenities.
- Operational: change in the way the property operates. Typically it includes removing trouble tenants, increasing occupancy, or adding additional revenue opportunities like laundry machines.
Value-Add
Any commercial property with existing income and significant opportunities for improvement via operational enhancements, property repositioning, or redevelopment. In other words, value-add properties have some income but are not yet at their maximum potential.
Suppose we can increase rents by 10-20% by only putting in 5% of the asset price. In that case, there is an inherent gain in value, especially when we leverage with financing. The most typical ways to add value to an asset are through construction upgrades and reduction of costs. Learn more
Property Class
In multifamily investing, we categorize properties by classes: A through D.
- A-class properties are in excellent condition and quality.
- B-class properties may be a bit older with a couple of maintenance issues.
- C-class properties are older with a lot of deferred maintenance and likely a few larger-ticket issues.
- D-class properties typically require a complete rehab and significant repositioning. There are probably drug or crime issues at the property. These need a considerable investment upfront.
Key Performance Indicators
Return on Investment (ROI)
The percentage of how much you gain or lose vs. how much you invest. Since it's a percentage, it allows you to compare investments quickly. In general, a higher ROI is better. Learn more
Average Annual Return (AAR), aka Annualized Return
Think of it as the average ROI over a period of time. The AAR is what you'll earn on average each year of the investment. Another perk of this metric is that it helps compare other investments beyond real estate. Learn more
Annual Percentage Rate (APR)
The rate of return earned on a loan over a year. It's similar to the AAR, but it's used with loans and is particularly helpful when the hold period is less than a year because it shows the yearly equivalent. For example, if you earn 3% from a loan in 6 months, the APR is 6%. Learn more
Internal Rate of Return (IRR)
The IRR is similar to the AAR but also accounts for the value of time. A higher IRR percentage is better, but it's usually a little lower than the AAR because it factors in the passage of time, which reduces the investment's value. Learn more
Cash-on-Cash Return (COC)
The income from cash flows only as a percentage of your invested amount. This is the average return you can expect during the holding period. It usually starts low and grows over time as improvements are completed (and rents increase). Learn more
Equity Multiple (EM)
This answers the question: "If I invest a dollar, how many dollars will I get back from the investment?" Learn more
Capitalization Rate (Cap Rate)
The Cap Rate is a ratio between the annual net operating income (NOI) and the property price (Cap Rate = NOI / Price). It helps determine the relative value of a property's income after operating expenses. It excludes financing, but that's still helpful since there are many ways to finance a property. Think of it as the inverse of a company's stock's price-to-earnings (P/E) ratio.
It works the other way as well. You can calculate the property's price if you know the local market's average Cap Rate and a property's NOI:
Price = NOI / Cap Rate
Two counter-intuitive common phrases you might hear are:
- "Cap Rates are compressing": Market Cap Rates are dropping, meaning prices for the same NOI are increasing.
- "Cap Rares are expanding": Market Cap Rates are rising, meaning prices for the same NOI are decreasing.
Yield on Cost (YOC)
The Yield on Cost is similar to the Cap Rate, except it's a ratio between the stabilized net operating income (NOI) and the total cost of the project (YOC = stabilized NOI / Total Project Cost). Total project costs include the purchase price, capital improvements, acquisition closing and financing fees, and sponsor fees. This is especially useful in development or value-add projects because it tells you if the return on capital is sufficient to overcome a project's high upfront costs. Learn more
Development Spread and Lift
The difference between the Yield on Cost and the market cap rate is the development spread (development spread = YOC - Cap Rate). The greater the spread, the more potentially feasible the development project is. It's mostly used with development projects, and value-add multifamily projects are, in a sense, small development projects. Learn more
By itself, the spread doesn't provide a lot of insight. The development lift, however, expresses the spread as a percentage of the market cap rate (development lift = development spread / Cap Rate) and tells how much the property's value increased because of the improvements.
Pro tip: The development lift is a fancy way of calculating a growth rate. So, it can be simplified to: Cap Rate / YOC - 1
Break-Even Occupancy
It's the economic occupancy rate that results in zero cash flow - dropping below break-even occupancy results in negative cash flow. Economic occupancy includes physical occupancy, loss to lease (market rents vs. actual rents), bad debt, concessions, and non-revenue units. After stabilization, a break-even occupancy above 80% can be risky. Learn more
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