An accredited investor, in the context of a natural person, includes anyone who:
- Earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year, OR has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence)On the income test, the person must satisfy the thresholds for the three years consistently either alone or with a spouse, and cannot, for example, satisfy one year based on individual income and the next two years based on joint income with a spouse. The only exception is if a person is married within this period, in which case the person may satisfy the threshold on the basis of joint income for the years during which the person was married and on the basis of individual income for the other years.
- In addition, entities such as banks, partnerships, corporations, nonprofits and trusts may be accredited investors. Of the entities that would be considered accredited investors and depending on your circumstances, the following may be relevant to you:
Any trust, with total assets in excess of $5 million, not formed to specifically purchase the subject securities, whose purchase is directed by a sophisticated person, or
Any entity in which all of the equity owners are accredited investors.
A sophisticated person means the person must have, or the company or private fund offering the securities reasonably believes that this person has, sufficient knowledge and experience in financial and business matters to evaluate the merits and risks of the prospective investment.
For many this is a key metric for investing. Especially passive investors looking to capitalize on their investments in order to receive regular cash flows. It is a measure of an investment’s return and is applied to income producing assets. CoC is expressed as the ratio of the investment’s before tax cash flow divided by the amount of cash invested. For example if you invest $100,000 in an asset and receive total of $20,000 in a year then the CoC return, for that year, is 20% (CoC= 20,000/100,000).
Equity Multiple is a measure of an investment’s absolute return and is calculated as the total cash flows, received from an investment, divided by the total amount invested. For example, an Equity Multiple of 2.0 means that an investor received back the money they originally invested plus that same amount in returns. In other words, if you invested $100,000 and the EM is equal to 2, then you would have received your $100,000 back plus another $100,000.
An investor’s holding period is the amount of time for which an investor plans to hold an investment and can be expressed in either months or years. The holding period is a key consideration when considering any investment.
This is one that you'll need a computer to calculate. Or at least, you should. It’s calculated as the rate that sets the Net Present Value of an investment’s cash flows (positive or negative) equal to zero. IRR is used as a metric to estimate the profitability of potential investments. It becomes handy when you want to compare the potential return of an investment against the potential of another investment.
The research that an investor performs on a potential deal. This term is used in a number of cases and not just for financial analysis. But it is an important term when it comes to investing. Investors should perform extensive Due Diligence on any investment opportunity to determine if that opportunity is worth pursuing.
The GP makes money based on the value they bring to the deal. That value is usually expressed in a percent ownership of the deal. A more experienced GP, with a track record of success, usually brings more value to the partnership and would likely command a higher percentage. Less experience, lower percentage. For example, if a GP has a track record consisting of 10 successful deals with 12-18% Cash on Cash Returns and an Equity Multiple of 2x, inside 5 years, they will probably command 50% ownership of the deal. Similarly, a GP with 1 or 2, or even 0 deals, might command, less. Something like 30% of the deal. A question I often get, at this point in the process, is "If the GP did not invest in the deal, why such a high percentage". A good and fair question. What it comes down to is the GP paid for finding the deal, putting it together and the work required to execute the business plan. Which involves a great deal of work lining up resources, building a team to execute the plan, manage that team, manage expenses, etc. The take away here is that the GP has equity in the deal which is based on the work they do to make the whole thing happen and the experience they bring in ensuring that it happens well. The GP's equity incentivizes the GP to make sure the whole deal executes efficiently and maximizes profits so that everyone, including the LP, maximizes their return!
The LP makes money in a number of ways. They can make money through a Preferred Return, Profit Split and Refinance Proceeds. Refinance Proceeds are not uncommon but are not the most common terms provided to an LP. So let's focus on the other two. Preferred Return, is a return that the LP receives before the GP receives any payment. This is usually around 8% or so and is paid to the LP before any other profit distributions occur. Profit Spit, is the overall percentage each partner type owns. In a 50/50 profit split both the GP and LP are each entitled to 50% of the profits. In a 70/30 deal the LP is entitled to 70% of the profits while the GP is entitled to 30%. It's unusual for the LP to receive less than 50%. Let's take an example where the the LP has a preferred return of 8% and the profit split is 50/50. If the apartment cashflows more than 8% the LP receives their 8% distribution and any monthly profits remaining, after the 8%, is split 50/50 between the LP and GP. If the apartment's monthly cashflow is 8% or less, the LP receives a preferred return, up to 8%, but nothing would be left over to be distributed towards the profit split. In which case, the GP receives no distribution that month.
As a partner in the LLC that purchases the properties, you will receive a K-1. A K-1 is a tax form used by partnerships to provide investors with detailed information on their share of a partnership’s taxable income. Partnerships are generally not subject to federal or state income tax, but instead issue a K-1 to each investor to report his or her share of the partnership’s income, gains, losses, deductions and credits. The K-1s are provided to investors on an annual basis so that each investor can include K-1 amounts on his or her tax return.
