Passive Investing – Class A and Class B Shares in Real Estate Syndication

It is becoming more common for real estate syndicators to create multiple classes of investors. Some investors like immediate cash flow, and some prefer growth. Giving investors these options can make deals more attractive and target a wider audience of investor profiles. Below we break down the Class A (cash flow focus) and Class B (equity and growth focus) type of investing classes in a passive real estate syndication deal.

The Class A Investor – Cash Flow Focused

The A-Class investor intends to live off the cash flow right now. These get a higher immediate return than Class B investors, but do not participate in the sale proceeds. They might be retired or simply looking to reduce their hours at a full-time job, and they’re looking for a more reliable source of cash than CDs or bank savings accounts. In our approach, we create a Class A equity investor who receives a 10% preferred return (paid immediately) throughout the term of the hold – say, 5 to 7 years – but no returns above their initial investment at the sale of the property. As a limited equity partner, they are eligible for all tax benefits and deductions. As a Class A (prioritized over all other classes of investors on payouts), the consistency of meeting the 10% mark is exceptionally high. It’s not a guarantee, but it’s extremely close. Why? Typically syndicators will limit Class A shares to under 25% of the equity in the deal, Class B is 75%.

The Class B Investor – Participates in Equity Growth

The B Class investor gives up some cash flow to Class A, say 6% annual cash on cash and 7% preferred return over the hold period, but they get all the upside of a sale, resulting in a 15 percent to 16 percent internal rate of return (IRR) up to an 18 to 20% average annual return, which is higher than a blended deal rate and right on par with the returns growth investors expect. Class B investors sit behind Class A investors but in front of the General Partners in the syndication company in the deal. They get paid their preferred return before the General Partners get paid.

Blended Approach – Class A and B mix

Finally, the investor might hedge their chances by investing 25 percent to 75 percent in Class A and 75 percent to 25 percent in Class B, or 50 percent in one and 50 percent in the other. You can select between a prudent and high cash flow of 10% yearly for 4 to 5 years or growth if you don’t need or want a lot of passive income right now, even though a 7% preferred return with a 6% cash on cash is still a respectable return considering the tax benefits and current bank money rates.

Offering multiple share tiers and types in an apartment syndication deal gives investors the optionality to select what best meets their goals. Many deals in late 2021 and 2022 now start with a lower cash flow in year 1 and work their way upward in years 3-5. Some investors choose to take a blended approach so that they can participate in the upside while getting higher cash flow early on. What is your approach?

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