Investment returns in syndications are high due to four factors: cash flow, appreciation, tax advantages and scalability.

1. Cash flow

Passive investors make money from cash flow distributions which is usually dispersed on a quarterly basis. Cash flow is the money the asset generates after vacancy cost, operating expenses and mortgage are taken into account.

Once we have taken the Net Operating Income (NOI) and subtracted all expenses and debt service, it leaves us with our cash-on-cash returns. This allows investors to sit back and let their hard earned money work for them!

2. Forced appreciation

Depending on the business plan, most syndication deals are value add deals where sponsors improve the conditions of the commercial property and increase rent. Unlike residential real estate, which is valued based on comparable sales, commercial real estate is assessed based on Net Operating Income (NOI).

By improving operations, increasing rent and decreasing expenses, this forces the asset to appreciate in value (rather than waiting on market forces). This is similar to when businesses are valued on the amount of revenue they can generate, rather than comparing them with similar businesses in their industry.

3. Tax advantages

Passive investors also enjoy some of the tax benefits in investing in syndications through accelerated depreciation. A cost segregation study is performed by engineering firms to dissect the construction cost or purchase price that would otherwise be depreciated over 27.5 years (IRS benchmark for multifamily real estate).

This strategy allows for greater total depreciation in the first 5-7 years of buying the property. The depreciation amount allows investors to show a ‘paper loss’, however they can still enjoy distributions (tax free) until the sale of the property.

4. Scalability

Given the number of units, multifamily commercial properties allow for scalability, higher profits and minimizes risk. For real estate investors who manage their own rental properties, it can become a full time job, and unexpected costs to cover tenant vacancies or maintenance comes directly out of the owners pocket.

Multifamily properties (60 units and more) allow for economies of scale where it makes sense to hire a professional property management company to handle operations. This can include HR, accounting, marketing, leasing and professional maintenance companies, which are lifelines of the apartment business. Any costs are covered by the income the property generates and doesn’t affect the passive investor directly.

Multifamily properties also minimize risk by not relying solely on a handful of tenants. For a single family rental, if one tenant moves out, you will have $0 cash flow until a new tenant moves in. With multifamily properties, the financial impact of physical vacancy will not impact the bottom line as much and with a large team, another tenant is usually found quickly to fill the vacancy.