Have you ever gone to Target without a clear purpose for what you want to buy? You grab a cart because, hey, you might need it. You browse the clothing section and find some new tops you didn’t know you needed. Then you find some cute new towels and bathroom accessories you just can’t do without. By the time you hit the checkout lane, your cart has somehow filled up, and you don’t know exactly how it happened.
Contrast this with when you’re shopping for a specific occasion, like a wedding. You know that it’s going to be a dressy but casual summer outdoor evening affair, so you know that you want something sleeveless and flowy but with a cute little sweater to layer on top in case it gets breezy. It takes a while, but you find exactly what you need.
When you first start out researching passive investing through real estate syndications, it can sometimes feel like you’re browsing, with no particular agenda in mind.
“Ooh, this deal looks nice. Maybe I’ll try this one on for size…”
But, you should aim to get to the latter example, where you’re investing with a very specific goal in mind.
Once you start letting people know that you’re interested in investing passively in real estate syndications, you will start to receive email alerts every time a new investment opportunity opens up.
It can be easy to start browsing aimlessly and to get lost in these emails and the associated investment summaries, which can often be over 50 pages long.
But who the heck has time for that?
You should be able to decide within 5 minutes of opening an email for a new investment opportunity whether the deal meets your investing goals and whether you want to move forward with the investment, and that’s exactly what we’ll walk through in this article.
The First Glance
When you receive a new deal alert email, it can sometimes feel like a surprise gift has just been dropped under your Christmas tree. You didn’t know it was coming, but you’re excited to rip the wrapping paper to shreds and see what’s inside.
Typically, a new deal alert email will give you a few very important pieces of information. Among these data points, there are a few that you should pick out on your first glance through the email:
- Type of asset
- Hold time
- Minimum investment
- Deadline for funding
The first time you open up a new deal alert email, just aim to extract these key pieces of information. Don’t get lost in the weeds of the projected returns or the business plan just yet. Those will come later. Just figure out if, at a high level, this investment meets your investing goals and if you’re actually able to invest in this deal.
For example, you might receive a deal alert and gather this information:
- Type of asset: B-class multifamily
- Market: Dallas, TX
- Hold time: 5 years
- Minimum investment: $50,000
- Deadline for funding: 3 weeks from now
Once you take stock of this information, you might realize that, although this is the asset class and market you wanted to invest in, you were looking for a longer projected hold time, or more of an emerging market. Or perhaps you’re not able to get your funds ready before the deadline to wire in your funds.
If so, pass! Don’t spend another minute hemming and hawing over this deal.
If it’s not going to work for you, move on. You’ve just saved yourself hours of reading through and analyzing all the data in the investment summary.
If the investment doesn’t meet your investing goals, or you’re not able to invest in this deal, don’t worry. Another deal will likely open up soon.
But, if the deal does meet all of your criteria at first glance, it’s time to dig in.
Now that you know you’re able to invest in this deal and that it meets your investing goals, it’s time to dig into the numbers. If you were to invest in this deal, how much money could you stand to gain?
Almost all deal alert emails will give you a high-level idea of the returns you can expect from investing in the deal.
For example, you might see something like this:
- 8% preferred return
- 9% average cash-on-cash return
- 17% IRR
- 20% average annual return including sale
- 2.0x equity multiple
- $50,000 minimum investment
- 5-year hold time
The problem is, what in the world do all those percentages mean for you and your money? And are they good, compared with other deals?
Don’t worry, with time and practice, you’ll be able to skim through those figures and know exactly what they mean and how much you can expect if you were to invest.
But, let’s assume that this is the first time you’re looking at these numbers. They can be quite intimidating, and also not very forthcoming with exactly what they mean for your individual investment.
Preferred Return & Cash-on-Cash Return
Let’s start at the top with the preferred return, which is a common way for deals to be structured. An 8% preferred return means that, for the first 8% of the returns, those go 100% to you, the limited partner passive investors. The sponsors don’t get any of that first 8%.
What this means for you is that, if you were to invest the minimum $50,000, assuming everything goes according to plan, you should expect to see about 8% of that $50,000 every year.
In other words, if the investment paid out monthly cash flow distributions, you should expect to receive $4,000 per year ($50,000 x 8% preferred return), which would be paid out to you in monthly checks of $333.33 ( $4,000 / 12 months).
If you were to invest $50,000 in this deal, you should expect monthly cash flow distributions of about $333.
Given that the average cash-on-cash return is 9% (which is higher than the 8% preferred return), that means that this deal is projected to pay out above that 8% during part of the hold time, but you can dig into that later when reviewing the full investment summary.
For now, you’ve got a basic benchmark of $333 in monthly cash flow based on that 8% preferred return, which is pretty typically for most of the deals we do.
The next thing that I typically jump to is the equity multiple. At a glance, the equity multiple tells you how much your investment will grow during the lifecycle of the project.
For example, if you were to invest $50,000 into a deal with a 2x equity multiple, you would end up with twice your original investment, or $100,000, once the asset is sold (this is when adding up all the cash flow distributions, as well as the profits from the sale).
Side note: We typically aim for an equity multiple between 1.75x and 2x over a 5-year hold period, so you can use that as your benchmark starting out.
Average Annual Return & IRR
These are the last two numbers I look at when reviewing a new deal alert.
The average annual return tells you the returns you can expect, averaged over the hold time. If you were to invest $50,000 and doubled that to $100,000 in 5 years, that means the total returns would be 100% of your original investment.
Given that, your average annual return would be 20% (100% or your original investment / 5 years).
The IRR, or the internal rate of return, takes the average annual return and adjusts for the time delay. In other words, because there’s a hold period of 5 years, you’re not getting all of your returns at once. The time delay has a cost that comes with it, since you’re not able to earn interest on those returns or invest them elsewhere. The IRR takes that time delay into account.
Side note: We typically aim for an average annual return of around 16-20% and an IRR of at least 14%.
Once you’ve reviewed the high level investment highlights, as well as the numbers, it’s time to make a quick decision.
Remember, this isn’t the full decision of whether or not to actually wire your money in right this instant. This is the decision of whether or not it’s worth your time and energy to continue down the path of researching and vetting this opportunity to see if it is indeed something you want to invest in for the next 5 or so years.
Based on the information you’ve gathered about the asset class, market, and the numbers, decide whether this investment opportunity meets your investing goals. If so, let the sponsor know that you’re interested (either by requesting the full investment summary or by submitting a soft reserve with the amount you might want to invest). This will then give you more time to review all the materials in more depth.
It can be exciting, yet sometimes overwhelming, to get a deal alert email announcing a new real estate syndication investment opportunity.
Maybe you’ve had your funds ready for several weeks now, and you’re ready to pounce on the next deal. Or perhaps you’re still scrambling to roll over your 401(k) into a self-directed IRA and aren’t sure whether the funds will be ready in time.
Whatever your situation, it’s important to know exactly what you’re looking for going in so you can make a quick decision and go on with your day without wasting too much time. If the deal meets your criteria, it’s important to know why it’s a good fit, and if it doesn’t meet your criteria, you can get back to your day.
Either way, knowing what you’re looking for will help you navigate these deal alert emails and find the best investment for you.