Different Types of Multifamily Syndication Deals & How to Decide Which is Right for You
As you begin exploring investment opportunities as a passive investor, you will notice several different deal structures available to you. You may hear terms like “buy and hold” or “value add” used to describe someone’s investment strategy, specifically in the multifamily apartment space. With so many different ways to invest your money, it may feel overwhelming trying to decide which strategy is best for you.
This article will outline the three most common types of multifamily syndications - new development, buy and hold, and value add.
These different investment strategies all carry a certain amount of risk and reward. We will dive into all of those details, as well as how the deals are structured and how to know which deal type is best for you based on your investment goals.
Before we get started, it’s important to note that for the purpose of this article, we are referring to single-deal syndications and not funds. You may see certain investment funds combine investment strategies, but our purpose here is to help you understand each different approach so you can learn the terminology and have a better grasp of the implications of each.
New Development Syndications
This investment strategy can be considered a higher risk, and higher reward. New development (sometimes referred to as “new construction”) is exactly what it sounds like - building and developing an apartment building from the ground up.
This is a complex project that comes with a great deal of uncertainty while also allowing for potentially massive gains! New development deals are often very costly, with the need for architectural designs, building materials, and permitting and analysis than other investment projects. Investors typically will not see cash flow throughout the duration of the deal. However, when the property is sold at the end of the project’s life cycle, they often receive a higher return in comparison to other types of deals.
Two Types of New Development Deals
There are two different types of new development deals. The difference comes down to the investor’s intention with the property once it is finished being built.
Investors either build a new apartment building with the intention of holding onto it and renting the units to tenants or with the plan to sell the property for a profit.
Build to sell
This method is used when the investor plans to build the property from the ground up, then turn around and sell it to a different investor for a profit. The person who purchases the property will then manage, rent, and operate the building.
The main risk factor associated with building to sell the potential for market changes during the construction process and the potential that the property would sell for less than anticipated. On the other hand, there is a high probability of a great ROI, especially if the particular market conditions improve over the course of the project.
Build to rent
This method is used when the investor plans to build the property and then rent it to tenants to create cash flow for a period of time. The syndicator is responsible for managing, renting, and operating the building until the property is sold at a future date.
The main risk factor is the rent rate when the project is ready for market. For these investments to make financial sense, the rents must be able to cover the mortgage payments and other costs associated with the building. If the syndication team underwrote the assumptions aggressively with too much assumption that the market will continue to grow organically, there is a risk that the projected rents can’t be achieved and the cash flow is much lower than projected.
Risks and Benefits of New Development
Assuming that units are filled, and rents are up to par, there is a great reward opportunity when building to rent. Ideally, you’re getting consistent monthly cash flow, and you still see a significant profit at the end of the deal after the property is sold.
New construction often takes multiple years to finish. During that time, there is a large window for unforeseen circumstances to arise. These can include construction materials that end up costing more than expected due to increased raw material costs, economic downturns, environmental issues such as toxic waste in the ground, permit issues, zoning and municipality approval delays, and more. If a permit doesn’t get approved for any reason, it could delay the completion of the project by many months.
This is not to say that you should not invest in new development deals because of these risks. It’s just that it is important to go into these projects with your eyes wide open and to ask the right questions about how the investment team is planning to mitigate risks before investing.
Why Invest in New Development Syndications?
If you’re not looking for immediate or consistent cash flow and you’re comfortable with waiting until the end of a deal to see any profits or equity, then new development investing might be a good fit for you. Projects like these are great for investors who have a higher risk tolerance and are willing to withstand the risks associated with ground-up development in exchange for a high return on investment. These individuals are typically in a stage of life where they are focused on wealth building more than receiving steady month-to-month cash flow to cover part of their income (i.e., if you’re retired early or working part-time).
Buy & hold Syndications
This investment method is used when a syndicator purchases an existing property where units are already rented. There is typically much less risk associated with buy-and-hold projects and usually less return on the tail end of the deal. However, for an investor looking to own cash-flowing properties, this is a perfect avenue to do so.
These syndications typically span 5-10 years. Without any plans to force appreciation through renovation, they will continue to produce minimal but consistent rental income. Any significant increases to the cash flow will happen through organic market rental growth. Most syndicators who invest this way will look to lower certain expenses in order to earn a higher profit; however, your typical value-add renovations, such as upgraded cabinets and flooring, won’t apply.
Risks and Benefits of Investing in Buy & Hold
It is typically assumed that there is less risk associated with buy-and-hold properties, as the investor buying the property usually has a good idea of the expenses, revenue, and rent rates before going into the deal. They know how much income they will be earning each month and the expenses they need to account for. They also know the vacancy trends and current rates, so there are fewer surprises about getting units rented than a new development project
Going into a property that is already rented is a safer bet in many ways but can pose a few risks as well, including any changes in the market that result in higher vacancy or lower rent rates. Changes in either of these can dramatically affect the bottom line.
If the previous owner had poorly managed the property, the current syndicator may be faced with unexpected repairs and maintenance costs. This, or poor property management, can also result in bad online reviews, making it challenging to rent out to prospective tenants even if these issues are fixed.
Why Invest in Buy & Hold Syndications?
Buy-and-hold syndications are great for passive investors looking for a property with predictable, steady cash flow. These individuals tend to be in the wealth conservation phase of their lives, often nearing retirement and looking for a monthly income to maintain their lifestyle.
This option can also be attractive for investors with a large amount of money they want to deploy but want to know what kind of returns they can expect. When they contribute a higher principal investment, their cash flow is higher. For example, if the rate of return is 11%, then the investor who puts down $500,000 is going to earn significantly more than the person who invested $100,000. It can be a good way to earn a higher return on your investment than, say, the stock market or having it sit in a high-yield savings account while still receiving the tax benefits of investing in real estate.
Value add Syndications
This investment strategy is similar to buy-and-hold in that the syndicator purchases a multifamily apartment building that is already in the process of being rented. However, the key difference is the value-adding component.
In this scenario, the syndicator has plans to improve the property and/or the units by adding amenities such as a new gym, enhancing the landscaping, installing washers and dryers, or upgrading the flooring and cabinetry in the units. These changes often result in the ability to increase the rents and, ultimately, the sale price at the end of the deal.
Risks and Benefits of Investing in Value Add Syndications
Value-add syndications are a good balance between the previously mentioned investment strategies. They offer a medium risk factor with balanced returns.
These properties offer the same reassurance when it comes to knowing the expenses, rent rates, and revenue before entering the deal. However, the bonus perk is the ability to increase the returns by adding value to the property and subsequently increasing rents instead of solely relying on organic rent growth. This is called forced appreciation.
There is the risk that even with the enhancements made to the property, the anticipated higher rents can not be achieved. With any renovation comes the risk that material or labor costs increase and they end up going over the planned budget, or that it takes longer to complete the projects. Any of these scenarios may delay the ability to increase the rents.
Why Invest in Value Add Syndications?
Adding value to a multifamily apartment building is an excellent investment strategy for someone who wants to strike a balance between monthly cash flow and end-of-deal profit payout.
This is the type of investment that our syndication company focuses on. We want to create cash flow during the project as well as upside at the end of the deal, all while also tempering our risks. We plan for our deals to last 2-5 years, but sometimes the target returns can be achieved even faster in a high-growth market. If you want a good balance of risk and return without locking up your money for too long and you’re in the wealth-building phase of your life, this might be a perfect investment for you. You can typically plan to receive a small amount of cash flow during the project and also receive a larger payout at the end of the project lifecycle.
There are many paths to choose from as a real estate investor. If you’re considering multifamily apartment syndications, dive deeper into the available options. Understand the possible outcomes, including both risks and rewards, how those stack up against your personal risk tolerance, as well as how each of these methods might help you reach your investment goals.
If you’re interested in learning about furthering your own investing journey, schedule a one-on-one consultation with our team to see how we can help guide you.
You Might Also Like:
