This blog post will cover some of the basics of Multifamily Investing and demystify some of the terms used to set the stage for understanding the investment and how to perform your due diligence when you see an investment opportunity.
A. real estate syndication provides a way for investors to pool their financial resources to invest in properties much larger than they could afford on their own.
The illustration above highlights a typical multifamily syndication where the sponsorship team puts together the investment and the investors pool in their money with the sponsors to buy an apartment building. Some of the sponsors might also be a part of the investor pool as it’s important to look for investments where the sponsors have skin-in-the-game.
The sponsorship team is ideally comprised of a group of multifamily investors that have
- Established connections with Multifamily brokers and listings
- Experience with Commercial lenders – Taking Fannie Mae and Freddie Mac loans
- Operations and Asset management of Multifamily properties
- Knowledge of good property management companies and their track record
- Formulating and delivering on the business plan for the investment.
- Successful track record of previous multifamily investments
If you’re considering an investment in any real estate syndication of a commercial building like an apartment building some terms to be aware of:
T-12 (Trailing 12) – 12 months of Profit & Loss statement from the previous owner that the current buyer/sponsor uses to establish a baseline for income, bad debt, vacancy and expenses for the building.
Rent Rolls – Document detailing the current tenants – unit occupied monthly rent, security deposits, balance owed, late fees etcetera
Underwriting – You will hear this term often in syndications and if you are from the residential real estate world this is where your loan request is scrutinized by an “underwriter” to determine how much risk the lender is willing to accept. In commercial real estate syndicators sponsors underwrite and calculate their projections based on T-12 and Rent rolls we talked about before. They create what is called a proforma. This allows them to determine if the investment is a financially viable one both from a sponsor and investor perspective.
Proforma– The proforma includes the projections for rent and other income (late fees, laundry income), expenses, rent growth, expenses growth, economic vacancy, reversion/exit cap rate among other factors.
Most syndicated multifamily sponsors will present a 5-year proforma detailing some the assumptions and projections of how the investment is expected to perform. A typical 5 year pro forma looks like the illustration below
Highlighted in the pro forma illustration are some important considerations like projected rent growth, expense growth among others. Some of the important calculated parameters based on the assumptions above include DSCR (Debt service coverage ratio), net cashflow, % Cash on Cash return, purchase cap rate to highlight a few keys ones.
DSCR indicates the ability of the investment to cover the debt repayment. Lenders are usually looking for a number higher than 1.25 and conservatively we should look for a DSCR of 1.5 and above.
Stay tuned for future posts about cap rates – purchase and exit/reversion cap rates, IRR, CoC and others.
