Understanding Cash Flow Distributions When Investing in Real Estate Syndications

Have you ever wondered exactly where the distributions come from when you have invested in a commercial real estate project? This article will help clarify that question for you.

What Actually Constitutes Your Quarterly Distributions?

Let’s say you’ve just invested in your first real estate syndication. Together with a group of other real estate investors – both a group of passive investors and the real estate syndicator team – you acquired a 100-unit apartment building in a fast-growing submarket of a thriving metro area. Congratulations!

Now what?

You Can Expect Regular Communications

You can expect to receive consistent (usually monthly) communications from the deal sponsors on the progress of the business plan being executed and the status of the renovated units, efficiencies being implemented, and how the professional management team is taking care of any maintenance issues and occupancy issues. You will also likely see photos of updates to the property. On a quarterly basis, you can also expect to receive a more detailed financial statement and reports.

Ahhh…Cash Flow Distributions

Now that you’re the proud owner of a commercial property, you can expect to receive regular cash flow distributions – either monthly or quarterly depending on how the legal documents such as the PPM (private placement memorandum), operating agreement, and investment summary have been outlined in the distribution plan.

You can count on these cash flow distributions as a steady stream of passive income. A better way to look at it is that you will receive this “mailbox money” without having to do any work. The property management company and the lead sponsor team members take care of all of the day-to-day operations on your behalf. Pretty sweet, right?

But, where do these cash flow distributions actually come from? Commercial real estate investments are very lucrative, but let’s take a look at why these investment opportunities are so favorable among savvy investors.

Where Does This Cash Flow Actually Come From?

Real estate investing – whether you are investing in a single-family home or commercial properties like office buildings, mobile home parks, or apartment complexes – at the end of the day, is a business. As a business, the investment property generates income, as well as expenses.

Gross Potential Income

In apartment real estate syndication deals, the main source of income to the business will be the rental income that the property is generating each month.

There are, of course, many other sources of income such as storage rentals, parking upgrades, etc., but for this example, we’ll just discuss the rental income.

For easy math, let’s say that there are 100 units in your apartment community, and rent for each unit has been collected at a rental rate of $1000 per unit. That means that the gross potential income is $100,000 per month or $1,200,000 per year.

Monthly Gross Potential Income

100 units x $1000 each = $100,000 per month

Annual Gross Potential Income

$100,000 per month x 12 months = $1,200,000 per year

But, obviously, we won’t be receiving a check for $1,200,000, as amazing as that would be, right?

That is because this is the gross POTENTIAL income meaning that this would be the gross annual income for the year if all of the stars were aligned meaning there were no vacancies, all rents were collected each month in full at market rate, and there were no concessions. As a side note, concessions are a way to bring in tenants by way of promotions and typically reductions in rents.

Net Rental Income

Now, as you consider factors such as vacancy costs, concessions, and loss to lease (which means that you are not receiving the full market rent on some units), you get the net rental income. In this example, we’ll just consider the vacancy costs to make it simple.

Let’s say that 10% of the units (i.e., 10 units) are vacant. So, if each of these units could rent for $1,000 then your monthly vacancy cost will be $10,000.

Monthly Vacancy Cost

10 units x $1000 each = $10,000 vacancy cost per month

Over the course of the year, assuming the vacancy rate stays the same each month throughout the year then the vacancy cost annually would be $120,000.

Net Rental Income – Annually

$1,200,000 gross potential income for the year – ($10,000 vacancy cost per month x 12 months) = $1,080,000 net rental income for the year.

Operating Expenses

As with any business, a multifamily property will have expenses as well.

Operating expenses include things like maintenance and repairs, asset management fees, property management fees, landscaping costs, cleaning fees, utilities, legal and accounting and bookkeeping fees, insurance costs, payroll costs, pest control expenses, and more.

Just like all businesses are different, so too are multifamily properties and each will require different expenses.

Let’s say that the total projected operating expenses per month are $40,000. Now, to clarify the lead syndicator and sponsorship team along with the asset manager and property management team will be working diligently to streamline efficiencies and mitigate expenses over the course of the hold term on the project. But for now, let’s just say that the operating expenses for the year will be $480,000 ($40,000 per month)

Annual Operating Expenses

$40,000 monthly operating expenses x 12 months = $480,000 in annual operating expenses.

You would subtract the annual operating expenses from the net rental income – remember that was $1,080,000 and that gives you your net operating income figure for the year – NOI.

Net Operating Income (NOI)

$1,080,000 net rental income – $480,000 operating expenses = $600,000 NOI – Net Operating Income for the year.

Debt Service To The Lender

We can’t forget the payments to the lender, of course, that have to be deducted each month as well.

As with any real estate acquisition, we would typically need 20-30% of the down payment and then the lender comes in with the rest of the purchase price. The 70-80% remaining is the outstanding debt that needs to be paid back each month in the form of principal and interest payments to the lender.

As a side note: this is where our limited partnership members come into play – these are the group of people – individual investors – who bring in most of the equity portion of the acquisition cost as well as the general partnership, and then the lender brings in the remaining debt portion of the acquisition cost.

Let’s say, for example, that our payments to the lender (principal and interest) will be $25,000 per month. That would mean we would be paying the lender $300,000 a year for the debt payments.

Annual Mortgage Payments

$25,000 monthly debt payment x 12 months = $300,000 annual debt payments to the lender.

Cash-on-Cash Returns Or Cash Flow

So, once we have taken the net operating income figure and subtracted out all of the expenses, and subtracted out the debt service, this leaves us with our cash-on-cash returns or our cash flow for the first year.

As a side note: I mention “first year” because the objective of the property manager and the sponsorship team and the asset manager is to conduct the work of finding ways to streamline efficiencies and cut expenses over time to optimize and significantly improve the property value by increasing the NOI.

First Year Total Cash Flow

$600,000 NOI – $300,000 debt payment to the lender = $300,000 total cash flow for the first year.

This amount is then split up among the investors, according to how the deal was structured and agreed upon by all of the investors. For example, in a typical real estate syndication, if the structure is a straight split of an 80/20 allocation, that would mean that 80% of the cash flow will go to the investors (i.e., the investors in the limited partnership), and 20% go to the deal sponsor team (i.e., the investors in the general partnership).

First Year Cash Flow To The Investors

So we take the $300,000 first year cash flow x 80% = $240,000 cash flow for the first year which will be distributed to the passive investors (limited partnership) as they have an 80% ownership stake.

Your passive income each quarter that you receive will be based on how much you invested into the project. You would get a share of that cash flow every quarter, in the form of a distribution check.

In Conclusion

Are these guarantees? Of course not. As we always say, ANY investment has risk.

Real estate assets like apartment communities have residents and as such can create MANY variables that can alter a deal sponsorship’s projections. Remember these are always just projections and never guarantees.

Since we only have projections to go on, however, this is the best way to compare potential real estate syndication investments against others, to help you understand how each dollar was invested and where each dollar of projected distributions – passive income – is coming from.

We hope this helped you understand more about how to Earn Passively & Live Abundantly!

Until next time….