The Essential Guide to Multifamily Syndication Terms

To thrive as an apartment syndicator/investor, it’s crucial to have a good understanding of the terminology used in the industry. I’ve put together a list of important terms to help you navigate this world and reap the rewards of apartment syndication.

1. 1031 Exchange: One term to know as an apartment syndicator/investor is the “1031 Exchange.” This refers to a provision in the US tax code that allows for the exchange of like-kind property used in a trade or business or held as an investment, without incurring capital gains taxes. Essentially, if you trade your real estate for other like-kind property, you can defer paying taxes on any capital gains until you dispose of the newly acquired property in a taxable transaction. This is based on the principle that as long as the original investment remains intact in the form of real estate, taxation should be deferred.

2. Assumption Fee: An assumption fee is a charge that the buyer pays to the lender when taking over an existing mortgage. This fee is typically included in the closing costs and usually amounts to around 1% of the mortgage.

3. Capital Expenditure (CapEx): Capital Expenditure (CapEx) refers to the funds utilized by a business entity to either obtain or improve an asset. This is distinct from short-term operating expenses and typically involves the depreciation of the asset over its useful life.

4. Capitalization Rate (CAP): Capitalization Rate (CAP) refers to the rate of return that an investor can expect to receive on a real estate investment property based on the income the property is expected to generate. A higher CAP is generally preferred when acquiring a property as it indicates a better return on investment. Conversely, a lower CAP is less desirable.

5. Cash-on-Cash Returns: Cash-on-Cash Returns refers to the percentage ratio of before-tax cash flow generated annually by an income-producing asset, compared to the total amount of cash invested in the asset. It is a useful metric for evaluating the cash flow potential of an investment property.

6. Debt Service Coverage Ratio (DSCR): The Debt Service Coverage Ratio (DSCR) is a metric that measures the amount of cash available to fulfill current debt obligations. It calculates the ratio of net operating income to the total amount of debt payments due within one year, which includes principal, interest, sinking-fund, and lease payments.

7. Defeasance: Defeasance is a process that enables the borrower to substitute collateral for an existing mortgage, leading to the cancellation of the mortgage upon the repayment of the loan.

8. Demographics: Demographics refer to the statistical characteristics of human populations, including factors such as population size, density, growth rates, migration patterns, and vital statistics. These factors can have significant impacts on social and economic conditions in different regions.

9. Due Diligence: Due diligence is a comprehensive process of investigating a property, its financial records, relevant documents, and procedures to be conducted by or for potential lenders or buyers. Its purpose is to minimize the risk of investment or acquisition.

10. Economies of Scale: Economies of scale refer to the cost advantages that come with an increase in production, resulting in lower costs per unit.

11. Equity Multiplier: The Equity Multiplier is a metric that compares the total cash distributions received from an investment to the total equity invested. If the value is less than 1, it indicates a loss for the investor, while a value greater than 1 suggests a profitable investment.

12. Forced Appreciation: Forced Appreciation: The rise in value of an asset, either by natural market conditions or by strategic efforts of the investor. Natural appreciation happens when there’s a higher demand for rental properties than the supply available or due to inflation and interest rate changes. On the other hand, forced appreciation is intentionally achieved through various strategies, such as increasing the property’s net operating income (NOI) by raising rents or decreasing expenses, making property improvements, or repositioning the asset in the market.

13. K-1 Tax Form: A K-1 tax form enables companies to utilize pass-through taxation, which means that the tax liability for the income earned by the entity is shifted to those who have a beneficial interest in it.

14. Internal Rate of Return (IRR): The Internal Rate of Return (IRR) is the interest rate at which the present value of future cash flows from a real estate investment equals the initial investment. It is a measure of the investment’s profitability over time and is often used as a benchmark to evaluate the potential of future projects. Companies may use the IRR of their past projects to set a benchmark rate against which they assess the viability of future investments.

15. Metropolitan Statistical Area (MSA): An MSA is a geographic region characterized by a densely populated core area and its surrounding communities, with strong economic connections across the region.

16. Net Operating Income (NOI): Net Operating Income (NOI) is the total revenue generated from an investment property minus all operating expenses such as property taxes, maintenance fees, and insurance costs.

17. Net Present Value (NPV): An investment’s Net Present Value (NPV) is the value of its future cash flows after being adjusted for the time value of money and subtracting the initial investment.

18. Operating Expense Ratio (OER) or Expense Ratio: The Net Present Value (NPV) of an investment takes into account the future cash flows of the investment, adjusted for the time value of money, and subtracts the initial investment to determine its value.

19. Preferred Return: A preferred return is the initial allocation of profits promised to investors and is prioritized until a specified target return is met. This serves as a safety net for investors, reducing their risk and increasing the investment’s appeal.

20. Pro-forma: Pro-forma refers to the estimated financial statements that project future performance based on a set of assumptions and expectations.

21. Promote: A “promote” is an incentive given to the sponsor of a project to encourage them to exceed the expected returns and acknowledge their efforts in identifying, managing and enhancing the value of the asset.

22. Ratio Utility Billing Systems (RUBS): Ratio Utility Billing Systems (RUBS) is a technique that calculates the utility expenses of a tenant by taking into account various factors such as occupancy, apartment square footage, number of beds or a combination of these factors.

23. Sensitivity Analysis: Sensitivity analysis, also known as what-if or simulation analysis, involves predicting a specific outcome by altering various variables. This method is commonly used to demonstrate returns under different economic conditions, including adverse scenarios such as a downturn.

24. Syndicate: A syndicate is a group of individuals or organizations that combine their resources to raise capital for a multifamily property investment.

25. Value-Add: “Value-Add” refers to a property that has the potential to generate greater cash flows through various means such as renovations, rebranding or improved operational efficiency.

26. Waterfall: Reworded: In a multifamily deal, the waterfall refers to a system for distributing profits among the partners involved.