How To Evaluate The Projected Returns On A Real Estate Syndication Deal
The most common questions I field about real estate syndications have to do with the potential returns (i.e., cash flow and profits) from the investment. They’re often phrased similar to, “If I were to invest $50,000 with you today, what kinds of returns should I expect?”
I totally get it. You put in long hours for your money and in return, you want stability and a “low stress” way to generate wealth, responsibly. You want to know if real estate syndications are the real deal – if they are actually a great choice, how they can make your money work as hard as possible for you, and how passive real estate investing compares to your other investment vehicles.
Before we get started, you should first know that we will be talking about projected returns. That is, these returns are projections, based on our analyses, experience, and best guesses, but they aren’t guaranteed, and there’s always risk associated with any investment. The examples herein are only meant to provide some ballpark ideas to get you started.
In this article, let’s explore the 3 main criteria you should look into when evaluating projected returns on a potential real estate syndication deal:
- Projected hold time
- Projected cash-on-cash returns
- Projected profits at the sale
Projected Hold Time: ~5 Years
Projected hold time, perhaps the easiest concept, is the number of years we would hold the asset before selling it. This is the amount of time that your (and our) capital would be invested in the deal.
A hold time of around five years is beneficial for a few reasons:
- Plenty can change in just five years. You could start and complete a new professional certification, sell your practice, buy a practice, move, get married, or …you get the point. You need enough time to earn healthy returns, but not so much that your kids graduate before the sale.
- Considering market cycles, five years is a modest stint in which to invest, make improvements, allow appreciation, and exit before it’s time to remodel again.
- A five-year projected hold provides a buffer between the estimated sale and the typical seven-to-ten-year commercial loan term. If the market softens at the 5-year mark, we can opt to hold the asset for a longer period of time, allowing the market to rebound.
Projected Cash-on-Cash Returns: 7-8% Per Year
Next, consider cash-on-cash returns, otherwise known as cash flow or passive income. Cash-on-cash returns are what remain after vacancy costs, mortgage, and expenses. It’s the pot of money that gets distributed to investors.
If you invested $100,000, and earned eight percent per year, the projected cash flow would be about $8,000 per year or about $667 per month. That’s $40,000 over the five-year hold.
Just for kicks, notice the same value invested in a “high” interest savings account (earning 1%). That would return $1,000 a year and a measly $5,000 over a 5 year period.
That’s a difference of $35,000 over the span of 5 years!
Projected Profit Upon Sale: ~40-60%
Perhaps the largest puzzle piece is the projected profit upon sale. Typically, we aim for about 40-60% in profit at the sale in year 5.
In five years’ time, should the acquisition be a value-add investment, the units and property amenities will have been updated, tenant occupancy rates would be strong, and rent would accurately reflect market rates.
Since commercial property values are based on the amount of income generated, these improvements, along with market appreciation, typically lead to a substantial increase in the overall value of the asset, thus leading to sizable profits upon the sale.
Summing It All Up
Simple enough, right? Typically, we look for the following in a deal:
- 5-year hold
- 7-8% annual cash-on-cash returns
- 40-60% profits upon sale
Sticking with the previous example, you’d invest $100,000, hold for 5 years, collect $8,000 per year in cash flow distributions paid out monthly (a total of $40,000 over 5 years), and earn $60,000 in profit at the sale. Stocks and equities are great, but I’ve never seen any do this!
This results in $200,000 at the end of 5 years – $100,000 of your initial investment, and $100,000 in total returns. With this fast-paced path toward building wealth independent from your W2, I’m sure you can imagine how quickly you’ll be able to spend less time stressing about your billable hours and more time present to live life on your terms and be with the ones you love.
Again, these results are not guaranteed, and each real estate syndication deal is different, but this should give you a rough idea of what to expect and help paint a future you can be excited about.