4 Ways to Measure Your Investment Returns in Apartment Syndications
One of the first questions syndication investors should ask is “what’s my return on investment?” The most accurate answer, unfortunately, is not a short answer. That’s because there are several methods of measuring or describing potential returns for your investment in apartment syndications. Taking one of these measurements by itself may be misleading. In isolation, one return metric may not give you accurate information unless it’s given in the context of other metrics. Also, your investment objectives may prioritize one or more of these measurements. Here’s the 4 investment return metrics that every investor should evaluate for each offering.
Cash-on-Cash Return
Cash flow is a primary motivator for many investors in apartment syndications. This is for good reason. Cash flow from apartment syndications is the very definition of a passive investment. The investor contributes capital to become a limited partner in a syndication, leaves all the work up to the general partners, and he or she gets paid quarterly cash returns. Cash-on-cash return is defined as the amount of cash distributions relative to the amount of initial investment. Mathematically, it is the amount of distributions in a year divided by the initial investment. If you invest $50,0000 and get a total of $5,000 in distributions over the course of a year, that’s a 10% cash-on-cash return.
Cash-on-cash returns in apartment syndications may vary. You could see cash-on-cash return as low as 5% or as high as 12% projected in an offering. An investor may be tempted to focus solely on this metric and choose to invest in syndications that project 10% or more. However, this metric has some disadvantages. First, it’s simply a measure of how much cash distributions your investment will produce. This metric completely ignores the overall growth in value your initial investment could realize over the hold period of the investment. For example, if you achieve 10% cash-on-cash but the value of the property doesn’t increase and you are simply returned your $50,000 investment after 5 years, then they may not be a wise investment. Compare that to an offering that pays 8% cash-on-cash returns but grows the value of that $50,000 to $75,000 at the 5 year exit. This is the perfect example of why one metric should not be evaluated in a vacuum.
Total Return (and Equity Multiple)
As the above example illustrates, it’s wise to consider more than just cash flow if wealth growth is also an objective. That’s where Total Return comes into play. Total Return is the total amount of money returned to an investor. This includes yearly cash flow, return of initial capital, and profit from the sale of the property. For example, you invest $50,000 initially. The syndication pays you 8% cash-on-cash each year–which is $4,000 for 5 years. That’s $20,000. At the end of the year 5, the property is sold and you are given back your initial $50,000 plus $30,000 as your share in the sale profits. That was a total profit of $50,000 off a $50,000 investment or a 100% return. In this market, a 90-95% total return on a 5 or 6 year hold is very good.
A slightly different way to express the same metric is Equity Multiple. This is really to say what factor of growth does your initial investment experience over the course of the syndication. Basically, how many times does your money grow? Using the example above, what’s the total amount of money this put out by the end of the investment cycle? It’s $20,000 (cash payouts over 5 years) + $50,000 (returned investment) + $30,000 (profit from sale) = $100,000. We divide that by the initial investment of $50,000 to get an Equity Multiple of 2.0x. Essentially, if you take into consideration cash flow and profits, the initial investment increased by a multiple of 2.0x over the 5 years. An Equity Multiple of 1.9x to 2.0x is considered favorable by many investors over a 5 or 6 year hold period.
Average Return or Annual Rate of Return (ARR)
This is a common metric investors use to compare apartment syndication returns to other types of investments, like the stock market or mutual funds, etc. It’s really using the same information as Total Return but it annualizes the result to show you what growth of your money is achieved on an annual basis. Let’s return to the example above. We’ve already calculated the investor has an initial investment of $50,000 returned plus a cumulative profit of another $50,000 (cash distributions plus sale profit). We take that $50,000 profit and divide by the number of years of the investment (5 years) = $10,000. That’s the average annualized amount of return. As a percentage, that’s 20% of the initial investment. In essence, this investment grew by 20% each year when you consider all cash distributions and net sale profit. Now, compare that to stock market index funds, individual stock returns, or bonds.
Internal Rate of Return (IRR)
When you look at an apartment syndication offering, you’ll most likely see an Internal Rate of Return. In simple terms, IRR is very similar to ARR with one key difference: IRR takes into account the time value of money. Let’s take a look at the example above one more time. In the first few years, the investor’s return consisted solely of cash dividends of 8%. But, in the final year there is returned capital plus profit from sale proceeds. The average annualized return may be 20%, but the bulk of that return was on the backend of the 5 year hold period. IRR, however, seeks to weigh the velocity of returns because it defines money as having more value today than in the future. IRR is a complex algebraic calculation. For the example above, the calculated IRR is 16.6%. Again, that’s not your actual annualized return, but it’s a formulaic way of describing your return by placing a higher value on money today than in 5 years. IRR can vary considerably among syndication offerings, depending on how much of the return is paid out in the earlier years of the investment cycle.
Which investment return measurement is best for you? That really depends on your investment objectives. If you are targeting higher cash flow, then cash-on-cash returns may be a higher priority. Yet, that metric should also be evaluated within the context of other factors, such as risk of the investment. If an investor is seeking higher stability investments with significant equity growth, then total return and equity multiple may be a priority. That investor would also want to consider the IRR of the deal and evaluate their comfort in realizing higher returns on the back end of the hold period vs more front-loaded returns. Again, there’s a lot to consider when investing in apartment syndications. If you have questions about these metrics, feel free to reach out to us at russ@newsightcapital.com. Also, be sure to register with us so that we can connect regarding current and upcoming investment offerings.
