A real estate investment is one of the most effective ways for people to accumulate wealth. If you are seeking to be a passive multifamily property investor, there are many advantages in choosing a preferred return model of investment. While you do not need to be an expert in multifamily properties to be a passive investor, the preferred return model ensures you receive your profit before the general partnership does.
What is preferred return?
A preferred return refers to a model of profit-sharing in multifamily real estate investing. Preferred return, also called ‘pref,’ is the profit share received by preferred investors for a project. The term ‘preferred’ here denotes that these investors are the first ones to receive returns from the investment, which typically ranges between 5-10 percent. Once the preferred investor reaches this percentage of profit, the excess profits are then distributed between the limited and general partners per the operating agreement. Preferred returns are the most commonly used model of profit-sharing in multifamily syndication investments.
Preferred return is one of the most effective ways to compensate and reward investors who were the first investors willing to invest cash towards the property.
Who are multifamily passive investors?
Passive investors of multifamily properties are “limited partners,” and while they invest money with sponsors (also called general partners), they do not participate in the management of the property or make day to day decisions concerning the property. The person or company who puts the real estate transaction together is the the “sponsor/general partner.”
The Sponsor has the expertise and knowledge in multifamily real estate investing. They know how to find the multifamily property that has the maximum potential for profitability for passive investors to invest in. The sponsor is responsible for legal compliance, due diligence, renovations, executing the business plan and exit strategy for the property.
Calculating the preferred return
There is no predefined formula or template to calculate preferred returns in real estate. Each passive real estate investment is unique, and the terms are decided by the Sponsor. Some of the features of the investment that the passive investor needs to know are whether the returns are:
Non-compounded or compounded: A compounded return is the sum of invested capital plus unpaid amounts already earned. For non-compounded returns, only the invested capital is taken into consideration.
Non-cumulative or cumulative: A cumulative return is where any unpaid earned money is carried forward to the next period, while for non-cumulative returns, there is no carry-over.
Pari Passu versus true preferred return: The Latin term “Pari Passu” translates to ‘equal footing.’ If the passive investor receives the preferred return first, it is termed as true return, when both the investor and sponsor receive the preferred return at the same time for the same amount, it is termed Pari-Passu return.
Why do passive multifamily property investors love preferred return?
Clearly, preferred return investment has significant advantages over other types of investment for the passive investor. These investors are given the distribution preference for profit while they do not have the hassles of active property management or limited liability. The returns on an annual basis can be above 7%, which is a great return without the active involvement or expenditure of time and effort.
-The Multifamily Team
Hi, my name is Michael Avent. I founded The Multifamily Review in June 2020. I’m a Commercial Agent at Northcap Multifamily located in Las Vegas, Nevada. My vision for The Multifamily Review is to be the most trusted resource for all Multifamily Investors and Industry Professionals. We strive to offer the best and most up to date content to our readers and are always open for suggestions. Make sure you sign up to join our newsletter to stay up to date on our latest blog, ebook, and more exclusive content that’s coming your way! The Multifamily Review team and I look forward to building a deeper relationship with you!
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