Are you intrigued by the potential cash flow returns promised by real estate syndications but find yourself skeptical? You’re not alone. Many investors are surprised by the passive income prospects offered by these investments. To quell your doubts, let’s unravel the mystery of where this cash flow originates and how it finds its way into your pocket.
Cash Flow Distributions
Typically, within the first few months after closing, you can expect to start receiving monthly cash flow distributions—a new stream of passive income. But how do these investments generate such lucrative returns? Let’s explore the sources of this income.
Where Cash Flow Comes From
Every investment property, regardless of size or the number of tenants, is an asset that generates both income and expenses. Let’s delve into how apartment complexes generate income, the associated expenses, and how cash flow is calculated.
Gross Potential Income
In an apartment building, the primary income source is the monthly rent paid by tenants. For example, if the average rent in a 100-unit building is $800, the gross potential income is $80,000 per month, translating to $960,000 per year.
Monthly Gross Potential Income: units×$800 each=$80,000 per month
Annual Gross Potential Income: $80,000 per month×12 months=$960,000 per year
However, this figure represents the gross potential income under ideal conditions, assuming no vacancies or discounts.
Net Rental Income
Accounting for vacancy costs, loss to lease, and concessions results in net rental income. Assuming a 10% vacancy rate, the monthly vacancy cost would be $8,000, totaling $96,000 annually.
Vacancy Cost: 10 units vacant×$800 lost rent per unit=$8,000 vacancy cost per month
Annual Vacancy Cost: $8,000 per month×12 months=$96,000 per year
Subtracting the annual vacancy cost from the gross potential income gives the net rental income.
Net Rental Income: $960,000 annual gross potential income−$96,000 annual vacancy cost=$864,000 annual net rental income
Operating Expenses
Business expenses such as maintenance, repairs, property management, and utilities must be considered. Assuming monthly operating expenses of $38,000, the annual total is $456,000.
Annual Operating Expenses: $38,000 monthly operating expenses×12 months=$456,000 annual operating expenses
Net Operating Income (NOI)
Net Operating Income is the net rental income after subtracting operating expenses.
NOI: $864,000 net rental income−$456,000 operating expenses=$408,000 NOI
Mortgage
Mortgage payments are a crucial consideration. If, for instance, the monthly mortgage is $20,000, the annual payments amount to $240,000.
Annual Mortgage Payments: $20,000 monthly mortgage×12 months=$240,000 annual mortgage payments
Cash Flow / Cash on Cash Returns
Subtracting expenses from income yields the first-year cash flow. For this example, let’s assume an 80/20 deal structure, with 80% of profits going to investors and 20% to the sponsor team.
First-Year Total Cash Flow: $408,000 NOI−$240,000 mortgage=$168,000 first−year total cash flow
First Year Cash Flow to Investors: $168,000 first−year cash flow×80%=$134,400 first−year cash flow to investors
Depending on your investment level, you might expect a monthly distribution check. For a $100,000 investment, this could mean a $667 monthly check, totaling $8,628 for the year.
Recap
The cash flow you receive each month originates from tenant rent. After deducting expenses, paying the mortgage, taxes, and insurance, the remaining amount is divided among investors. Is this passive income guaranteed? Absolutely not. Variables like location, team members, and the economy can impact these estimates. However, understanding where the cash flow comes from empowers you to scrutinize investment figures and make informed decisions in the realm of real estate syndications.
