The EQUALIZER™
PRIOR STEP: THE MATH
The EQUALIZER™ is meant to be used as a "screening" technique, which will help you to sort through multiple deals you may be considering at one time. While there are other factors that will likely ultimately impact the actual/future results, we will address those with other analytical tools (and "Math" sites coming soon) to undertake due diligence and, assuming you make the decision to invest, the interim, by interpreting the ongoing financial reporting of the Partnership.
Debt terms undertaken to acquire the property(s), the level of sponsor fees, the property's actual future financial performance, including the relative allocations of cash flows to the Passive Partners vs. the Sponsor (including overrides) and, in some cases, the tax laws, are additional factors that are NOT addressed by this basic "sanity check" tool.
The EQUALIZER™ is very straight forward: If the gross "partnership purchase price" is relatively too high (i.e. a low EQUALIZER™), then consider your other options, because there is likely no "magic sauce" that will change the ultimate outcome.
Three data elements are needed for calculating the EQUALIZER™
(1) Net Operating Income ("NOI")
(2) Total Equity Contributions to the Partnership
(3) The amount of leverage (loans) used by the Partnership (mortgages loans, sponsor advances etc.). This amount includes ALL debt for which the Partnership is responsible for repayment.
THE FORMULA:
NOI* / (Total Present Value of ALL Cash Contributions + the Principal Amount of ALL Outstanding Debt)
* Use the first full year of ownership, post-stabilization, usually this will be Year 2.
The total capitalization of the Partnership is the amount that the property acquisition(s) must be worth on sale for investors to get their money back (ignoring accrued items).
The total capitalization of the Partnership is the capital contributions ("Equity") added to the total debt ("Debt") of the partnership. Equity contributions to the partnership are the present value of all cash contributions by the Partners (Passive and Active [Lead] Partner(s), including the present value of interest paid on deferred contributions (if any), syndicator expense reimbursements, or other deferred amounts the Partnership is obligated to pay that are known at the time of calculation.
The EQUALIZER™ is a "current yield". Think of it as the cap rate of the property figured at the "partnership" level. The higher the EQUALIZER™, or current yield, the better the deal.
NOTE: The EQUALIZER™ does not predict the rate of return on investment. Over time, the cash flow, appreciation, and in some cases, tax benefits must be considered to calculate the rate of return (see the Next Step below, Rate of Return).
That said, the EQUALIZER™ is an easy method to compare "partnership purchase prices" at the time you are considering alternative real estate investment opportunities.