Are you considering investing in a real estate syndication but are leery that it sounds a little too good to be true? You’re not alone.

Many investors are shocked when they first learn about the potential cash flow returns they could receive through investing passively in real estate syndications.

The key, though, to putting your doubts and skepticism to rest, is to understand where that cash flow comes from and how it makes its way from the asset itself to your pocket, and that’s exactly what we’ll cover in this article.

Cash Flow Distributions

Typically, within two or three quarters after closing, you can expect to start seeing quarterly or monthly cash flow distributions – your new stream of passive income!

But how is it that these investments are so lucrative? Where does the money really come from? 

Where Cash Flow Comes From

Every investment property, no matter the size or number of tenants, is an asset that generates income as well as expenses. Let’s talk about how apartment complexes generate income, the expenses they typically incur, and how cash flow is calculated.

Gross Potential Income

In the case of an apartment building, the main source of income is the tenants’ rent that’s due each month.

As an example, let’s say the average rent in a 100-unit building is $800. That means the gross potential income is $80,000 per month, which comes out to $960,000 per year.

Monthly Gross Potential Income

100 units x $800 each = $80,000 per month

Annual Gross Potential Income

$80,000 per month x 12 months = $960,000 per year

Now, don’t get too excited. I hate to break it to you, but that $960,000 is the gross POTENTIAL income for the whole complex assuming 0% vacancy and full rent payments with no expenses, deals, or discounts (e.g., “first month’s rent free!”).

Net Rental Income

Vacancy costs (illustrated below), loss-to-lease (rent actually charged is less than the gross potential rent, eg, there is a $40 loss to lease if the unit is rented for $760 instead of $800), and concessions (discounts) decrease the potential income and together are called economic vacancy. Once economic vacancy is subtracted from the gross potential income, you’re left with something called net rental income.

Vacancy Cost

This is typically the largest adjustment to get from GPI to NRI. Assuming only 10% of the units are vacant (i.e., in a 100 apartment complex, only 10 are empty), at $800 a month, the monthly vacancy cost would be $8,000:

10 units vacant x $800 in lost rent per unit = $8,000 vacancy cost per month

If the vacancy rate remains constant throughout the year, the annual vacancy cost would be $96,000.

$8,000 per month x 12 months = $96,000 per year

Net Rental Income

Remember, to get the net rental income, we must take the gross potential income (the total income if all units were filled) and subtract out the vacancy cost (as well as the loss to lease and concessions).

$960,000 annual gross potential income – $96,000 annual vacancy cost – $19,200 (loss to lease and concessions) = $844,800 annual net rental income

Operating Expenses

Don’t forget, there are business expenses too.

Operating expenses like maintenance, repairs, property management, cleaning, landscaping, utilities, legal and bank fees, pest control, etc. have to be paid. No two apartment buildings have the same needs or the same expense structure. We target these to be 50% or less of the Net Rental Income.

Let’s presume that total projected monthly operating expenses equal $38,000, which works out to $456,000 per year. The sponsor team would work toward reducing these expenses over time, but we’ll use this figure as a starting point.

Annual Operating Expenses

$38,000 monthly operating expenses x 12 months = $456,000 annual operating expenses

Net Operating Income (NOI)

NOI or Net Operating Income is what’s left from the net rental income after operating expenses are removed.

$844,800 net rental income – $456,000 operating expenses = $388,800 NOI

If you’re a little confused at this point it’s okay! There are a lot of numbers here. The important thing to remember is that you want the NOI to be a positive number and as high as possible, meaning that the asset has the potential to generate a profit and thus create those cash flow distributions that got you into this in the first place.

Mortgage

Next, let’s talk about the mortgage. As with any property purchase, you’ve got to pay the lender back. Much like in a single-family home purchase, a loan on a commercial property consists of a down payment and a loan amount – usually around 25% down and 75% leveraged – and the loan would need to be paid back through monthly principal and interest payments.

In this case, let’s say the group owes $20,000 each month (which is $240,000 per year) in mortgage payments.

Annual Mortgage Payments

$20,000 monthly mortgage x 12 months = $240,000 annual mortgage payments

Cash Flow / Cash on Cash Returns

Now that we’ve subtracted the expenses from the income, we arrive at our cash flow for the first year.
Keep in mind that a number of factors can change in subsequent years as the sponsor team optimizes the property and its expenses, so the cash flow figures tend to increase over time, though this is not guaranteed.

First-Year Total Cash Flow

$388,800 NOI – $240,000 mortgage = $148,800 first-year total cash flow

This amount is then split up, according to the agreed-upon structure for the deal. Assuming this deal uses an 80/20 deal structure, 80% of the profits go to the investors (i.e., the limited partners), and 20% goes to the sponsor team (i.e., the general partners).

First Year Cash Flow to Investors

$148,800 first-year cash flow x 80% = $119,040 first-year cash flow to investors

Depending on your level of investment, you would get a share of that cash flow each month, in the form of a distribution check or direct deposit.

Your Quarterly Cash Flow Distribution Checks

If you’d invested $100,000 into this deal, you might expect a $1800 check each quarter, which works out to $7,200 for the year.

Recap

So there you have it. The cash flow that arrives in your bank account each month originates from the rent that the tenants pay. Then, we deduct the expenses, pay the mortgage, taxes, and insurance, and what’s left over is then divided and shared with investors.

Is this passive income guaranteed? Absolutely not.

Considering all the variables – location, team members, tenants, economy, and MUCH more – it’s important to keep in mind that these are, although useful numbers, just estimates. Projections are fun to track but should never be taken as absolute truth.

However, now that you have a better understanding of where the cash flow in a real estate syndication comes from, you should be able to more thoroughly understand and vet the figures you see in the pro forma and investment summary, which will lead you to make wiser investing decisions.

Do you want to know more about how you can take advantage of the cashflow and huge potential returns from investing in real estate syndications? Click this link to schedule a call to discuss your investment goals. Or, maybe you are already in the business of passive real estate investing, but you want to raise your game even further. If so, sign up for the GrowAbility Equity Club to ensure you can access our real estate opportunities as they become available. Until next time, keep growing your ability to accelerate your wealth-building!