How Apartment Syndications Make Passive Investors Money
I think you’ll probably agree that it’s not completely apparent how potential investors earn passive income in an apartment syndication.
After all, a real estate syndication doesn’t operate in the same way as your local restaurant where you have a meal, swipe your card, and then leave. The restaurant is a business, yes, but investing in apartment complexes are completely different investment opportunities. In fact, most people don’t even know that apartment buildings are viable businesses.
I was one of those people that didn’t give much thought to a multifamily syndication as a business even though I have been a residential real estate investor for almost 20 years. As I began to learn about passively investing in multifamily properties, it has opened up a whole new world of possibilities with all of the different ways that these particular real estate assets can generate income and provide enormous tax benefits. There are so many ways to generate and save money with a real estate syndicate that go well beyond the asset just performing as a rental property.
Once I understood the difference between this type of investment property and investing in single-family homes, then I realized what a superior investment a multifamily property was for so many reasons.
So let me share with you how an apartment community generates income so that you’ll start to see how each building you pass by on the street is actually a bonafide business.
A business is simply a way to make other people’s lives better. – Richard Branson
One of the main ways everyone would associate an apartment complex making money is through acquiring rental income from the various residents. After all, many of us have rented an apartment at one time or another in our lives and so we understand that process.
Rental income plays one of the main roles in how an apartment community makes money. The monthly income generated from each of these individual rental properties creates the largest portion of the gross income generated for that month. Then, the debt service to the lender and various other monthly expenses will need to be paid, and once all of those expenses are paid, then that leaves the net operating income or NOI.
What is NOI?
The NOI is essentially your monthly profit. As an individual investor, you are part of a limited partnership with a group of investors who are a.k.a passive investors. Then we also have the general partnership which is comprised of another group of people that are the real estate syndicators or a.k.a the deal sponsor team. So, when you are invested in a real estate syndication, you are invested with a team, and you split the NOI (net profit) amongst the partners and investors.
For example, let’s say you’re a passive investor in an apartment building with 250 units. Let’s say that each apartment rents for $1000.00 or $250,000 monthly gross income. Now, let’s say that the debt service on the loan to the lender ($75,000.00) and all expenses such as property management fees, utilities, maintenance, repairs, and other expenses ($125,000.00) come to a grand total of $200,000 a month. This would leave a monthly NOI of $50,000.00.
$250,000 (gross income) – $75,000 (mortgage) – $125,000 (expenses) = $50,000 (NOI)
If you had owned this property outright without any debt service or other investors, you would receive a net income of $50,000.00 per month. But you are likely invested with a group of individuals such as limited partners and general partners so that $50,000.00 would be split. The cash flow distributions (or profit) would be sent out either monthly or quarterly to all of the investors.
The property management team is tasked with making sure that all rents are collected from the tenants for their use of their rented apartment space, but a great way that investors can make additional income in an apartment community is through ancillary income, and it should be a part of any well-thought-out business plan.
Ancillary income is generated by various other add-on amenities such as clubhouse rentals, bike storage, mailbox lockers, pet fees, trash valet, covered parking, vending machines, reserved parking spaces, storage unit fees, and many more common fees that tenants are willing to pay additionally for in order to receive these add-ons. A good apartment sponsor team and a property manager will understand the needs of their residents and offer them additional amenities based on those needs.
While these various add-on fees are usually not a lot of money to each individual resident, all of the fees increase the annual income that the real estate deal generates and ultimately can increase the value of the property.
Commercial investment properties are valued differently than single family homes. The market value of a single-family home is determined by comparables or (comps) based on like/kind properties in a close geographic area. In contrast, the valuation of commercial properties is based on the net income that the property generates.
So, if for example, you were to purchase a single-family home and put a lot of work into the property renovating it, if you were to improve the property well beyond the standards of that neighborhood, you wouldn’t likely get much more valuation out of the property because you would have “over-improved” the property for the neighborhood, and there will be a cap on the valuation.
Commercial properties such as apartments are different.
The valuation of apartment communities is not based on comparables of like/kind properties but rather, on how much money they generate.
Let’s say we have an apartment community valued at $20,000,000 today, and the property generates an NOI (net operating income) of $1,000,000 a year, with a market cap rate of 5%. Now, let’s say that the apartment sponsor team and the property management company work together to increase efficiencies, decrease expenses, and increase occupancy and other revenue streams.
If over the course of the year the NOI increased by just $50,000, then at a 5% cap rate, the valuation will have increased by a full $1,000,000! Yes, you read that correctly.
How does this happen?!
One of the best ways to explain how this works is – simply put – that for every dollar that is generated in NOI if, for example, the property is at a 5% cap rate, it will increase the value of the property by 20 times. So, a $50,000 increase in NOI in a current year at a 5% cap rate is an additional $1,000,0000 added to the valuation.
And as counterintuitive as this sounds the lower the cap rate is for the commercial property, the greater the valuation increase for every dollar generated to the NOI. Strange as it sounds, that is the way cap rates work with all commercial properties.
This valuation increase is the goal of every apartment syndicator team and their property management team – to drive up the NOI over the hold period so that the profits are maximized for all of the investors when the property is sold.
There is such a thing as market appreciation, which essentially means that the real estate market conditions are helping to drive up the property value, but we never rely on market appreciation to increase the value of the asset.
Another way that apartment communities generate income is by renovating the property to improve the value. The act of improving and renovating a property provides the residents with a cleaner, safer, and more desirable place to live, and improves the surrounding community as well.
A more desirable place to live for residents can generate a greater net income for the investors in the apartment community, and as was mentioned earlier, an increase in the NOI creates an increase in the valuation of the property. Increased profits lead to investors receiving a larger share of the cash flow returns on a quarterly basis, as well an increased share of the equity when the property sells.
Additionally, when all of these renovations take place and the residents feel a certain amount of pride in their community, then more and more people are referred to the community, vacancies can decrease, the reputation of the community improves, the community will start attracting more conscientious tenants. And once that happens, the NOI will almost invariably increase.
With this strategy, we can improve communities one apartment building at a time.
A Note On Making Money
Some people take issue with apartment owners making money. They think of the rents that the apartment owners charge is indicative of greed or exploitation.
But let’s look at the big picture. What would happen if apartment owners didn’t renovate and improve the apartment communities for the residents? Worse yet…What would happen if people didn’t provide this type of housing at all?
The need for shelter is a basic fundamental human need, and those that provide clean, safe, and affordable housing should be compensated for that. We have no tolerance for bad landlords that don’t provide good, decent housing for their tenants, but the majority of apartment owners are in this particular business so that they can provide a basic essential need, while providing a great place for people to live while making a positive impact on local communities, and yes while making an honest profit.
So, these are the ways that apartment buildings act as businesses and not just as a place for individuals to live. Apartments are for all intents and purposes – businesses. But apartment buildings provide so much more such as a place to live life, a place to thrive, and a place to make memories.
These are the best types of businesses. The types of businesses that make money, but also provide valuable services to the people and to the communities they serve.
Ready to Learn More?
The best way for you to learn more about passive investment opportunities in commercial real estate syndications is to join the PCRP Passive Investor Club.
Through the PCRP Passive Investor Club, you’ll get a priority review of all the deals we offer. We’ll work with you to determine your investing goals and then present you with the best deals to meet those goals. We’ll then guide you every step of the way as you invest in those deals.
So if you’re ready to start investing passively in institutional-grade, commercial real estate in fast-growing, climate-resilient markets in the U.S., join the PCRP Passive Investor Club – IT’S FREE! – and get started on your path to EARN PASSIVELY and LIVE ABUNDANTLY!
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