Where Does Cash Flow In A Real Estate Syndication Actually Come From?

Are you considering investing in a real estate syndication but are leery that it sounds a little too good to be true? You are not alone.

Many investors are shocked when they first learn about the potential cash flow returns, they

could receive through investing passively in real estate syndications.

The key, though, to putting your doubts and skepticism to rest, is to understand where that cash flow comes from and how it makes its way from the asset itself to your pocket, and that is exactly what we will cover in this article.

Cash Flow Distributions

Typically, within the first few months after closing, you can expect to start seeing monthly cash flow distributions - your new stream of passive income!

But how is it that these investments are so lucrative? Where does the money really come from?

Where Cash Flow Comes From

Every investment property, no matter the size or number of tenants, is an asset that generates income as well as expenses. Let us talk about how apartment complexes generate income, the expenses they typically incur, and how cash flow is calculated.

Gross Potential Income

In the case of an apartment building, the main source of income is the tenants’ rent that is due each month.

As an example, let us say the average rent in a 100-unit building is $800. That means the gross potential income is $80,000 per month, which comes out to $960,000 per year.

Monthly Gross Potential Income

100 units x $800 each = $80,000 per month

Annual Gross Potential Income

$80,000 per month x 12 months = $960,000 per year

Now, do not get too excited. I hate to break it to you, but that $960,000 is the gross POTENTIAL income for the whole complex assuming 0% vacancy and full rent payments with no expenses, deals, or discounts (e.g., “first month’s rent free!”).

Net Rental Income

Vacancy costs, loss to lease, and concessions decrease the potential income, and once they

are removed, you’re left with something called net rental income.

Assuming only 10% of the units are vacant (i.e., in a 100 apartment complex, only 10 are

empty), at $800 a month, the monthly vacancy cost would be $8,000.

Vacancy Cost

10 units vacant x $800 in lost rent per unit = $8,000 vacancy cost per month

If the vacancy rate remains constant throughout the year, the annual vacancy cost would be

$96,000.

$8,000 per month x 12 months = $96,000 per year

Net Rental Income

Remember, to get the net rental income, we must take the gross potential income (the total

income if all units were filled) and subtract out the vacancy cost.

$960,000 annual gross potential income – $96,000 annual vacancy cost = $864,000 annual net rental income

Operating Expenses

Do not forget, there are business expenses too.

Operating expenses like maintenance, repairs, property management, cleaning, landscaping,

utilities, legal and bank fees, pest control, etc. must be paid. No two apartment buildings have

the same needs or the same expense structure.

Let us presume that total projected monthly operating expenses equal $38,000, which works out to $456,000 per year. The sponsor team would work toward reducing these expenses over time, but we will use this figure as a starting point.

Annual Operating Expenses

$38,000 monthly operating expenses x 12 months = $456,000 annual operating expenses

Net Operating Income (NOI)

NOI or Net Operating Income is what is left from the net rental income after operating expenses are removed.

$864,000 net rental income – $456,000 operating expenses = $408,000 NOI

If you are a little confused at this point it’s okay! There are a lot of numbers here. The important thing to remember is that you want the NOI to be a positive number and as high as possible, meaning that the asset has the potential to generate a profit and thus create those cash flow distributions that got you into this in the first place.

Mortgage

Next, let’s talk about the mortgage. As with any property purchase, you have got to pay the lender back. Much like in a single-family home purchase, a loan on a commercial property consists of a down payment and a loan amount – usually around 25% down and 75% leveraged – and the loan would need to be paid back through monthly principal and interest payments.

In this case, let us say the group owes $20,000 each month (which is $240,000 per year) in

mortgage payments.

Annual Mortgage Payments

$20,000 monthly mortgage x 12 months = $240,000 annual mortgage payments

Cash Flow / Cash on Cash Returns

Now that we have subtracted the expenses from the income, we arrive at our cash flow for the first year.

Keep in mind that a number of factors can change in subsequent years as the sponsor team

optimizes the property and its expenses, so the cash flow figures tend to increase over time,

though this is not guaranteed.

First-Year Total Cash Flow

$408,000 NOI – $240,000 mortgage = $168,000 first-year total cash flow

This amount is then split up, according to the agreed-upon structure for the deal. Assuming this deal uses an 80/20 deal structure, 80% of the profits go to the investors (i.e., the limited

partners), and 20% goes to the sponsor team (i.e., the general partners).

First Year Cash Flow to Investors

$168,000 first-year cash flow x 80% = $134,400 first-year cash flow to investors

Depending on your level of investment, you would get a share of that cash flow each month, in the form of a distribution check or direct deposit.

Your Monthly Cash Flow Distribution Checks

If you had invested $100,000 into this deal, you might expect a $667 check each month, which works out to $8,628 for the year.

Recap

So there you have it. The cash flow that arrives in your bank account each month originates

from the rent that the tenants pay. Then, we deduct the expenses, pay the mortgage, taxes, and insurance, and what is left over is then divided and shared with investors.

Is this passive income guaranteed? Absolutely not.

Considering all the variables - location, team members, tenants, economy, and MUCH more -

it is important to keep in mind that these are, although useful numbers, just estimates.

Projections are fun to track but should never be taken as absolute truth.

However, now that you have a better understanding of where the cash flow in a real estate

syndication comes from, you should be able to more thoroughly understand and vet the figures you see in the pro forma and investment summary, which will lead you to make wiser investing decisions.