Investor distribution FAQ. That’s the topic for today’s Syndication School, I don’t think I need to explain much more about what’s inside this value packed episode. Without further ado, hit play and learn the next step of the apartment syndication process. If you enjoyed today’s episode remember to subscribe in iTunes and leave us a review!
Best Ever Tweet:
“You pay the preferred return to investors, after that, the profits get split”
Free Document:
http://bit.ly/weeklyperformancereview
Evicting a tenant can be painful, costing as much as $10,000 in court costs and legal fees, and take as long as four weeks to complete.
TransUnion SmartMove’s online tenant screening solution can help you quickly understand if you’re getting a reliable tenant, which can help you avoid potential problems such as non-payment and evictions. For a limited time, listeners of this podcast are invited to try SmartMove tenant screening for 25% off.
Go to tenantscreening.com and enter code FAIRLESS for 25% off your next screening.
TRANSCRIPTION
Joe Fairless: There needed to be a resource on apartment syndication that not only talked about each aspect of the syndication process, but how to actually do each of the things, and go into it in detail… And we thought “Hey, why not make it free, too?” That’s why we launched Syndication School.
Theo Hicks will go through a particular aspect of apartment syndication on today’s episode, and get into the details of how to do that particular thing. Enjoy this episode, and for more on apartment syndication and how to do things, go to apartmentsyndication.com, or to learn more about the Apartment Syndication School, go to syndicationschool.com, so you can listen to all the previous episodes.
Theo Hicks: Hi, Best Ever listeners. Welcome back to another episode of the Syndication School series, a free resource focused on the how-to’s of apartment syndication. As always, I am your host, Theo Hicks.
Each week we air two podcast episodes – now they’re also in video form as well, on YouTube – that are part of a larger podcast or video series that’s focused on a specific aspect of the apartment syndication investment strategy. For all of these series we offer some sort of PDF document, an Excel template, a PowerPoint presentation template, some sort of resource for you to download for free. All of these free documents, as well as past and future Syndication School series can be found at SyndicationSchool.com.
This week and this episode is going to be a continuation of a series entitled “How to asset-manage a newly-acquired apartment syndication deal.” This is part nine. This is gonna be a ten-part series, so we’re gonna end it in the next episode that we do for the Syndication School. If you haven’t done so already, I highly recommend listening to parts one through eight. Again, those are available at SyndicationSchool.com.
The episodes for this series can be seen as a standalone after you go through parts one through three. So at the very least listen to parts one through three, where you learned the top ten asset management duties – the ten things that you need to do in order to execute the business plan successfully after you’ve closed and before you sell. So that’s parts one through three.
Then in parts four through eight we went into more details on those ten asset management duties. In part four we discussed in more detail how to maintain the economic occupancy – the rate of paying residents – and we went over 19 different ways to market your rental listings and make sure that you are attracting the right residents to your property.
Parts five and six were all about the property management company. In part five we talked about some tips on how to effectively manage a property management company… Because in reality, one of the main duties of the asset manager is to manage the property management company who’s actually at the property on a daily basis.
Then in part six we talked about what happens if you’ve determined that your property management company is not doing what they’re supposed to be doing, and what they’re supposed to be doing we discussed in that episode as well. If that happens and you need to fire them, how to go about doing that so that the transition from the old management company to the new management company is as smooth as possible.
Then in parts seven and eight we focused even more on how to maintain that economic occupancy, because at the end of the day the economic occupancy is going to determine how much money you can distribute to your investors.
So in part seven we talked about how you can attract high-quality residents to your apartment community, and then in part eight we talked about some resident appreciation ideas for how you can actually retain these high-quality residents once you’ve attracted them and gotten them into the actual building.
In this episode, part nine, we’re going to go over some questions that you might have about distributing the money to your investors. So we’re gonna go over eight different questions that you might have, or eight frequently asked questions that we received about the logistics and how to go about distributing your money to your investors.
And for the purposes of this episode, we’re going to assume that the structure you have with your passive investors is a preferred return and then a profit split. We’re gonna assume that you have an 8% preferred return, and then after that the remaining profits are split 70/30; 70% of the profits go to the limited partners or the investors, 30% go to you, the GP. Just because I’m gonna use some examples and some numbers, and I don’t want to have to give a million different calculations, we’re gonna assume 8% preferred return, 70/30 split.
Now, we’re not gonna talk about how to structure the actual partnership, so why we’ve selected this 8%, 70/30. That’s in a previous episode, where we’ve talked about creating your team, attracting investors, setting up the compensation structure, and at this point in the process your passive investors have already agreed to the compensation structure, because they’ve invested their money in the deal. The deal is closed, and now they are getting their distribution, so here are some things you should think about, or questions you might have about how to actually go about distributing the money to your investors. Again, these are eight questions.
Number one is “How do you know if you can make a distribution?” First you have to know where the distributions come from. The distributions come out of the cashflow. The cashflow is calculated by essentially all of the income, minus all of the operating expenses, so things like maintenance and repairs, payroll costs, paying the property management company, taxes, insurance etc. We talked about during the underwriting section. And then the debt service as well is taken out of the income; it’s the monthly payment to your lender for the loan, to service the debt. That cashflow number should be calculated for you automatically on your profit & loss statement that is provided to you by your management company. Then below that they might have some non-operating expenses, like any interest that’s accrued and the asset management fees that are paid out, any lender reserves that are saved, things like that. So that cashflow is what the distributions come out of.
In order to calculate how much money you need to distribute, you need to know how much money was invested in the deal. That initial preferred return is what the investors receive first. Let’s say for example you’ve got a limited partner who invests $100,000 into the deal. 8% preferred return is $8,000 per year. Then depending on your frequency of distributions, that could be $666,67 per month, or that could be 2k every single quarter, or it could be a lump sum of 8k per year.
Knowing whether or not you can make a distribution actually depends on the frequency. Because just because you would have in this example $8,000 in cashflow cumulatively for the entire year, but maybe it increases gradually throughout the year. So maybe the first six months is below 8%, and then the next six months is above 8%.
If you’re doing annual – great; if you’re doing monthly, you might run into an issue where you can’t distribute the full 8%; obviously, pro-rated, so 8% divided by 12 months, each month.
Let’s say you’ve got ten investors who all invested $100,000, a million dollar investment. That means that you need to distribute, at the 8% preferred return, $80,000 a year. That’s a million dollars times 8%, equals $80,000. The same logic applies that I mentioned before about the monthly versus quarterly versus annually.
Now, let’s say that that property cashflow is 80k. 80k divided by 12 each month, and you’re doing monthly distributions – then you know “Yes, I know I can distribute the 8% to my investors.”
Now let’s say that it does more than $80,000 that year. Then you distribute the 8%, and then you can distribute the additional profits based on what the profit split is.
Now, what happens if it cash-flows below 80k? Let’s say it cash-flows 60k. Then you can only distribute 60k, because that’s all you have; the investors technically didn’t hit the preferred return, so at that point it either rolls over to the next year, or it rolls over to the sale, depending on how it was outlined in the PPM, and you can’t make that distribution.
Again, the question is “How do I know if I can make the distribution?” That’s the long way of saying whatever the initial investment was, multiply that by your preferred return; that’s how much money your property needs to cash-flow for that year. If it does, the answer is “Yes, I can.” If it doesn’t, the answer is “No, I can’t.”
Number two, what happens if I cannot make a distribution? I guess I kind of already answered this. Following the example from before, if you need to cashflow $80,000 to hit the distribution number, but you only cash-flowed $60,000, then that gap of 20k can either roll over into the next year, or it can roll over at the closing. So when you close on the property, assuming, you have this catch-up provision in your PPM, however it’s outlined… If it’s at closing, then once you pay off the debt, you pay off the closing costs, whatever that lump sum profit is before it gets split between you and the investors, you have to pay that preferred return; then after that, those remaining profits will get split. But again, the process is whatever you have outlined in the operating agreement, the PPM, with your investors.
So it’s something you need to think about before you close on the deal, and figure out “Okay, if we cannot hit a distribution, what do we do? Is there a catch-up provision? Do we just never pay it out? What are we going to do?”
Number three, how do I calculate the distributions? I’ve already mentioned this as well – it is based on the preferred return that you offer to your investors, and their additional investment amount. So you take the initial investment amount and you multiply it by whatever that preferred return is, and that’s the annual return that they get. So if you’re doing quarterly distributions, you divide that number by four and distribute that quarterly. So $80,000 – that’d be 20k per quarter. If you’re doing monthly, then it’d be $80,000 divided by 12, which is the $6,666,67 number.
Obviously, if you’ve got ten investors, you divide that by ten, and each of those ten investors get their chunk. So it’s based on how much money that they actually invested times the preferred return, and that’s the annual distribution they get.
Number four is when do I pay out the actual distributions? As I mentioned, obviously you’ve got that preferred return if 8%, but what happens if the deal cash-flows 10%? What happens with that extra 2%? The answer is you don’t just get it; it’s based on the compensation structure. In this example that we talked about, the compensation structure, the profit split is 70/30. So of that 2%, the passive investors get 70% and you get 30%.
Logistically, what Joe does – for the first 12 months of the deal, so month one through twelve, he’ll just distribute the 8% prorated. Each month will get 8% divided by 12, multiplied by their investment. So $100,000 investment – that’s $666,67/month. Then at the end of a full 12 month of ownership, they will evaluate the profit and loss statement, as well as their bank statements, see their cash balance, things like that, and see how much money they cash-flowed above that 8%. Then whatever that is, the investors will get 70% of that, or how you structured the deal.
Let’s say for example you have ten investors who invested $100,000 each, at an 8% preferred return, and the property cash-flowed $100,000 year one. That’s 10%. So you distribute the 8% each month, and at the end you say “Okay, we’ve got $20,000 remaining. That means that each investor will get 70% of that $20,000.
So if you have ten investors, each of those investors will get $1,400 each. That’s calculated by $100,000 cashflow minus the $80,000 you’ve already distributed, which is $20,000. And then $20,000 multiplied by 70%, which is their portion of the profit split, is $14,000. If you’ve got ten investors, 14k divided by ten equals $1,400.
Then for your investors, this would actually equal 9.4% return for year one, because they got that 8k plus 1,4k. That’s $9,400, divided by their initial investment of $100,000, which is 9.4%. So you can say to your investors, “Hey, we’ve projected 8% for year one, but we were actually able to distribute 9.4%, and you’re gonna get an extra $1,400 for your first distribution of the year two.”
Question number five, who sends out these distributions? We’ve already talked about this before in parts one through three, when we talked about the asset management duties, as well as part five, where we talked about how to manage your property management company. The answer is ideally, your property management company is the party responsible for sending out these monthly distributions, or quarterly distributions, or annual distributions.
Obviously, you tell them “Hey, this is how much we distribute”, but logistically, they’re the ones that are actually sending out the checks and sending out the direct deposits to your investors, so you wanna make sure that you have set expectations with your property management company about these distributions before you’ve closed on the deal. So let them know “Hey, we wanna send out distributions via check, or direct deposit, on a monthly basis. It should be this much, but each month we’ll confirm that with you. At the end of 12 months of ownership, we want to reevaluate the performance and I want you to let us know how much money we can distribute extra. That will be distributed the same way as the regular distributions – direct deposit or check in the mail.”
Question number six, when do I send out the first distribution? Generally, Joe sends out the first distribution at the end of the third month of ownership, and it’ll cover the time that the property was owned during that first month and the second month.
As an example, let’s say that the property was closed on January 15th. Then the first distribution will be send at the end of the third month, which is going to be March, and it’ll cover the time the property was owned from January 15th to February 28th. So it’ll be a full month, plus half a month. Then after that, each distribution will cover one month fully, and then it will be sent at the end of the following month. So the distribution that covers the month of March will be sent by the end of April.
That just gives your property management company time to send out distributions, make sure the money is there… So you don’t wanna send that March distribution at the end of March, because you might not have collected all of the money, you might not have paid all of your bills until maybe mid-April. So you make sure all of your ducks are in a row before you send out those distributions.
And then of course, make sure that when you’re setting expectations with your investors, they know that the first distribution is going to be a little bit larger, just because it’s covering multiple months of ownership.
Second to last question, number seven, is how do I send the distribution? I’ve kind of already mentioned this, but the two main ways to send distributions are 1) direct deposit, or 2) check in the mail. You can either just send them via direct deposit, you can either send them just through the mail, or you can do a combination of both and let your investors pick an option. But as I said before, make sure that your property management company is capable of doing whatever method your investors want, or whatever method you decide on.
If they, for some reason, don’t wanna send out checks, then you can’t offer checks to your investors. If for some reason they don’t wanna do direct deposits, then you can’t offer direct deposits to your investors. The last thing you wanna do is have them fill a direct deposit sheet, you tell them that they’re gonna get their first distribution by the end of March, for example, and then when the time comes, your property management company says “Hey, by the way, we can’t send out direct deposit, we can only do check in the mail.” Then you have to go back to your investors and let them know why they can’t get direct deposit, which makes you look bad, it makes everyone look bad… So make sure that you know exactly how your management company can send these distributions before you set that up with your investors.
And then lastly, question number eight, which might be the most important question to you, I don’t know – it is “When do you actually get paid?” So depending on how you structured the deal with your investors, you might get an acquisition fee, which you would be paid at closing. You might have some other fee that you charge for putting the deal together, and you collect all those fees at closing. So think of it as similar to the broker’s commission. They get their check at closing, you get your check at closing.
From an ongoing distribution perspective, you might get paid an asset management fee each month, or each quarter, depending on how you decide to set up these distributions with your investors. If you have an asset management fee, that’s considered a non-operating expense. What Joe does is he puts that in second position to the preferred return, which means that if the investors don’t get their preferred return, then Joe doesn’t get his asset management fee… Which is a little bit extra alignment of interests with the investors, to say “Hey, I’m not getting paid unless we get paid. I’d rather invest with someone like that, than someone who takes their money first and then tells me that they can’t pay me because they took 2% out of the deal already for themselves.”
So whatever that percentage is, you want to collect that after you’ve sent out the preferred return, if that’s what you want to do, and if you want to have that alignment of interest with your investors.
The other way you’ll get paid on an ongoing basis is if you’re able to exceed that preferred return. Again, you can do this on a monthly basis or you can do it whenever you calculate the extra distributions you send to your investors.
Going back to our previous example of the preferred return being 8%, so you owe your investors 80k per year, but the property cash-flows 100k, so 14k of that extra 20k, which is 70%, goes to your investors; the 6k which is the 30% go to you. So you’re gonna collect that each month, each quarter, or you can collect that once you send out that 14k to your investors.
And of course, you’ll get paid at closing based on that profit split as well. So if there’s a million dollars of sales proceeds after paying everything off, the investors get 70% of that, which is $700,000, and then you, the GP, gets $300,000.
Those are some of the questions that you might have about investor distributions. Some things we haven’t exactly talked about yet, kind of going into the details of the logistics behind how you actually calculate distributions, how you send them out, what happens if you can’t hit them, what happens if you exceed your cashflow amount, how do you approach that… So we’ve hit on all of those in this episode.
If you have any other questions about distributions, feel free to email me, theo@joefairless.com. I’ll be happy to answer those for you, or make them a topic of a future Syndication School series.
Now, this concludes part nine. I’m really excited, because tomorrow is going to be part ten, and that will be the conclusion of the second-to-last step of the syndication process, which is the asset managing a newly-acquired apartment syndication deal.
Tomorrow we’re gonna talk about how to secure a supplemental loan. We’ll talk about what that is and how to do that tomorrow. Then next week is going to be the start of the last series, and in fact it’s probably just going to be a two-part series, which is how to sell your apartment community at the end of the business plan. That will conclude the entire apartment syndication cycle.
At that point, we will just kind of go back over the entire cycle and focus in more detail on certain aspects of the process, but by the end of next week you should have an entire overview of the entire apartment syndication process, from start to finish. I think it’s 21 series that have between two episodes – and this one’s the longest, so ten episodes. Hundreds of hours of content that teaches you the how-to’s of apartment syndications, and at least 21 free documents as well. All of those are available at SyndicationSchool.com.
Thank you for listening, and we will talk to you tomorrow.
