You've done everything right: you decided to invest in a syndication, you planned out your area of investing (say, multi-family apartments in the Sunbelt of the United States), you researched and found a great syndicator, you invested $50,000 with them a few years ago, you collected monthly "mail box" money for a while... and then, out of the blue, you receive an email from the friendly syndication team with these beautiful words:
"Great news!!! We are under contract to sell the XYZ Property!"
Every syndication deal should have an exit plan. That "exit" should lead to a "liquidity event"--a moment in time when your illiquid investment becomes liquid again. You have a chance to get your original investment back in cash as well as some kind of a return.
To break this down: you want (at least) two things from a syndication investment.
- You want a return on capital. You expect that you have invested in a profitable enterprise, in this case an apartment building, and as such, you should be getting a percentage of those profits. That's return on your capital invested. That's the money you get each month deposited into your account. You also hope that there might be a return on capital that comes at the end of the investment. In the case of a multi-family apartment building, that return on capital at the end of the process comes largely from the appreciation of the property's value. (We will get into the way a syndicated property of this sort is valued in another post.) Imagine that the apartment building was worth $10,000,000 when you and your syndication partners bought it. If it gets sold for $15,000,000, then you will get a split of the resulting profit of $5,000,000, less expenses.
- You want a return of capital. Remember that first $50,000 you invested? You probably want that back at some point. So long as the investment doesn't have a negative return, you will get a return of your original capital. That can happen a variety of ways, but in the ordinary case, it will come back to you when the property is sold to another owner. You might also get cash out through a cash-out refinance or other liquidity event.
- Yes, you want some other things from your syndication investments, like ongoing tax benefits, but we're keeping this post simple for now.
Back to our story. Your friendly syndicators have succeeded in finding a buyer who is going to pay 50% more than you and your partners paid several years ago for the property. Due to the magic of leverage, you will get a very nice return from this sale. Given the number of variables that goes into calculating the amount that comes to you--such as the "split" negotiated at the front end between the General Partner and the Limited Partner, how much leverage was used in the deal, how much other money was invested, and so forth--it's impossible to say exactly what you'd get back, but let's imagine that between what you have gotten back in monthly "mail-box money" and what you get back in this final payment, you are earning more than 2x your original investment within a few years. Not bad, right?
The next email says:
"You can get a check for the proceeds or you can roll the investment into our next deal."
Your friendly syndicators have an offer for you. In this deal, let's imagine that you are getting a final payment at closing of your original $50,000 back plus a 50% return on that original investment of $25,000 = a total of $75,000. (In the example above, the amount would likely be more than this amount because you and your partners used leverage, but let's keep the numbers simple for now.)
You have (at least) two choices at this point in the process:
- You can say, "thanks so much. Here's my bank account number." They will send you a transfer (or check) in the amount of $75,000. Then: pop the Champagne! You've made a successful investment. You've gotten a return of your capital (in the amount of the original $50,000) plus a return on your capital (in the amount of $25,000 you didn't have before). Depending on many factors in your personal life, you most likely will have to pay taxes on the $25,000 of profit (please recall we cannot and do not give tax, legal, or investment advice on this site!).
- You can say, "nice work--and yes, please, let's re-invest in your next deal." In this case, you may be lucky enough to be working with a syndicator that is offering you a chance to invest in an excellent new deal that is similar enough to the previous deal to be able to qualify for a tax-free rollover into the new deal. We'll cover this process in more detail later on another post, but it's called a 1031 exchange. If you jump through all the hoops, you don't have to pay the tax on that $25,000 in tax right now--you are rolling the profit forward into a new deal. At least in theory, you could keep doing so in deal after deal and not pay the tax for a good long time, if ever. The most sophisticated real estate investors manage to avoid much if any taxation on their investment returns through consistent and clever use of the 1031 exchange process.
This is what it means to go "full cycle" on a deal. You invest, you get some mail box money along the way, and you make a nice profit upon the sale at the end. If you want the money back and feel like a big vacation or just prefer to move on, you can cash out. If you like the partners you are working with and they offer a 1031 exchange opportunity, you can roll the investment forward, defer some taxes to another day, and enjoy the rewards of a new investment with a higher basis (instead of being in the deal for just the original $50,000, you're now in the new deal with an invested amount of $75,000 in our hypothetical example--so your mail box money should be 50% higher as well, all things being equal).
How long does this take, you ask? Well, that definitely depends. It can happen as soon as after maybe a year at the soonest. In most deals involving multi-family apartments, the target is 3 to 5 years. Some might be 7 to 10 years. But unfortunately the honest answer is the dreaded "it depends." It depends on what your syndication team is going for, what the overall market conditions are like at the time, what the submarket is like at the time, and so forth.
If this is you and you are reading this post because it is happening to you and your investment--congratulations! We have been there and it is a great feeling. We look forward to you having this great feeling, too.