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 it’s going to be a dressy but casual summer outdoor evening affair, so you know 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 start researching potential investments and are deep in the weeds trying to decide whether a rental property or other real estate investment properties are right for you, it can sometimes feel like you’re browsing – no, lost in Target – without a particular agenda in mind.
You’ll likely come across many options for generating rental income, like single-family rentals, duplexes, and triplexes. You’ll also find real estate investment funds and REITs. And, if you look at larger properties, if you’re lucky, you might discover something called real estate syndications. What to do? Who to trust? Where to go? Oh no!
Weighing The Odds Whether to Invest in Rental Property
Soon your head feels like it’s spinning. At the same time, your brain tries to weigh the benefits of annual rental income versus taking on additional mortgage payments and the liability exposure you’d assume weighed against the diversified real estate portfolio filled with investment properties you’ve always wanted. It already sounds overwhelming, right?
Just like in the shopping example above, you’ve got to go into real estate investments with your end goal 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 share that you’re interested in investing passively in real estate, don’t be surprised to find an inbox full of potential rentals, fund announcements, and real estate syndication opportunities.
It can be easy to start browsing aimlessly and to get lost in these emails and the associated real estate investment summaries, which can often be over 50 pages long, with details of the property’s net operating income, the down payment, operating expenses, rental income, and annual cash flow.
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.
What Is An Investment Opportunity?
If you were to pursue a residential rental property on your own, you’d generally refer to that property simply as a residential rental, a single-family rental property, or a small real estate investment. Sure, it’s an investment opportunity for you with potential rental income, but it wouldn’t typically be referred to online or in emails as an “opportunity.”
More often, “investment opportunities” are offered by larger investment firms that manage assets on a much larger scale. You might be offered the option to invest in a real estate fund, REIT, or syndication as a passive (limited liability) investor while an experienced management team handles the asset, operating costs, tenant and property management, and takes on the majority of the risk associated with handling the multi-million dollar asset.
As an example, Goodegg Investments offers investors the opportunity to invest in multifamily and hotel assets passively in exchange for tax benefits and quarterly cash on cash return. By pooling the total cash invested into an investment opportunity, we can all generate returns that wouldn’t be possible individually.
These real estate deals (called commercial real estate syndications) aren’t allowed to be publicly advertised, and investors must qualify to invest. Therefore, syndication and fund investment opportunities are more likely to be discussed in forums, at conferences, and on private emails and Zoom calls.
Investment Opportunity for 50K: Real Estate Syndication or Rental Property?
Rental real estate properties are undoubtedly a great way to make money and build wealth. Still, you need to double-check that the investment vehicle you chose is right for you, whether you’re looking at real estate syndications, traditional rental property, or real estate investment trusts (REITs).
Let’s pretend you have 50K to invest and you’re just looking for the right deal. Should you pursue rental income and use the cash as a down payment on a residential single-family or duplex home? Or would it be better to invest as a limited partner in a multifamily syndication?
On one hand, perhaps you can find a 200K single-family home for sale, put 40K (20%) as the down payment, and keep 10K in reserves for repairs, maintenance, and, in a pinch, to make a few mortgage payments. Your insurance, mortgage payment, and property taxes come out to about $1,800 per month and you manage to find renters who agree to pay $2,300 in monthly rent. Sweet deal!
You’re looking at $500/month in cash flow provided no repairs or surprise costs come your way. This isn’t typical, but hey, we can dream, right?
On the downside, you also take on all debt and liability associated with owning this new property plus all responsibility for property and tenant management. Ugh.
Real Estate Syndication:
On the other hand, perhaps you find out about a multifamily syndication deal with a total investment of 50K upfront. Meanwhile, you take on no debt, never have to deal with a tenant or contractor, aren’t responsible for any insurance, tax filings (for the asset), or bookkeeping, and you still get cash distributions like clockwork every quarter.
According to the PPM (private placement memorandum) you signed and the sponsors’ projections, you can anticipate annual returns of about 8%, a share of the profits once the property is sold, plus your initial investment capital back in about 5 years.
Over the 5 year illiquid hold period, you earn about $1,000 every quarter. Then when the sponsors sell the multifamily investment property for a profit, let’s say your cut is about $30,000. Plus you receive your initial investment of $50,000 back. All with no responsibility toward managing the property, tenants, contractors, or brokers.
So, which would you do?
Well, it all goes back to your personal goals with your finances. Use the financial calculator all you want, fuss over how much profit each option might garnish, but if you wouldn’t be happy with either a hands-on or hands-off investment, then that particular option just isn’t for you.
Average Yearly ROI Calculation
Real estate investors who want to diversify their investment portfolio may choose to measure their rental income return on investment to determine whether an opportunity is profitable or not. Your return on investment is a percentage that measures the profitability of your rental property based on how much income it generates versus the costs to maintain.
Several different factors affect ROI, such as the property type, how much rental income you make, purchase price, total operating expenses, and property taxes. Some property owners include their home equity in the equation, which is the market value of a property minus what’s owed on the mortgage.
Here’s the formula for calculating ROI:
ROI = (Final Value of Investment – Initial Cost of Investment) / Total Cost of Investment
For the purposes of this article, let’s pretend your ultimate desire is to invest as a completely hands-off investor, with no obligations to ever fix holes in walls or deal with tenants, and that your qualifiers are steady returns, limited liability, and tax benefits.
This rules out a rental property because even with a property management firm on board, you’re still ultimately responsible for the repair and maintenance costs and tenants. So, real estate syndications look like a pretty sweet investment based on those factors alone.
The First Glance for Passive Real Estate Investors
When you receive a new deal alert email for a real estate syndication, it can sometimes feel like a surprise gift has just been dropped under your Christmas tree. You didn’t know it was coming, but if you’re keen to start real estate investing, 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
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
Understanding the Options
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, a different type of investment property, 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. Serious real estate investors aim to be strategic about where they have cash invested.
If so, pass! Don’t spend another minute hemming and hawing over this deal.
If the investment property isn’t 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 – plenty of investment properties are out there.
But, if the deal meets all your criteria at first glance, it’s time to dig in.
Real Estate Syndication Investments: The Numbers
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, and what’s the total investment?
Almost all deal alert emails will give you a high-level idea of the return on investment (ROI) 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
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? How do you calculate ROI? 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 intimidating and not very forthcoming with exactly what they mean for your individual real estate investments.
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). *note that’s the same as $1,000 every quarter like we talked about earlier
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 typical for most 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 project’s lifecycle.
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.
How to Calculate the Rate of Return on a Real Estate Investment Opportunity
The last number I look at when reviewing a new deal alert or comparing it to similar real estate investments are the average annual return.
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 and 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 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 submitting a soft reserve with the amount you might want to invest). This will give you more time to review all the materials on rental properties or real estate syndications in more depth.
Understanding Your Average Yearly Return on Investment for Real Estate Investors
It can be exciting, yet sometimes overwhelming, to get a deal alert email announcing a new real estate syndication investment opportunity or rental property with an attractive purchase price.
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 purchase price funds will be ready in time, or you’re hesitant about paying cash.
Whatever your situation, it’s important to know exactly what you’re looking for going into an investment property deal 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 decipher investment opportunities, navigate calculating ROI, and wade through deal alert emails to find your next best investment opportunity.