You’re ready to diversify away from the stock market or get your nest egg working harder and growing faster so you can get back more time to enjoy those after-school soccer games. You know it’s possible through passive real estate investing.
But it’s all just so confusing.
What does the preferred return have to do with equity multiple? Why are there so many ways to express return on investment? And who is the operator exactly?
Well, you’re not alone.
Investing in a real estate syndication can be night and day from investing in a rental property, and taking the time to learn the lingo of passive real estate investing will launch your confidence when selecting investments and understanding how your money is growing. Before you can determine if a deal is right for you, you need to understand what all the words mean inside that deal.
Real estate investing terminology is a great place to start when beginning your journey into passive investing. It’s also a great place to come back to when you need a refresher on how terms relate to each other and what it all means for your investing decisions.
This article is meant to be both a resource and a reference. Whether you’ve invested in a rental property before or are new to real estate altogether, we’ve got you covered.
Below you’ll find real estate terms grouped together to better illustrate their meaning. Inside those groupings, terms are mostly listed alphabetically, except where it makes sense to group by topic instead. What can we say – we are educators at heart here, so it’s hard to ignore the dictionary format altogether.
Feel free to jump to the sections that sound the most relevant to your current situation. Perhaps you’re evaluating a hotel investment opportunity and need to know the specific language for that asset class. Or maybe you want to understand the numbers better, head over to the Projected Return Terms section.
Why Should You Understand Real Estate Terms?
It can seem boring to learn a bunch of real estate terms, but we promise – it’s well worth your time. The more time you spend educating yourself and learning the lingo, the more well-versed you’ll be in the world of syndications, which means you’ll be able to ask better questions and find stronger opportunities.
Below are 5 benefits of learning real estate investing terms. Remember, this is all in service of getting you confident and comfortable so that you can build wealth faster while doing good.
#1 Benefit: Be The Culinary Connoisseur of Investment
Think of understanding the jargon like being a gourmet chef. Each investment detail you comprehend is like a unique ingredient you understand down to its molecular level. And you’re not just randomly throwing ingredients into a pot.
You understand how the flavors combine, the subtle notes each detail brings, and how to balance them perfectly to cook up the most delicious investment decisions. You’re the Gordon Ramsay of real estate syndications, minus the shouting – the kitchen nightmares of the investment world stand no chance against you!
#2 Benefit: Speak The Lingo, Win the Bingo
Imagine walking into a party, knowing the language everyone’s speaking, and being able to dive right into the conversation. You’re not just repeating “umm, yeah” while secretly googling what a “capital call” means.
Instead, you’re firing off questions to real estate syndicators like a pro, nodding sagely at their answers, and maybe even impressing them with your insightful remarks. You’re the life of the investor party. No Google required.
#3 Benefit: Confidence? Check!
Have you ever gone to a foreign country without knowing the language and felt utterly lost? Now imagine, you’ve learned the language, and you’re traveling with your kids. You’re no longer a lost puppy but a confident momma-wolf, strutting down the streets and wowing her kids with ordering ice cream.
Knowing the jargon gives you a similar confidence boost. You’re not stumbling through the world of syndications like a newbie; instead, you’re cruising through it with the confidence of a seasoned pro.
#4 Benefit: Spotting the Gems and Dodging the Dirt
When you’re well-versed in syndication-speak, you’re like a prospector who’s got a nose for gold (or in this case, profitable investments). You see opportunities sparkling where others see gibberish, and you spot risks like they’re bright red flags at a bullfight.
You’re the Indiana Jones of the real estate investment world, finding treasures and avoiding traps.
#5 Benefit: Keeping Up with Real Estate Operators and Owners
Real estate lingo isn’t static; it evolves, much like fashion trends. What’s the investment equivalent of wearing flared jeans in a skinny jeans world? Probably not knowing the latest jargon.
But with your grip on the lingo, you’re always in style and on top of your game. You’re not just keeping up with the Kardashians; you’re keeping up with the General Partners (definition below).
Your Real Estate Terminology Guide
James The Chiropractor
To guide you through these real estate terms, we’re going to follow James, a successful chiropractor who’s been mastering the art of spinal adjustments for decades and has only recently started investing in real estate. He owns one rental property, but he’s looking to scale his real estate portfolio and doesn’t want to be a landlord.
As he contemplates selling his practice, he’s thinking more about how to deploy this large capital event. Looking to yield a hefty return on his sale, James is diving deep into understanding real estate syndications.
If they are a good fit, he’s thinking of also selling his rental property so he can be a fully passive investor, mainly because he’s tired of being a landlord, paying property taxes, and dealing with maintenance and repair issues.
We’ll follow James’s journey using an example of a multifamily real estate investment property that has gone full cycle called The Blakely, and one that is more recent and nearing the closing as of the publish date of this article, the Goodegg Wealth Fund II.
The Blakely Apartments Multifamily Investment Summary
Formerly known as Lamar Union, The Blakely was purchased at $18.8 million in December 2019 and sold at a whopping $28.1 million after a brief 36-month holding period. It was a remarkable tale of investment property success that piqued James’ curiosity, and he knew he had to understand the process and the terminology behind the numbers.
Goodegg Wealth Fund II Investment Opportunity Summary
Goodegg Wealth Fund II is a fund investment opportunity with multiple multifamily investment property assets set to be purchased inside the fund. We’ll reference the first asset of the fund, Encore Metro at Millenia in Orlando, FL. We’ll also look at how the fund is structured to better guide James through the process of understanding investing in real estate syndications and funds.
Let’s take a step back and walk alongside James as he familiarizes himself with the key terms and practices of real estate syndication, using The Blakely deal and the Goodegg Wealth Fund II as his real-world guide.
The People Behind A Commercial Real Estate Investment
James first wants to understand who is who as he looks over the Investment Summary documents, as well as how he as an investor would fit into the overall picture. He begins to see that many individuals or entities (like Goodegg Investments) wear multiple hats.
He starts to learn about the types of investors, as well as the different roles within a real estate syndication, such as the terms you’ll find below.
An accredited investor is someone who meets one of two financial criteria based on income or net worth that can participate in certain investment offerings (called securities). It is a proxy for ensuring that investors are financially savvy enough to understand the offering details.
The criteria to qualify as an accredited investor are set by the SEC and can change at any point. Currently, if you make over $200k/year ($300k jointly), have been at that threshold for the last 2 years, and expect to be making that amount for the next 2 years, you qualify as an accredited investor.
If you don’t meet the income threshold, you can also qualify as an accredited investor if your net worth (excluding your primary residence) is over $1 million.
The criteria to become accredited expanded recently to include a few other ways to achieve this illustrious status. Generally, if you have certain certifications, work for a company that offers securities, or can meet the income or net worth requirements with a “spousal equivalent” then you could qualify as accredited.
Most real estate investment opportunities will provide a way for you to submit your information to determine accreditation status. James knows that he’ll qualify as accredited since he is nearing the end of a successful career and has a substantial net worth that he’s looking to deploy into real estate investments.
A non-accredited investor is simply an individual who has not yet met the income or net worth requirements to be classified as accredited.
These investors are eligible to participate in certain investment offerings, including some 506(b) offerings and crowdfunding offerings, but they are not eligible to participate in 506(c) offerings, which are open to accredited investors only.
While James is accredited, he begins to think about his daughter, Adrianne, who is an early-career software engineer with her first child on the way.
James is beginning to see the value in real estate investments for their ongoing passive income and knows that she will soon be confronted with the decision to take a break from work to raise her child.
He likes the idea of real estate investment offerings being open to non-accredited investors, like Adrianne, to allow them to continue building their wealth and achieving accredited status while also stepping aside from a career path to prioritize family.
Further, because many crowdfunding offerings have low minimum investments, Adrianne would be able to invest just a few thousand dollars at a time, rather than the $50k or $100k minimums in many traditional real estate syndication offerings.
The capital stack is the rank or order of equity and debt in a real estate syndication. Another way to look at this is to see that each tier of the stack is a group of people, or an entity.
The highest priority capital (or ownership stake) and lowest risk sits toward the top of the capital stack, with the priority decreasing (and risk increasing) as you move down the stack. The different steps in this stack – like building blocks – are called Classes (i.e. Class A, B, or C).
Debt, or mortgage loan payments, sit at the top of the stack. This is a typical requirement from any bank offering a loan. From there, the Class A real estate investors with preferred equity come next. Other classes of limited partners follow and the Common Equity (general) Partners typically sit at the bottom in the lowest priority and highest risk place in the stack.
Where Do You Want To Sit In The Capital Stack?
Our friend James likes the idea of sitting closer to the top of that capital stack, in a class A position for example. He highly values a lower-risk position since he’ll be deploying the capital he’s spent his life’s work growing. He’s willing to accept a little less equity on the sale of each asset in exchange for being paid out first.
Looking back at the Blakely deal, he sees that only one position was open to investors.
However, in subsequent investment offerings on the Goodegg Deals webpage, he sees options for Class A, B, C, and D, such as the example below from the Goodegg Wealth Fund II. In this deal, he can also see the value in entering the capital stack in Class D, since he has a larger sum of money to invest and the equity multiple is highest.
The General Partners in a real estate syndication are also known as the operating partners and are sometimes called the sponsor. This is essentially the acquisition and management team of the deal. It may consist of multiple entities responsible for specific tasks in the deal, from raising the equity to overseeing property management and performing underwriting tasks.
General partners typically sit at the bottom of the capital stack, which means they are paid out last.
The limited partners in a real estate syndication are the passive real estate investors who come together to purchase an asset. This is you! You are a limited partner passive real estate investor. As you can probably guess, these members have limited liability but share in the profits of the asset.
This is the sweet spot role for passive real estate investors who want to leverage the power of real estate in their portfolios, but don’t want to spend their precious time as landlords.
The operators in a real estate syndication generally take responsibility for managing the acquisition of the asset and executing the business plan for each investment property. They often manage the property managers, keep an eye on any issues related to property taxes, and keep any value-add projects on schedule and budget.
The sponsor in a commercial real estate syndication investment is the person or entity signing on the dotted line for the loan. They are heavily involved in the underwriting and acquisition process. The operators are often also the sponsors, but these can be different individuals or entities.
Related Video: Real Estate Syndication Structures – Key Team Members
Reviewing The Investment Summary and Understanding A Real Estate Fund Offering
Now that James has a general understanding of who will be involved in the deals, he begins to dive into the investment summaries. Here he’ll begin to see things data and terms like the ones listed below.
Capitalization Rate (Cap Rate)
The cap rate is the rate of return on a real estate investment property based on the expected income the property will generate. The cap rate is used to estimate the investor’s potential return on his or her investment. This is done by dividing the net operating income the property generates by the total value of the property.
When acquiring an investment property, the higher the capitalization rate, the better. When selling an investment property, the lower the cap rate the better. A higher cap rate implies a lower price, a lower cap rate implies a higher price.
Cash flow is cash generated from the operations of an investment property and is generally defined as revenues less all operating expenses. A simplified example of this looks like this:
Revenue = Rents paid + parking fees collected – loss to concessions – loss to vacancy
Operating Expenses = Property management + contract services + property taxes
Revenue – Operating Expenses = Cash Flow
However, cash flow does not necessarily mean that amount will be distributed to investors. Cash flow may be dispersed to investors according to the capital stack and preferred return structure, or it may be held in a reserve fund to increase operational resiliency (for example, if a global pandemic is on the horizon). Jump down to the definition of Net Operating Income for another view of cash flow.
Debt Service Coverage Ratio (DSCR)
The debt service coverage ratio is the multiple of cash flow available to meet annual interest and principal payments on the debt, or mortgage loan. This ratio should ideally be over 1. That would mean the property is generating enough income to pay its debt obligations.
Real estate diversification means leveraging different types of asset classes, markets, and even investment classes within a capital stack to spread out risk and reach different goals. This could look like investing money in a hotel fund with assets in the midwest and a multifamily fund with assets in the southeast and Texas.
In this example, your investment is diversified in different markets, both in two different funds, but also within the assets inside those funds. You are also leveraging diversification in asset types with both hotels and multifamily properties in your portfolio.
Each of these differences, markets and asset classes, may respond differently if the market shifts in any way. If something happens to one of your investments, such as a hurricane, that may decrease distributions, but your impact will likely be minimized if your money is spread out (or diversified) across other investments simultaneously.
You may also choose to diversify your real estate investments within a single fund by placing some capital in Class A and some capital in Class B, for example. Class A typically has higher preferred returns, which can provide short-term cash flow.
Class B, on the other hand, may have a preferred return that is more likely to accrue in the early years of a value-add investment and be paid out at the end of the deal, along with the proceeds from the sale of the asset.
An Investment Summary is a marketing document similar to a vacation package brochure, only for embarking on a real estate investment journey rather than a cruise or trek. The real estate fund investment summary contains the business plan, underwriting analysis results, projected returns, description of investment classes, market overviews, and much, much more.
These documents can look beautiful, but to determine if an investment opportunity will meet your goals, you need to look beyond the fancy fonts and dig into the details.
Net Operating Income (NOI)
The Net Operating Income is a valuation tool for an income-producing commercial real estate property and is calculated by subtracting operating expenses from total income.
This calculation is really similar to cash flow, often even the same amount. The term NOI is also used in the calculation for determining the capitalization rate of a property.
Private Placement Memorandum (PPM)
The PPM is a legal document, and a hefty one, that is presented to investors when selling a security. The Security and Exchange Commission (SEC) requires this document when a security falls under an exemption, like Regulation…
The document is meant to fully disclose key elements of the sponsorship team and any risks associated with the investment. You’ll also find sections that outline what is expected from investors, any fees earned, and a general description of the property.
Some people also call the PPM the Offering Memorandum.
The pro forma in a real estate investment is another word for budget. This is the breakdown of income and expenses that will show the net operating income and the potential cash flow on a property. This is a look ahead, at what could be the sources for cash flow in the future.
James sees the NOI calculated for the Encore Metro at Millenia property inside the Goodegg Wealth Fund II as a breakdown of both income and expenses. He sees that these numbers are found inside the Pro Forma.
A value-add real estate investment is one where improvements will be made to increase the value of the property over the life of the hold period. Many investors have heard of a fix-and-flip real estate investment where an owner renovates some (or all) of a home, often adding beautiful features and upgraded amenities. Then, they can sell it and make a substantial profit.
This is the way value-add investments work for multifamily real estate investments as well, except on a much bigger scale. Owners and managers work to improve the common areas of a property and exterior, as well as on individual units. With a more modernized appeal and additional amenities, rents can be raised. This increases the NOI, which in turn will increase the sale price.
A value-add investment may require more capital in the early stages when renovations and improvements are being made. This may reduce distributions, initiating the accrual of preferred returns. We describe how accruals work in real estate syndications below in more detail.
James can tell that The Blakely was a value-add opportunity based on the capital expenditure budget provided in the investment summary.
It details a value-add business plan that will invest $10k for each unit in interior upgrades, such as stainless steel appliances or new countertops, in order to increase the property income and hence the overall property value. There are even photos provided for the “next generation” style of renovations planned.
Projected Returns: The Metrics That Mean Money
James wants to know how much he stands to make if he were to invest his money in a real estate syndication. We can’t blame him; it’s a big reason we love passive real estate investing so much.
He’s worked hard to grow his business and sell it for a large sum, and he wants his money to keep growing to create generational wealth and a comfortable retirement for himself and his wife.
James will look at the different ways that cash flow, distributions, and returns are presented in the investment summary.
The term accrual is used in real estate investing to refer to the distributions (or income) that are owed to investors, but will be paid out at a later date. For example, when a value-add project begins, there may be lower returns in the first year as units are renovated and rents begin to increase.
An investor may only receive 6% distributions, even though they have an 8% preferred return. That additional 2% will be returned to the investor as soon as the reserve account (or incoming cash flow) is enough to distribute. Sometimes this occurs during the next distribution cycle, sometimes it doesn’t occur until the sale of the asset.
Either way, the accrued income as part of a preferred return will be realized before other profits are paid out to those lower in the capital stack.
Average Annual Return (AAR)
The average annual return in a real estate investment is a percentage of the total profits earned divided by the total amount invested. This calculation does not include the return of invested capital.
The average annual return is the total return from the investment divided by the length of time your capital was invested. Average annual return takes into account both the cash-on-cash return during the length of the hold, as well as the profit from the sale of the asset.
For example, if you invested $100k over 5 years and received $30,000 in cash-on-cash returns over the 5 years, plus $50,000 upon the sale, your total return would be $80,000. When you divide this by 5 years, you get 16%, which would be your average annual return.
Cash-on-Cash Return (CoC)
The cash-on-cash return is the annual income divided by the total equity invested. It is a rate of return metric often used in real estate transactions. The calculation for cash-on-cash return determines the cash income on the cash invested. It is a quick and dirty way to compare how much you stand to make by investing in a deal.
The equity multiple (EQM) is the best metric to estimate the total return of a real estate syndication investment opportunity. It shows how much total money is returned to an investor.
For instance, if you make a $500k investment and receive a 2x multiple, that means you get your $500k back as well as $500k in total returns (distributions + proceeds from sale). The total you receive is $1M (which is 2x your initial $500k investment).
James, like many of our investors, like the wholistic simplicity of the equity multiple metric. When paired with the hold period (or a length of time), an equity multiple gives a clear picture of how much money James could make by investing passively in a real estate syndication.
Internal Rate of Return (IRR)
The internal rate of return, or IRR, helps investors better understand the return they receive when they factor in the amount of time it took to receive that return. The actual formula is fairly daunting, but the concept is easier to grasp.
When we factor in the amount of time that your investment has been working for you, it is easier to compare different deals. An 8% ROI on an investment that took 7 years to realize just isn’t as exciting as an 8% ROI on a 3-year investment.
The preferred return for an investor is the percentage of the asset’s return, or income received, that will be paid before any other income is distributed to other tiers within the capital stack. Preferred return is paid first. That’s most important.
Once everyone receives their preferred return distributions (even if that income is accrued and distributed at a later date), and initial capital is returned, then ownership percentages dictate who receives the income. To understand when you’ll get paid out, you’ll want to know where you sit in the capital stack and then reference the section that describes the plan of distribution within your PPM (Private Placement Memorandum, see below for definition).
Return on Equity (ROE)
This is another way to understand how hard your money is working for you. The Return on Equity (ROE) is the amount of net income returned as a percentage of shareholders equity. ROE is expressed as a percentage and calculated as: Return on Equity = Net Income/ Shareholder’s Equity.
Comparing Return Projections With Realized Returns
Since The Blakely has gone full cycle (meaning it has been purchased, the business plan has been executed, and the asset has been sold), James can compare what the projections for performance looked like compared to the returns realized by investors in the deal.
This is why reviewing the track record and case studies of exited deals can be so helpful for vetting potential sponsors to invest alongside. You can see if they measured up to their projections, both in terms of projected investor returns, as well as whether they delivered on the business plan and achieved the target increase in property value.
James is excited to see these numbers.
He sees that for The Blakely, investors saw a 24.1% average annual return when the deal was only projected to produce an 18.9% average annual return. He also sees a 2.12x equity multiple (annualized over 5-years), which means that capital was more than doubled.
Performing Due Diligence – Property Management and Underwriting Lingo
Concessions in multifamily real estate investments are any reduction in rent or other benefit (such as first month free) provided to a tenant or buyer as an inducement to sign a lease. Since this is lost income to a property, it should be quantified in any underwriting scenario.
This real estate term covers the dollar amount of rent that hasn’t been paid by residents who are physically occupying units. This is essentially back-rent that is owed. Property managers are very aware of this number as they must work with tenants to collect monies owed or seek court judgements in the eviction process.
Loss to Lease
Loss to lease is an income amount that is lost due to in-place leases or new leases signed that are below the market rent price for the property. Ideally, the business plan includes initiatives to get this number down to zero.
Expressed as a percentage, the occupancy of a real estate property is the percentage of units (either apartments or hotel rooms) occupied for a given period of time.
Taxes and Real Estate Investing
Being a high-income earner, James has had to pay his share of higher taxes over the course of his career. He’s heard that real estate investing can have tax advantages and that he should think about REPS (real estate professional status), but he doesn’t know how any of it works.
The illustrious 1031 exchange is a process that deferred capital gains taxes by swapping one real estate investment property for another one. Investors love this idea and for good reason. It is a fantastic way to build wealth and execute significant tax advantages.
It can also get complicated, particularly when investing in a real estate fund or syndication. If you’re considering leveraging this little bit of tax code to grow your nest egg, consult with a real estate CPA or tax strategist to understand the process better.
James can see that most deals, including The Blakely apartments, are not eligible for 1031 exchanges. He sees that most people leverage this tax strategy when selling and buying properties that they 100% own (instead of with a group in a fund model).
Can You 1031 Into A Real Estate Syndication?
As James thinks about his own rental property, he realizes that he could pursue a 1031 exchange for that rental property, but he would need to 1031 into another rental property or similar asset. Unfortunately, he would not be able to 1031 the proceeds from the rental property directly into a syndication, since title would need to be held in the same name for the relinquished and replacement properties.
Since each asset in a syndication is purchased with an LLC or entity specifically created for that purpose, the title for his rental property would not match, and thus the rental property would not be eligible for 1031 directly into a syndication.
A cost segregation study is typically conducted during the acquisition of a real estate asset, to determine the potential for accelerated and bonus depreciation. All components of a property are itemized (from office printers to wall outlets) and assigned a unique lifespan. Depreciation can then be accelerated based on shorter lifespans.
For example, the cost segregation report might show that the flooring could be depreciated on a 7-year schedule, the lighting on a 10-year schedule, and so forth. As such, a higher portion of the total depreciation can be taken in the first few years after acquisition, which can greatly benefit both the investors and the property itself.
Most real estate assets are depreciated over a set period of time. This means that the cost of buying and improving the property are deducted and spread across the hold period, which reduces each year’s tax bill.
As a passive investor, you are a partial property owner of the underlying real estate asset, and as such, you share in a portion of the depreciation benefits. Each year, you will receive a Schedule K-1 tax form that will show you your portion of the income and losses for the property.
Hint: Higher paper losses are a good thing, and one of the main reasons many people love investing in real estate! Those paper losses largely come as a result of the accelerated depreciation.
Keep in mind, though, that the rules regarding depreciation are always subject to change, so it’s important to talk to your CPA about your unique tax situation.
Of course, the IRS still collects tax on the real estate gains when you sell that asset. This is where depreciation recapture comes into the equation.
Hotel Investment Asset Class Terminology
The term keys is the hotel investing industry term for rooms. Number of keys is the number of rooms.
ADR (Average Daily Rate)
This metric is used in the hospitality industry to quantify average income earned for an occupied room. It is calculated by dividing the number of rooms occupied by the total room revenue.
RevPAR (Revenue Per Available Room)
This is another metric used to evaluate a hotel investment opportunity. RevPAR breaks down revenue per available room and is calculated by taking the average daily room rate (ADR) and multiplying it by the occupancy rate.
PIP (Property Improvement Plan)
As a portion of the business plan, the PIP is an action plan designed to bring a hotel into compliance with the latest brand standards, with the goals of (1) helping brands maintain a consistent guest experience across properties and (2) improving the profitability of the property for the owners. It is a little bit like the plan to add value to a multifamily property.
Here at Goodegg Investments, we have a variety of options for you to help you learn about and invest in real estate so you can take advantage of the cash flow, equity, appreciation, and tax benefits. If you are looking to become a passive real estate investor, you’ll find a few resources below to get you started.
If you’re accredited and ready to invest right now, we invite you to check out our open deals page to learn more about our current or upcoming opportunities.
If you’re not yet ready to invest but are curious about how all of this works, we invite you to dip your toe in the water with us through our free 7-day email course – Passive Real Estate Investing 101 – or to get a free hardcover copy of our book – Investing For Good.