Types of Returns from Syndications

We were pleased to receive a reader question about the types of options you have as an investor in a syndication. This investor is looking at the types of returns they can expect and when. They wonder what type of investment to choose within the world of syndications.

As always, the annoying answer is "it depends" but there are also a few concepts about syndication returns that are worth bearing in mind going in.

Many syndications, especially multifamily apartments, offer different classes of investments even on the same deal. A typical private offering to invest, say, in an apartment building syndication might call for an investment of $50,000 or $100,000 as a minimum. You might be given a choice between the type of returns you seek. In this typical structure, there's a Class A offering and a Class B offering.

For the Class A offering, the syndicator might offer a preferred return of, say, 8% to 10%. This cash flow might be paid out monthly or quarterly. You might think of this type of investment as closer to a debt investment than an equity investment in the sense that you are getting a monthly payment from the cash flow at the property but you will not get anything on the "back end" beyond your preferred return. So, as a Class A investor, you can likely count on this 8% or 10% per month; if it is not paid out consistently, you can likely count on being "caught up" at the end of the investment when there is a happy liquidity event; and you can also count on not participating in the upside return. Of course, nothing is guaranteed in this type of investment--you have to do your due diligence and choose well. The property still has to generate cash flow to be able to pay you out consistently over time. But a Class A investment is often lower risk and lower return for you as an investor than other types of syndication investments.

For the Class B offering, you might think of this as more of the classic equity-type investment. You may get less in monthly, quarterly, semi-annual, or annual cash flow. But you stand to get your preferred return caught up at the end and also might get a bigger upside if the deal goes well than if you had gone for the steady cash flow of Class A shares in the deal.  So, as a Class B investor, you might get 1% - 2% in the first year or two of the investment, you might get more like 6% - 8% in years three and four of the investment, and when it sells in year 5, you might get a total return of 100% on your investment--doubling your money overall. That may come out to a slightly better overall return than if you had chosen the Class A shares but you have to wait longer to get your return.

How might you analyze the choices? You always should run the numbers to make sure that the IRR--Internal Rate of Return--is what you are after, not just the total return. By that, consider the difference between and investment that pays you out a 10% return after one year and an investment that pays you the same 10% return after three years. The total return might be the same on your money. But the first investment is likely a better one: it only took one year to generate the 10% return while the second investment took three years. The IRR on the first deal is higher than on the second deal, even though the total return is exactly the same. What is different is the timeframe between the two. The function of time corresponds to the opportunity cost for your capital.

You also might analyze these choices based on your own needs. In our family, we don't have near-term cash flow needs. The funds we invest in syndications are for the long run. As such, we seek the best total IRR for a deal. We are happy to wait a few years for any cash flow at all if that means that in year 4 or 5 or 6 there will be an outsized return. As "patient capital," we can seek the best returns generated by the best operators, providing the best service and value for the tenants.

You might be in very different circumstance than we are. Perhaps you have recently retired or wish to retire and you are in it for the steady cash flow. In that case, Class A investments may well make much more sense. They can provide a good rate of return with a reasonably high degree of certainty compared to many other investments. With a well-chosen, well-diversified portfolio of investments from reliable operators, you should be able to sleep well at night that you have cash flow coming in.

There can be variations on the theme. We've seen deals with a Class C; we've been offered blends of Class A and Class B; and we favor one syndicator who has everyone in the deal in the same class and has been providing terrific results year-to-year. So YMMV--Your Mileage May Vary. You likely will have some choices for how you'd like to structure your syndication investments and portfolio for the types of returns you seek.