An accredited investor is 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 expectation of earning the same or higher or a net worth exceeding $1 million either individually or jointly with a spouse.
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.
An apartment syndication is a temporary professional financial services alliance formed for the purpose of handling a large apartment transaction that would be hard or impossible for the entities involved to handle individually, which allows companies to pool their resources and share risks and returns. In regards to apartments, a syndication is typically 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.
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.
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.
Bad debt is the amount of uncollected money a former tenant owes after move-out.
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%
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.
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.) Examples of things that wouldn’t be considered CapEx are operating expenses, like 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, utility expenses, etc.
CAPITALIZATION RATE (CAP 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%.
Cash flow is the revenue remaining after paying all expenses. Cash flow is calculated by subtracting the operating expense and debt service from the collected revenue
For example, here is the cash flow of a 216-unit apartment community:
Total Income $1,879,669
Total Operating Expense $1,137,424
Debt Service $581,090
Asset Mgmt Fee $40,195
Cash Flow $120,960
CASH-ON-CASH (COC) RETURN
The cash-on-cash (CoC) return is 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%
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 and due diligence fees.
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.
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 the privilege of 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. For example, a 216-unit apartment community with an annual debt service of $581,090 and a NOI of $960,029 has a DSCR of 1.65.
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.
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. For example, a 216-unit property charges, on average, $847.11 per month per unit. Each month, a total of $3,025.50 is lost due to various concessions. There are 17 vacant units which could be rented for a total of $13,204.50 per month. Monthly bad debt is $4,595.58. The physical occupancy rate is 92%: 199 occupied units / 216 total units. The economic occupancy rate is 86%.
Current revenue = $1,945,808 = [($847.11 * 216) – $3,025.50 concessions – $13,204.50 vacancy loss – $4,595.58 bad debt] * 12 months.
Current revenue / total possible revenue = $1,945,808 / (216 units * 847.11 * 12 months) = 86%.
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.
For example, if a 216-unit apartment community has a gross potential rent of $2,263,624, loses $158,454 due to vacancy (7% vacancy rate) and $159,362 in credit costs (loss-to-lease, concessions, employee units, model unit, bad debt, etc.) and collects $177,462 in other income, then EGI is $2,123,235.
An employee unit is a unit rented to an employee at a discount or for free.
An employee unit is a unit rented to an employee at a discount or for free.
EQUITY MULTIPLIER (EM)
Equity Multiplier (EM) is 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.
The exit strategy is the plan of action for selling the apartment community at the end of the business plan.
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 1.75% of the purchase price. For example, a 216-unit apartment community purchased for $12,200,000 will have an estimated $213,500 in financing fees.
GENERAL PARTNER (GP)
The general partner (GP) is an owner of a partnership who has unlimited liability. A general partner is also usually a managing partner and active in the day-to-day operations of the business. In apartment syndications, the GP is also referred to as the sponsor or syndicator. The GP is responsible for managing the entire apartment project.
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.
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:
Unit Type # of Units Bed/Bath Market Rent
A1 48 1×1 $737
A2 96 1×1 $796
B1 72 2×1 $990
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.
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.
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.
INTERNAL RATE OF RETURN (IRR)
The internal rate of return (IRR) is the rate, expressed as a percentage, needed to convert the sum of all future uneven cash flow (cash flow, sales proceeds and principal pay down) to equal the equity investment. IRR is one of the main factors the passive 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).
Simple division would say that the return is 50% ($25/50). But since 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.
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.
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.
LONDON INTERBANK OFFERED RATE (LIBOR)
The London Interbank Offered Rate (LIBOR) is a benchmark rate that some of the world’s leading banks charge each other for short-term loans. LIBOR serves as the first step to calculating interest rates on various loans, including commercial loans, throughout the world.
LOSS TO LEASE (LTL)
Loss to lease (LtL) is the revenue lost based on the market rent and the actual rent. LtL is calculated by dividing the gross potential rent minus the actual rent collected 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%.
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 typical calculated by performing a rent comparable analysis.
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).
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.
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.
OPERATION ACCOUNT FUNDING
The operating account funding is a reserves fund, 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 operating account fund is typically created by raising extra money from the limited partners.
Operating expenses are the costs of running and maintaining the property and its grounds.
For example, here are operating expenses for a 216-unit apartment community:
Contract Services ($82,837)
Turn/Make Ready ($43,598)
Mgmt Fees ($65,788)
Total Expenses ($1,137,424)
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.
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%.
Referred Return: the threshold return that limited partners are offered prior to the general partners receiving payment.
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.
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.
is the projected budget of an 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.
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.
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:
1 . Class A: new construction, command highest rents in the area, high-end amenities
2 . Class B: 10 – 15 years old, well maintained, little deferred maintenance
3 . Class C: built within the last 30 years, shows age, some deferred maintenance
4 . Class D: over 30 years old, no amenity package, low occupancy, needs work
1 . Class A: most affluent neighborhood, expensive homes nearby, maybe have a golf course
2 . Class B: middle class part of town, safe neighborhood
3 . Class C: low-to-moderate income neighborhood
4 . Class D: high crime, very bad neighborhood
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.
RATION 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.
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.
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.
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.
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.
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.
The sales proceeds are the profit collected at the sale of the apartment community.
For example, here is a how the sales proceeds is calculated for a 216-unit apartment
community purchased at $12,200,000 and sold after a five year value-add business plan:
Exit NOI $1,134,723
Exit Cap Rate 5.9%
Exit Price $19,232,593
Closing Costs ($192,326)
Remaining Debt ($10,711,909)
Sales Proceeds $8,328,358
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.
The subject property is the apartment the general partner intends on purchasing.
The submarket is a geographic subdivision of a market.
For example, Richardson, Carrolton and Arlington are submarkets of the Dallas-Fort Worth market.
Underwriting is the process of financially evaluating an apartment community to determine the projected returns and an offer price.
Vacancy loss is the amount of revenue lost due to unoccupied units.
For example, a 216-unit apartment community that has 17 vacant units that rent for an average of $777 per unit per month has a vacancy loss of $158,508 per year.
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%