Financing the 1st apartment deal

[Sid23]

Let's say I found 30-unit apartment deal that I could acquire for $1M. I have 10 friends willing to invest ~$20k each to reach a ~$200k down payment. I’d be looking for a 70-80% loan.

I have over 4 years experience working on development and apartment acquisition deals, though never as a principal or partner in the deal. I would have a detailed business plan with all aspects of the project, strategy and financials outlined in gret detail.

I have 710 personal credit, but do not own a home, nor have I ever owned a piece of real estate. I know it’s said that commercial lenders only look at the property, but every deal I’ve been a part of here, my boss’s personal finances are reviewed in depth by the lenders. Granted, we get construction loans mostly, but even when we get acquisition loans with a portion set aside for improvements, their personal financials are required.

Once the economy clears up a bit (I’m not expecting a loan in this market), how realistic is it for me to think I could get the deal financed as the person running the deal? Would I be looking at a recourse deal for sure? What if I have a negative net worth with minimal assets – what is there to take from me?

 

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[Jito]

Are you talking about a syndication?

 

[Sid23]

Are you talking about a syndication?

To be honest, I'm not sure. I just know there are ways to combine monies for the purposes of acquisition. I'm not sure if it would be a syndication, held as a TIC, or what.

Does it matter how you do it for purposes of financing?

 

[Jito]

What I am seeing is this - first you have to find a lender that likes the area the property is in. They will then look at the income/expense and use their numbers to make sure it pencils out to their guidelines for DSCR etc.

They will want to see experience with Real Estate, tax returns, personal financial statements, schedule of real estate owned. Basically full disclosure. Sorry I can't be more specific, but financing is now done on a personal basis as the CMBS market is all but dried up for now.

Also depends on where this property is located. Prime Bay Area locations expect 50% LTV, B locations 25-30%, but as prices decline in less than A+ neighborhoods so does the down payment.

 

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[hatterasguy]

If your boss has experiance and contacts why not bring him in as a partner on the first couple? This might be a good way for you to get started.

I'd look into hard money too.

 

[Sid23]

If your boss has experiance and contacts why not bring him in as a partner on the first couple? This might be a good way for you to get started.

I'd look into hard money too.

Great ideas, thanks.

 

[hakrjak]

You'll need more than the 20% down... You also need money for the account the lender will make you set up to put your operating money into. On this size deal it will probably be about $100k?

Cheers,

- Hakrjak

 

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[Sid23]

You'll need more than the 20% down... You also need money for the account the lender will make you set up to put your operating money into. On this size deal it will probably be about $100k?

Cheers,

- Hakrjak

$100k for operating in addition to the $200k+ needed for the down payment?

 

[RealOG]

Sid23,

How timely this question is. There were lots of conversations about this at B&P 2009, you missed a potential solution to your issue.

What I have found for small deals is that lenders look at the following in the following order:

1. The terms of the loan. Your down payment, DSCR, amortization, etc, will be prescribed to you. Sometimes you can negotiate these terms, but with a low loan amount it may be difficult.
2. The property's performance. The real performance, verifiable with bank records and ledgers. Not the "performance" the seller states.
3. Principals' experience. You may need to submit a resume and they may interview you. If you are lacking any necessary skills, make sure you are aligned with someone who can pick up the slack.
4. Principals' balance sheets. They will try to make you personally liable for the loan, especially if it is small. It helps lower their risk as the lower loan amounts seem to have a higher rate of default.

Good luck with you pursuit, the smaller buildings are a good way to get your "learn" on before moving to the big stuff.

 

[Sid23]

Sid23,

How timely this question is. There were lots of conversations about this at B&P 2009, you missed a potential solution to your issue.


What I have found for small deals is that lenders look at the following in the following order:

1. The terms of the loan. Your down payment, DSCR, amortization, etc, will be prescribed to you. Sometimes you can negotiate these terms, but with a low loan amount it may be difficult.
2. The property's performance. The real performance, verifiable with bank records and ledgers. Not the "performance" the seller states.
3. Principals' experience. You may need to submit a resume and they may interview you. If you are lacking any necessary skills, make sure you are aligned with someone who can pick up the slack.
4. Principals' balance sheets. They will try to make you personally liable for the loan, especially if it is small. It helps lower their risk as the lower loan amounts seem to have a higher rate of default.

Good luck with you pursuit, the smaller buildings are a good way to get your "learn" on before moving to the big stuff.

RealOG,

Thanks for your reply. I'm clear on numbers 1-3, but #4 gets at the heart of my initial question. If I show a lender good things on numbers 1-3, how important is #4?

Basically, I have a negative net worth and a poor balance sheet. I have nothing for them to take. I do have above average credit, though. WILL THIS KILL MY ABILITY TO GET FINANCED?

Thanks,
Sid23

 

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[RealOG]

You may run into difficulties with financing. The banks rationale will be: if you have problems managing your own finances, how will you be able to manage an apartment's finances?

This is where getting them on the phone, writing a letter, or otherwise is important. Having a conversation with them may help them alleviate the risk you represent. A balance sheet doesnt show your mental capabilities, maturity in dealing with problems, and people skills.

My thought: it will present a problem, so do whatever you can to get in front of them.

Your best chance will be a local bank. That is your greatest bet of getting an audience with them. Come prepared with your business plan, a sharp presentation and answers to all their questions.

You will likely get shot down a bunch of times before finding the right bank. Dont go in expecting be rejected, just be ready to handle it with class.

 

[randallg99]

when banks evaluate candidates for loans, they use the C list (Character, collatertal, credit, capability (to pay back)) and if the 710 score is only because you are actively using credit then you have nothing to worry about, IMHO. (if the score is 710 because you burned a credit card company, then the bank will frown on you)... in my experience, character goes a looong way.

I agree with RealOG about soliciting local banks - they're very eager (and they aren't in line for TARP). And I'll go one step further that you'll probably have to knock on 10 banks doors. They all have their own criteria and model so you may or may not fit all of their molds.... (I am finding this the hard way with another loan I am working on for my biz)

to answer your original question about raising capital and how to structure, this is what part of my plan is:

I am in the midst of raising the 30% deposit for our deal(s) leaving a loan to be financed of 70%. The 30% equity will be broken down into 29bpts as Class B shares and the other 1bpt being Class A (this is my direct ownership).

the return on investment to B class shareholders is guaranteed 10%. Anything over that becomes a 50/50 split down the middle with A share holder(s)

SteveO probably knows more than me, but everyone I have spoken with has eliminated all non-recourse products HOWEVER, I have found some that will cap personal exposure at 70/30 or 60/40 +/- but they all come with hefty price which can affect cash flow significantly

if you go to the bank with a strong financially sound deal that's put together by someone with credentials, you should be fine....

looking forward to your updates

 

[Sid23]

What about seller financing these days or assuming the existing loan? I'd think there are some landlords desperate to unload their properties these days. Are any of you guys looking for those types of deals?

 

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[randallg99]

I am only making an assumption here, but if someone is looking to unload a property due to distress and incapacity to meet obligations, then that owner is highly unlikely to carry the note....

assuming existing loans are a great idea especially if the loans were formed within past couple of years (rates were phenomenal) Many commercial loans have resets typically after 5 or 10 years so it's important to keep focused on that point.

But assuming existing loans may not be so easy, lots of clauses these days prevent someone assuming the loan but I could be wrong.... (banks/lenders make their money originating loans with fees/points and prefer to have loans paid off so they can sometimes collect early or prepayment fees)

I met with a broker and a large investor today and we discussed the distressed & overleveraged segment of the market. There is an overwhelming amount of data supporting that we will witness many more distressed properties and the best way to take them is by using cash and then possibly doing a cash out refi to cover out of pocket expenses.

what was most enlightening (or disturbing) after today's meeting was that these guys are in a camp where the depressed markets are here to stay so its most crucial to buy the property using very conservative metrics and make sure cash flow is strong regardless of appreciation.

 

[SteveO]

Randall's input is pretty accurate from my point of view.

Seller financing commands a premium as does assumable financing. It seems that sellers put way too much of a premium on this which tends to make expensive.

There are plenty of assumable loans out there. The lenders to have a strong choice in that decision. You must have a stronger net worth than the seller or they will not allow the transfer. At a minimum, they will want to see a lot of liquidity on your part.

I am not in the camp that low prices are here to stay. Everything goes in cycles. Supply and demand. Lenders lend, buyers buy. When the dynamics swing, prices will change.

More later...

 

[SteveO]

Fannie, Freddie, Ginny will all do non-recourse.

Credit score does not carry as much weight as liquidity these days. Properties do carry themselves but the lender will look at you as a sponsor.

 

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[Sid23]

Two follow-up questions:

1) Based on the comments above (liquidity being important and me having none of it) and an obviously tight credit market, would you recommend figuring out how to build up some liquidity before trying to put together a deal like this? If I have none but could find a partner, would that suffice in a lender's eyes? But then, would that "money" person be the one liable for the recourse loan?

2) When you do sign a recourse loan, what does that usually hold you to? Being 100% personally liable for the note? So if its $1M and the deal goes south, you're on the line with all of your personal assets for the $1M?

 

[GlobalWealth]

What about seller financing these days or assuming the existing loan? I'd think there are some landlords desperate to unload their properties these days. Are any of you guys looking for those types of deals?

It never hurts to enquire about seller financing. You never know the sellers real motivations or financial position. Even if they are desperate to sell, it may be another property that is draining their cash so they may be willing to do seller financing as the income stream from the note may help them cover their cash deficiency at the other property.

I bought some raw land a few years ago and I got the sellers to accept owner financing. It turned out they were retired and needed some monthly income. They didn't want to sell for all cash because of the big tax burden of selling at once. So they agreed and I gave them 20% down and got a 30 year note at 5% interest. The 20% paid off their existing debt (not sure what the debt was on, but the land was unencumbered) and the monthly payment was enough monthly cash to provide income for them.

The point is, I didn't try to figure out their reasons, I just asked if owner financing was available and they said 'sure'.

 

[GlobalWealth]

Two follow-up questions:

1) Based on the comments above (liquidity being important and me having none of it) and an obviously tight credit market, would you recommend figuring out how to build up some liquidity before trying to put together a deal like this? If I have none but could find a partner, would that suffice in a lender's eyes? But then, would that "money" person be the one liable for the recourse loan?

2) When you do sign a recourse loan, what does that usually hold you to? Being 100% personally liable for the note? So if its $1M and the deal goes south, you're on the line with all of your personal assets for the $1M?

A non-recourse loan means they cannot come after you personally on the loan defiency if you default. They cannot take more than the collateral. In a recourse loan, they can take the collateral and come after you personally. For example if you borrow $100k and 5 years later the property is only worth $50k and you default, in a recourse loan, they can take the property and sue you and get a deficiency judgment - in a non-recourse loan they can only take the property. Non-recourse really doesn't exist anymore, or at least I haven't heard of lenders doing this in the past couple of years. This is where a good asset protection plan comes into place to separate your assets into separate entities not owned by you (ie; owned by LLC's, LP's, trusts, etc).

 

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[EastWind]

non-recourse loans exist, but only in Cali and FL.

 

[RealOG]

Not true. Non-recourse is a condition that is built into your loan. It is not a requirement nor is it a state law. Due to the protection it provides the borrower, it is usually accompanied by a higher interest rate or reserved for top shelf properties. The lender makes the decision on who gets this type of term and when - not the State.

In fact, most state government stays out of commercial real estate financing. This is not the case with residential financing.

EastWind may be confusing non-recourse commercial loans with mandatory State homeowners exemption clauses in residential financing. These work very similar to the non-recourse commercial terms, but are more confining. For instance, the home must be your principle residence and you cannot have refi'd it in the past. Consult your local legislation if you want more specific info.

non-recourse loans exist, but only in Cali and FL.