Active Investing: The finding, qualifying and closing on an apartment building using one’s own capital and overseeing the business plan through its successful execution.
Passive Investing: Placing one’s capital into an apartment syndication that is managed in its entirety by a general partner.
Accredited Investor – An accredited investor is a designation given by the SEC to a person that can invest in securities (i.e. invest in an apartment syndication as a limited partner) by satisfying one of the requirements regarding income or net worth. The current requirements to qualify are an annual income of $200,000 or $300,000 for joint income for the last two years with the expectation of earning the same or higher in the future or a net worth exceeding $1 million either individually or jointly with a spouse. Additionally certain FINRA certificates qualify you as an accredited investor
A Syndication (or syndicate) is a temporary alliance created to handle a large transaction that would be impossible to execute individually. By forming a syndicate, members can pool their resources together, and share in both the risks and the potential for attractive returns.
Apartment Syndication – A partnership between general partners (i.e. the syndicator) and the limited partners (i.e. the investors) to acquire, manage, and sell an apartment community while sharing in the profits.
Sophisticated Investor – A sophisticated investor is a person who is deemed to have sufficient investing experience and knowledge to weigh the risks and merits of an investment opportunity.
General Partner (GP) – The general partner (GP) is an owner of a partnership who has unlimited liability. The GP is responsible for managing the entire apartment project including finding the deal, negotiating the terms, securing the debt and equity, overseeing the renovation and management of the property and determine the ideal exit timing and strategy. The GP is also referred to as the sponsor or syndicator.
Limited Partner (LP) – The limited partner (LP) is a partner whose liability is limited to the extent of the partner’s share of ownership. In apartment syndications, the LP is the passive investor and funds a portion of the equity investment. The LP then typically receives regular distributions from the project’s income and a share in the profits at the time of sale.
Private Placement Memorandum (PPM) – The private placement memorandum (PPM) is a document that outlines the terms of the investment and the primary risk factors involved with making the investment. The four main sections are the introduction, which is a brief summary of the offering, the basic disclosures, which includes general partner information, asset description and risk factors, the legal agreement and the subscription agreement
Underwriting – Underwriting is the process of financially evaluating an apartment community to determine the projected returns and an offer price.
Distributions – Distributions are the limited partner’s portion of the profits, which are sent on a monthly, quarterly or annual basis, at refinance and/or at sale.
Net Operating Income (NOI) – Net operating income (NOI) is all revenue from the property minus operating expenses, excluding capital expenditures and debt service. For example, a 216-unit apartment community with a total income of $1,879,669 and total operating expenses of $1,137,424 has a NOI of $742,245.
Capitalization Rate – Capitalization rate, typically referred to as cap rate, is the rate of return based on the income that the property is expected to generate. The cap rate is calculated by dividing the property’s net operating income (NOI) by the current market value or acquisition cost of a property (cap rate = NOI / Current market value)
For example, a 216-unit apartment community with a NOI of $742,245 that was purchased for $12,200,000 has a cap rate of 6.1%.
Price Per Unit – The cost of purchasing each individual apartment unit on the property. Calculated by dividing the purchase price by the number of units. For example, a 216-unit apartment community purchased for $12,200,000 has a price per unit of $56,481.
Rent Premium – A rent premium is the increase in rent after performing renovations to the interior or exterior of an apartment community. The rent premium is an assumption made by the general partner during the underwriting process based on the rental rates of similar units in the area or previously renovated units
Free Cash flow – Cash flow is the revenue remaining after paying all expenses. Cash flow is calculated by subtracting the debt service and asset management fee from the NOI to get to the amount of cash available to distribute to investors
Equity Investment – The equity investment is the upfront costs for purchasing an apartment community, which includes the down payment for a loan, closing costs, financing fees, operating account funding, and the various fees paid to the general partner for putting the deal together. May also be referred to as the initial cash outlay or the down payment.
Appreciation – Appreciation is an increase in the value of an asset over time. There are two main types of appreciation: natural and forced. Natural appreciation occurs when the market cap rate “naturally” decreases. Forced appreciation occurs when the net operating income is increased (either by increasing the revenue or decreasing the expenses).
Appreciation is one of the factors included in the Three Immutable Laws of Real Estate Investing. Click here to learn more about all three laws and their importance when investing in real estate.
Sales Proceeds – The sales proceeds are the profit collected at the sale of the apartment community. This profit is split between the limited partners and the general partner based on the terms outline in the operating agreement.
Preferred Return – The threshold return that limited partners are offered prior to the general partners receiving payment. Displayed as a percent of the initial investment. For example, 7% preferred return – the investor receives an annual 7% return before the general partner receives a split of the profits.
The Cash-on-cash (CoC) Return – The rate of return, expressed as a percentage, based on the cash flow and the equity investment. CoC return is calculated by dividing the cash flow by the initial investment.
For example, a 216-unit apartment community with a cash flow of $330,383 and an initial investment of $3,843,270 results in a CoC return of 8.6%
The Internal Rate of Return (IRR) -The internal rate of return (IRR) is a way of calculating the return you receive on your invest that takes into account when you receive your payments by discounting future cashflows more than near-term cash flow (know as the time value of money). Longer-term deals have lower IRRs than short-term deals and the IRR moves inversely to the Equity Multiple. IRR is one of the main factors an investor should focus on when qualifying a deal.
A very simple example is let’s say that you invest $50. The investment has cash flow of $5 in year 1, and $20 in year 2. At the end of year 2, the investment is liquidated and the $50 is returned.
The total profit is $25 ($5 year 1 + $20 year 2).
A simple average would say that the return is 50% ($25/50). But since the time value of money (two years in this example) impacts return, the IRR is actually only 23.43%. If we had received the $25 cash flow and $50 investment returned all in year 1, then yes, the IRR would be 50%. But because we had to “spread” the cash flow over two years, the return percentage is negatively impacted. The timing of when cash flow is received has a significant and direct impact on the calculated return. In other words, the sooner you receive the cash, the higher the IRR will be.
Equity Multiple (EM) – The rate of return based on the total net profit (cash flow plus sales proceeds) and the equity investment. EM is calculated by dividing the sum of the total net profit and the equity investment by the equity investment.
For example, if the limited partners invested $3,843,270 into a 216-unit apartment community with a 5-year gross cash flow of $2,030,172 and total proceeds at sale of $6,002,116, the EM is ($2,030,172 +$ 6,002,116) / $3842,270 = 2.09
Breakeven Occupancy – Breakeven occupancy is the occupancy rate required to cover the all of the expenses of an apartment community. The breakeven occupancy rate is calculated by dividing the sum of the operating expenses and debt service by the gross potential income.
For example, a 216-unit apartment community with $1,166,489 in operating expenses, $581,090 in debt service and $2,263,624 in gross potential income has a breakeven occupancy of 77.2%
Gross Rent Multiplier (GRM) – The gross rent multiplier (GRM) is the number of years the apartment would take to pay for itself based on the gross potential rent (GPR). The GRM is calculated by dividing the purchase price by the annual GPR.
For example, a 216-unit apartment community purchased for $12,200,000 with a GPR of $183,072 per month has a GRM of 5.6.
Market Rent – The market rent is the rent amount a willing landlord might reasonably expect to receive, and a willing tenant might reasonably expect to pay for a tenancy, which is based on the rent charged at similar apartment communities in the area. Market rent is typically calculated by performing a rent comparable analysis.
Gross Potential Rent (GPR) – The gross potential rent (GPR) is the hypothetical amount of revenue if the apartment community was 100% leased year-round at market rental rates.
For example, here is how the GPR is calculated for a 216-unit apartment building:
Gross Potential Income -The gross potential income is the hypothetical amount of revenue if the apartment community was 100% leased year-round at market rates plus all other income.
For example, a 216-unit apartment community with a GPR of $183,072 and monthly other income of $14,153 from late fees, pet fees and a RUBS program has a gross potential income of $197,225 per month.
Loss to Lease (LtL) – Loss to lease (LtL) is the revenue lost based on the actual rent being charged vs. what could be charged at current market rates. LtL is calculated by subtracting the gross potential rent by the actual rent collected then dividing by the gross potential rent.
For example, a 216-unit apartment community with a GPR of $183,072 and with an actual rent of $157,270 has a LtL of 14%.
Bad Debt – Bad debt is the amount of uncollected money a former tenant owes after move-out.
Concessions – Concessions are the credits (dollars) given to offset rent, application fees, move-in fees and any other revenue line time, which are generally given to tenants at move-in.
Model Unit – A model unit is a representative apartment unit used as a sales tool to show prospective tenants how the actual unit will appear once occupied.
Employee Unit – An employee unit is a unit rented to an employee at a discount or for free.
Vacancy Rate – The vacancy rate is the rate of unoccupied units. The vacancy rate is calculated by dividing the total number of unoccupied units by the total number of units.
For example, a 216-unit apartment community that has 17 vacant units has a vacancy rate of 7.9%
Physical Occupancy Rate – The physical occupancy rate is the rate of occupied units. The physical occupancy rate is calculated by dividing the total number of occupied units by the total number of units.
For example, a 216-unit apartment community with 199 occupied units has a physical occupancy rate of 92%.
Economic Occupancy Rate – The economic occupancy rate is the rate of paying tenants based on the total possible revenue and the actual revenue collected. The economic occupancy rate is calculated by dividing the actual revenue collected by the gross potential income. It is important to know
Vacancy Loss – Vacancy loss is the amount of revenue lost due to unoccupied units. The inverse of Economic Occupancy Rate.
Effective Gross Income (EGI) – Effective gross income (EGI) is the true positive cash flow of an apartment community. EGI is calculated by the sum of the gross potential rent and the other income minus the income lost due to vacancy, loss-to-lease, concessions, employee units, model units and bad debt.
Capital Expenditures (CapEx) – Capital expenditures, typically referred to as CapEx, are the funds used by a company to acquire, upgrade and maintain an apartment community. An expense is considered to be a capital expenditure when it improves the useful life of an apartment and is capitalized – spreading the cost of the expenditure over the useful life of the asset.
Capital expenditures include both interior and exterior renovations.
Examples of exterior CapEx are repairing or replacing a parking lot, repairing or replacing a roof, repairing, replacing or installing balconies or patios, installing carports, large landscaping projects, rebranding the community, new paint, new siding, repairing or replacing HVAC and renovating a clubhouse.
Examples of interior CapEx are new cabinetry, new countertops, new appliances, new flooring, installing fireplaces, opening up or enclosing a kitchen, new light fixtures, interior paint, plumbing projects, new blinds and new hardware (i.e. door knobs, cabinet handles, outlet covers, faucets, etc.).
Operating Expenses – Operating expenses are the costs of running and maintaining the property and its grounds. Operating Expenses include the costs associated with turning over a unit (i.e. paint, new carpet, cleaning, etc.), ongoing maintenance and repairs, ongoing landscaping costs, payroll to employees, and utility expenses
Ratio Utility Billing System (RUBS) – Ration Utility Billing System (RUBS) is a method of calculating a tenant’s utility bill based on occupancy, apartment square footage or a combination of both. Once calculated, the amount is billed back to the resident, which results in an increase in revenue.
Interest Rate – The interest rate is the amount charged, expressed as a percentage of principal, by a lender to a borrower for the use of their funds.
Interest-Only Payment – An interest-only payment is the monthly payment on a loan where the lender only requires the borrower to pay the interest on the principal as opposed to the typical debt service, which requires the borrower to pay principal plus interest.
Debt Service – Debt service is the annual mortgage paid to the lender, which includes principal and interest. Principal is the original sum lent and the interest is the charge for borrowing the principal amount.
For example, a 24-month $11,505,500 loan with 5.28% interest amortized over 30 years results in a debt service of $60,977 per month
Debt Service Coverage Ratio (DSCR) – The debt service coverage ratio (DSCR) is a ratio that is a measure of the cash flow available to pay the debt obligation. DSCR is calculated by dividing the net operating income by the total debt service. A DSCR of 1.0 means that there is enough net operating income to cover 100% of the debt service. Ideally, the ratio is 1.25 or higher. An apartment with a DSCR too close to 1.0 is vulnerable, and a minor decline in cash flow would result in the inability to service (i.e. pay) the debt.
Bridge Loan – A bridge loan is a mortgage loan used until a person or company secures permanent financing, which are short-term (6 months to three years with the option to purchase an additional 6 months to two years). They generally have a higher interest rate and are almost exclusively interest-only. Also referred to as interim financing, gap financing or swing loan. The loan is ideal for repositioning an apartment community.
Permanent Agency Loan – A permanent agency loan is a long-term mortgage loan secured from Fannie Mae or Freddie Mac and is longer-term with lower interest rates compared to bridge loans. Typical loan term lengths are 5, 7 or 10 years amortized over 20 to 30 years.
Prepayment Penalty – A prepayment penalty is a clause in a mortgage contract stating that a penalty will be assessed if the mortgage is paid down or paid off within a certain period.
Refinance – A refinance is the replacing of an existing debt obligation with another debt obligation with different terms. In apartment syndication, a distressed or value-add general partner may refinance after increasing the value of a property, using the proceeds to return a portion of the limited partner’s equity investment.
Closing Costs – Closing costs are the expenses, over and above the price of the property, that buyers and sellers normally incur to complete a real estate transaction. Examples of closing costs are origination fees, application fees, recording fees, attorney fees, underwriting fees, credit search fees, third-party report fees and due diligence fees.
Financing Fees – Financing fees are the one-time, upfront fees charged by the lender for providing the debt service. Also referred to as a finance charge. Typically, the financing fees are 1-2% of the purchase price.
Rent Comparable Analysis – The rent comparable analysis is the process of analyzing similar apartment communities in the area to determine market rents of the subject apartment community.
Submarket – The submarket is a geographic subdivision of a market.
For example, Richardson, Carrolton and Arlington are submarkets of the Dallas-Fort Worth market.
Metropolitan Statistical Area (MSA) – A metropolitan statistical area (MSA) is a geographical region containing a substantial population nucleus, together with adjacent communities having a high degree of economic and social integration with that core, which are determined by the United States Office of Management and Budget (OMB).
Property and Neighborhood Classes – Property and neighborhood classes is a ranking system of A, B, C, or D given to a property or a neighborhood based on a variety of factors. These classes tend to be subjective, but the following are good guidelines:
- Class A: new construction, command highest rents in the area, high-end amenities
- Class B: 10 – 15 years old, well maintained, little deferred maintenance
- Class C: built within the last 30 years, shows age, some deferred maintenance
- Class D: over 30 years old, sever deferred maintenance, low occupancy, a lot of deferred maintenance
- Class A: most affluent neighborhood, expensive homes nearby
- Class B: middle-class part of town, safe neighborhood
- Class C: low-to-moderate income neighborhood
- Class D: high crime, bad neighborhood
Profit and Loss Statement – The profit and loss statement is a document or spreadsheet containing detailed information about the revenue and expenses of the apartment community over the last 12 months. Also referred to as a trailing 12-month profit and loss statement or a T12
Rent Roll – The rent roll is a document or spreadsheet containing detailed information on each of the units at the apartment community, along with a variety of data tables with summarized income.
Pro-Forma – A pro-forma is the projected budget, displayed as a Profit and Loss statement. for the apartment community with itemized line items for the income and expense for the next 12 months and 5 years, which is an output of the underwriting.
Working Capital – A reserve account over and above the price of the property, to cover things like unexpected dips in occupancy, lump sum insurance or tax payments or higher than expected capital expenditures. The working capital reserve is typically created by raising extra money from the limited partners.
Exit Strategy – The exit strategy is the plan of action for selling the apartment community at the end of the business plan.
Acquisition – The acquisition fee is the upfront fee paid by the new buying partnership entity to the general partner for finding, analyzing, evaluating, financing and closing the investment. Fees range from 0.5% to 5% of the purchase price, depending on the size of the deal.
Asset Management Fee – The asset management fee is an ongoing annual fee from the property operations paid to the general partner for property oversight. Generally, the fee is 2% of the collected income or $250 per unit per year.
Property Management Fee -The property management fee is an ongoing monthly fee paid to the property management company for managing the day-to-day operations of the property. This fee ranges from 2% to 8% of the total monthly collected revenues of the property, depending on the size of the deal.
Refinancing Fee – The refinancing fee is a fee paid for the work required to refinance the property. At closing of the new loan, a fee of 0.5% to 2% of the total loan amount is paid to the general partner.
Guaranty Fee -The guaranty fee is a fee paid to a loan guarantor at closing. The loan guarantor guarantees the loan. At closing of the loan, a fee of 0.25% to 1% of the principal balance of the mortgage loan is paid to the loan guarantor.