Typically, apartment syndicators will offer one compensation structure to their passive investors. A preferred return plus a profit split is most common.
The major drawback of this compensation structure is that it is a one-size fits-all approach. Accredited investors’ goals fall into one of two categories: (1) invest for ongoing cash flow and (2) invest for upside. By only offering one compensation structure, only one of these two goals can be achieved.
So, to offer investment opportunities that allow our investors to match their investment goals, we decided to offer a two-tiered investment structure: Class A and Class B.
In this blog post, I will outline the Class A and Class B compensations structures, as well as the pros and cons of each so that you can determine which offering is ideal for you.
What is Class A?
Class A investors sit behind the debt in the capital stack. Class A investors are offered a preferred return that is higher than the preferred return offered to Class B investors. Our Class A preferred return is prorated 10% paid out monthly (i.e., 10% of their investment divided by 12, or 0.83% each month). Class A investors have virtually no upside upon disposition or capital events, nor do they receive a split of the ongoing profits. However, in order to be taxed the same as Class B investors, Class A investors are provided with some (but very little) upside. In our deals, the Class A tier is limited to 15% to 25% of the total equity investment and the minimum investment per investor is $100,000.
Of course, other syndicators may offer a different preferred return or have different equity percentages and minimum investments for their Class A investors.
What is Class B?
Class B investors sit behind the Class A and in front of the General Partner in the capital stack. Class B investors are offered a preferred return that is lower than the preferred returned offered to Class A investors. Our Class B preferred return is a prorated 7% paid out monthly after Class A investors have received their prorated preferred return. If the full preferred return cannot be paid out each month (or each quarter, depending on the syndicator), it accrues over the life of the deal. Class B investors do participate in upside upon disposition or capital events. For our deals, Class B investors receive 70% of the profits up to a 13% IRR and 50% of the profits thereafter. The Class B minimum investment for our deals is $50,000 for first time investors and $25,000 for returning investors.
Like Class A, other syndicators may offer different preferred returns, profits splits, or have different minimum investments for their Class B investors.
Class A vs. Class B
Since Class A investors are in front of the Class B investors in the capital stack, they are paid first. Plus, the Class A investors are offered a higher preferred return. Therefore, the Class A tier is ideal for investors who prefer a stronger ongoing cashflow.
Since Class B investors are behind the Class A investors in the capital stack, they are paid what is left over after the Class A investors have received their preferred return. If the full preferred return isn’t met, it accrues and is (likely) paid out upon disposition or a capital event. Class B investors are offered a lower preferred return, but they participate in the upside upon disposition or capital events (i.e., supplemental loans or refinance). Since they participate in the upside, the overall return over the life of the profit is higher for Class B investors. Therefore, the Class B tier is ideal for investors who want to maximize their returns over the life of the investment.
“What if I want a strong ongoing cash flow AND participate in the upside?” For our deals, passive investors are allowed to invest in both Class A and Class B. For example, you can investor $75,000 as a Class A investor and $25,000 as a Class B investor.
Conclusion
Offering two or multiple tiers in apartment syndications allow passive investors to select the investment option that meets their financial goals.
For our deals, we offer a Class A and Class B tier. Class A Investors are offered a higher preferred return that is paid out first but do not participate in the upside. Class B investors are offered a lower preferred return that is paid out after Class A returns and do participate in the upside.
Class A is ideal for investors who want a stronger ongoing cash flow and Class B is ideal for investors who want a stronger return over the life of the deal.
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