May 2024 | Volume 13

KNOWLEDGE HUB: INSIGHTS AND INFORMATION

Understanding Capital Returns in Syndications: Cash Flow, Refinances, and Sales

 

Investing in syndications offers a variety of mechanisms for returning capital to investors. These mechanisms are essential for understanding how your investments will generate income and eventually return your initial capital. This article delves into three primary methods syndications use to return capital: cash flow distributions, refinancing, and sales of assets.

 

1. Cash Flow Distributions

One of the most straightforward and appealing methods of capital return in syndications is through regular cash flow distributions. These distributions typically come from the net operating income (NOI) generated by the asset.

How It Works:

• Rental Income: For real estate syndications, rental properties generate monthly or quarterly rental income. After deducting operating expenses and debt service, the remaining net income is distributed to investors.

• Preferred Returns: Many syndications offer a preferred return, ensuring that investors receive a predetermined return on their investment before any profits are shared with the general partners. This preferred return provides a safety cushion, ensuring investors receive steady income before the sponsors take their share.

Benefits:

• Regular Income: Investors benefit from a steady stream of income, enhancing liquidity and providing a predictable return.

• Early Return on Investment: Regular cash flow helps in recovering part of the invested capital sooner rather than later.

   

2. Refinancing

Refinancing is a strategic approach that allows syndications to return a portion or all of the investors' capital without selling the asset. This is particularly common when the asset has appreciated in value or when favorable financing terms are available.

How It Works:

• Increased Property Value: Over time, the property’s value may increase due to market appreciation, improvements made by the syndicate, or increased rental income.

• New Loan: The syndicate takes out a new loan based on the higher property value. The proceeds from this new loan are used to pay off the existing mortgage and return capital to investors.

• Maintained Ownership: Investors retain their equity stake in the property, continuing to benefit from future cash flows and appreciation.

Benefits:

• Return of Capital: Investors can recover a significant portion of their initial investment while still holding an ownership stake.

• Tax Efficiency: The proceeds from refinancing are generally not taxable, as they are considered loan proceeds rather than income.

 

3. Sale of Asset

Selling the asset is the most definitive way to return capital to investors and often occurs at the end of the syndication’s lifecycle.

How It Works:

• Disposition: The property or asset is sold, ideally at a higher value than the purchase price, capitalizing on market appreciation and value-add strategies implemented by the syndicate.

• Proceeds Distribution: The proceeds from the sale are used to pay off any remaining debts and expenses. The remaining profits are then distributed to investors, usually after meeting any preferred return thresholds.

Benefits:

• Significant Returns: Sales typically provide a lump sum return, which can include the return of initial capital plus substantial profits.

• Completion of Investment Cycle: This method provides a clear endpoint for the investment, allowing investors to realize the full return on their investment and reinvest in new opportunities.

 

Conclusion

Understanding these methods—cash flow distributions, refinancing, and sales—is crucial for investors in syndications. As described in the last newsletter, Lonicera has used both cash flow and a refinance of Lonicera Fund I to return all of the investors' capital. Each of these three methods will be used in each Fund to ensure their capital is returned to them. By employing these strategies, Lonicera aims to provide consistent and reliable returns, maintaining investor confidence and satisfaction throughout the lifecycle of each investment.