This Is Where The Cash Flow Distribution Come From In an Apartment Syndication Deal
- Thousand Doors Group
- Dec 16, 2022
- 6 min read
Imagine you have recently made your first investment in a real estate syndication. You and a group of other investors have purchased an apartment building with 100 units that is located in an attractive neighborhood of a bustling metropolitan area.
Distributions of Cash Based on Operations
After you've invested in an apartment syndication deal, you should also anticipate receiving regular cash flow dividends, which are typically made on a quarterly basis and begin anywhere from one month to several months after the closure of the transaction.
These cash flow distributions can be considered a new source of passive income that you are receiving. That is to say, you won't have to do any action in order for these checks to be sent. To die for, wouldn't you say?
But the question remains: where exactly do those checks originate? Although an apartment building does not quite have the same appearance as an ATM, there must be a reason why investments in apartment buildings are so rewarding.
Let's take a closer look at the origin of that money for those of you who, like me, are just as interested in knowing the specifics as I am.
Where the Cash Distribution Is Actually Coming From
A company can be any investment property, from a single-family home to an apartment complex with hundreds of units. As long as it’s runned like a company, the asset should result in both income and expenses being incurred.
Gross Potential Income
The rental checks that begin arriving at an apartment building on the first of each month are the primary source of income for the building.
For the sake of this demonstration, we will limit ourselves to discussing income from rentals even though there are undoubtedly additional sources of cash flow.
Let's imagine that the apartment complex you have purchased has 100 units, and that each one commands a monthly fee of $800. This indicates that the maximum possible gross income is $80,000 per month, which is equivalent to $960,000 per year.
Gross Potential Income on a Monthly Basis
100 units x $800 each = $80,000 per month
Annual Maximum Gross Income Potential
$80,000 per month x 12 months = $960,000 per year
But it's pretty obvious that you won't be receiving a check for $960,000, despite how nice it would be if you did. This is due, in part, to the fact that the aforementioned figure represents the gross POTENTIAL income. That indicates that the aforementioned amount is the total income under the assumption that all of the units were rented out at the going rate for rent and there were no concessions offered (for instance, "the first month's rent is free!").
Net Rental Income
You can calculate your net rental income by subtracting vacancy charges, loss to lease, and concessions from gross rental income. For the sake of simplicity, let's just take into account the vacancy cost and see what the results are. Supposing that 10% of the units, or 10 of them, are unoccupied, what does this mean? Because of this, your monthly vacancy cost is $8,000, even if each of these apartments rents for only $800.
Cost Per Month For Vacancy
10 units x $800 each = $8,000 vacancy cost per month
If we assume that the vacancy rate would remain the same during the course of the year, the yearly cost of vacancy will amount to $96,000.
Net Rental Income
$960,000 gross potential income – ($8,000 vacancy cost x 12 months) = $864,000 net rental income
Operating Expenses
Apartment complexes have costs just like any other type of commercial enterprise does.
Maintenance and repairs, fees for property management, fees for cleaning, landscaping, utility bills, legal fees, insurance, pest control, payroll, and other costs are included in operating expenses.
Each company is unique, and thus, so is each apartment, which means that the costs associated with each will be different.
Let's imagine that the whole expected monthly operating expenses come out to a total of $38,000. Let's assume that operational expenses will amount to $38,000 per month, or $456,000 per year, for the time being, but it is the responsibility of the sponsor team and the asset management to find ways to reduce those costs over time.
Annual Operating Expenses
$38,000 monthly operating expenses x 12 months = $456,000 annual operating expenses
After deducting these costs, you will have arrived at the net operating income, which is also abbreviated as the NOI.
Net Operating Income (NOI)
$864,000 net rental income – $456,000 operating expenses = $408,000 NOI
Mortgage
If we fail to take into account the amount of money that must be paid back to the lender on a monthly basis, the lender may become irritable and even threaten to foreclose on the property. Never good.
When purchasing an apartment complex, the down payment is often around 30% of the total purchase price, and the remaining balance is provided by the lender. You would be required to make repayments to the lender on a monthly basis, which would include both the principal and the interest on the loan.
Let's imagine that the total amount of principal and interest that we pay each month is $30,000. Because of this, our monthly mortgage payments would amount to $360,000 annually.
Annual Mortgage Payments
$30,000 monthly mortgage x 12 months = $360,000 annual mortgage payments
Cash Flow / Cash on Cash Returns
After deducting all of the costs from the income, we have arrived at our cash flow projections for the first year (aka, cash on cash returns).
Note that I say "for the first year," because many elements will shift and alter in the following years as the sponsor team strives to optimize and develop the property.
First Year Total Cash Flow
$408,000 NOI – $360,000 mortgage = $48,000 first year total cash flow
After then, the sum is partitioned in accordance with the framework for the transaction that had been previously agreed upon. Imagine for a moment that the structure of this contract is a 70/30 split. That is to say, seventy percent of the revenues are distributed to the passive investors (also known as limited partners), while thirty percent are distributed to the sponsor team (i.e., the general partners).
First Year Cash Flow to Investors
$48,000 first year cash flow x 70% = $33,600 first year cash flow to the passive investors
Granted, the cashflow might not seem much, however, it is important to understand that the most common business strategy carried out by syndicators is the Value-Add strategy. While the Value-Add strategy might not generate much cash flow in the first few years, after successfully raising the NOI of the property, the upside at the sale of property will be enormous. For most of the cases, investors will get the majority of their return after the property is sold at a higher price than the price it was originally acquired for.
Expecting The Delivery Of Your Cash Flow Distribution Four Times a Year
Going back to the example we’ve illustrated above, out of the $33,600 first year cash flow dedicated for LP share, you would receive a share of that cash flow once per quarter in the form of a distribution check or it could be wired to your desired account, in the amount of which would be proportional to the amount that you put in the project.
Apartment complexes are not static structures but rather living, breathing beings. To some extent, yes. At least there are people living and breathing in the rental units. As a result of this, the actual computations take into account a TON of different variables, and these predictions are nothing more than that. Projections. Having said that, such forecasts are an excellent method for evaluating the prospective returns on your assets, as well as for seeing precisely where each dollar of your investment is going and where each dollar of projected cash flow is coming from.
Conclusion
So that wraps up our discussion. The rent that the tenants pay is the source of the monthly cash flow that is sent into your bank account. After taking into account the expenses, the mortgage, the taxes, and the insurance, we have money left over to distribute to the owners and investors. Now that you have a better understanding of where the cash flow in a real estate syndication comes from, you should now understand the importance of having a positive cash flow from the apartment syndication deal you’ve invested in. As a result, you will be able to make wiser decisions regarding your investments as a result of this newfound knowledge.
WE'RE HONORED TO BE IN BUSINESS WITH YOU
Building wealth doesn’t always require you to do all the work you normally would as an independent real estate owner/investor. You can also accomplish the same goal by taking advantage of a syndicated real estate project.
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