Raising Money for Multifamily Properties for Beginners
By Terry Painter/Mortgage Banker, Author of “The Encyclopedia of Commercial Real Estate Advice”, Wiley Publishers. Member of The Forbes Business Council
I am a commercial mortgage banker. Every so often someone applies for an apartment building loan with me that is almost flat broke and has no multifamily ownership experience. So I tell them, “Oh, so you want me to lend you over a million dollars and you don’t have any experience - and you want me to take 100% of the risk?”
“Don’t worry about that, they say. I will be bringing in investors for that. They will want to invest in me in exchange for a 10% return. They can’t make that in the stock market”.
I reply, “Like you’re going to go up to a potential investors and tell them, “ Hey, I want you to take $50,000 that you have worked hard to save and give it to me for on the job training to buy a million dollar apartment building and in exchange I will give you a 10% return. And by the way, I’m certainly not going to risk any of my money. I’m planning on getting rich using other people’s money”!
“But you don’t understand” they tell me. “I’ve taken this course that has taught me how to do this. it can be done.”
My attitude towards these entrepreneurs might seem harsh, but I’m just being realistic and honest. So many real estate guru’s and coaches are promoting their seminars and coaching services these days by promoting that they can teach you how to buy commercial properties - especially apartment buildings no money or experience. But I’m not here to tell you this is very hard to do. I have closed hundreds of loans totaling over $4 billion since 1997 and I assure you that if this is your deal, if you are going to sign the purchase and sales contract and apply for financing, you will need to have some skin in the game and have an experienced key principal to sign the loan documents.
Don’t get me wrong. My mission is to help more people move up to investing in commercial real estate. If someone is inexperienced, and doesn’t’ have all the cash, they will always get my attention for a loan if they have found a great property that will cash flow my loan. I have worked with many new deal sponsors that hooked me because of their enthusiasm and because they knew the numbers, and the numbers worked. But they ultimately had achieved these 7 milestones:
Tip: Better not to tell the lender you don’t have the down payment yet, or that you are raising most of it. Better to find investors first
7 Milestones to Achieve for Beginners Raising Money to Buy Multifamily Property
They had found an outstanding property that was in a good neighborhood with many upsides, and they knew the property inside out. (list of upsides below in Cutting Edge Component #3) Better yet the property could cash flow the loan payments at a 1.25 DSCR or higher out of the gate.
They raised at least 10% of the down payment in their own name. 15 – 20% is even better. This meant they had some skin in the game. They could raise investors for the balance.
They had the down payment, closing costs and 12 months of post-closing cash.
If they did not have experience owning an apartment building, they brought in a partner that did and had the net worth to qualify to sign on the loan.
They had done their market research and could verify market rents, expenses and property condition.
They had collected the most important property financials – a current rent roll, trailing 12 month income and expenses and last 2 years historical annual income and expenses.
They had a solid business plan for the property including knowing their value adds and approximately how much these would cost.
I have several chapters in my book on how to raise investors and it goes into much more detail than this article. Sure, it’s much easier to raise funds from passive investors who just want to make money on their money and have nothing else to do with running the investment. But be careful. To use totally passive investors you will need to do a syndicated transaction which is regulated by the SEC – The Securities and Exchange Commission. As the deal sponsor or syndicator, you will have a highly regulated fiduciary responsibility to protect your investors money and to fully disclose the investments earnings and risks.
I have closed loans on over 50 syndicated deals and I don’t recommend going this route if this is you first multifamily deal. I assure you that this is just too complicated and expensive for most beginners. I’m going to recommend that you form a simple LLC for your first deal where all of your partners that are contributing funds have a small role in overseeing the investment. On your next property you can study how syndications work and decide if you want to go that route.
7 Cutting Edge Components to Raising Money from Investors and Lenders
CUTTING EDGE COMPONET #1 – BEING ABLE TO FAKE IT UNTIL YOU MAKE IT –If you don’t have the experience owning an apartment building, you want to come across like you do. You need to memorize the numbers and be able to present exactly why this property is going to be a winner. You not only have to sell your credibility to investors, but also to listing agents and lenders. Study commercial real estate due diligence and be able to pepper your delivery with real estate jargon like cap rate, cash on cash return, internal rate of return and so on. You can find all this in my book, or many other books or YouTube videos. You need to hype up your amazing accomplishments with a single family rental or two, or a property you have fixed and flipped. If you do not have this experience you are going to have to extrapolate from other accomplishments in your life and talk about yourself as a experienced leader. I’m not telling you to lie to potential investors, only to come across with confidence and know all the details about this outstanding property you have found.
CUTTING EDGE COMPONENT #2 – YOU CAN RAISE AT LEAST 10% OF THE EQUITY IN YOUR NAME – This will give you clout. However you have to raise this money, you just have to do it. You can take out a HELOC on your home, talk to your parents – just do it. Lenders will want you to have some skin in the game, and Every investor will ask you how much you are putting in. Do you really want to tell them zero?
Terry: HERE IS CUTTING EDGE COMPONENT #3 – FIND A DYNAMITE PROPERTY – This property needs to sell itself by having theses 6 upsides to get investors and lenders really excited about participating. Always remember that EXCITEMENT SELLS! It’s going to take a lot of work, but you absolutely have to find a property that has these 6 qualities: 1) It’s in a Good Neighborhood, 2) Proof that Rents can be Increased, because they are either under market or with inexpensive value adds you can raise the rent. 3) The property or your bank account can cash flow the loan from day one. 4) You have the property financials. This means current rent roll and at least 2 years of historical profit and loss statements. 5) You have completed a 5 year pro-forma that shows based on facts that the Cash Contributed to the deal can be doubled in 3 – 5 years from a sale or cash out refinance – this will sell the property to investors! And 6 You have a Good Understanding of the Property Condition.
Tip: It’s so much easier to get a loan and raise investors if the property already has the net operating income to make the loan payments. And if it doesn’t, that you have the cash to make up the difference until your value adds kick in. You should plan on raising extra working capital.
CUTTING EDGE COMPONENT #4 – HAVE AN EXPERIENCED TEAM – We are talking about: 1) a partner that has the experience and money if you don’t to be a key principal on the loan. 2) A good Property Management Company – most lenders are not going to want you to manage it if you don’t have experience doing this. 3) An excellent contractor with a good reputation that can give you a reliable bid, if renovations or repairs are needed. 4) a great real estate attorney – to clear the title and watch you and your investors back.
Tip: if this is your first deal, you don’t get to have your cake and eat it too! You will need to protect yourself by making it clear to the experienced investor that you want to be the managing partner. This partner needs to also have a high net worth to qualify for the financing. If you hate partners, think of this individual as being your mentor – just on your first deal. You can use them to sell the deal to lenders and investors. On the next deal, you will have the experience.
CUTTING EDGE COMPONENT #5 CREATE AN OUTSTANDING EXECUTIVE SUMMARY – this will be used to sell the deal to lenders and investors. This is your business plan and describes the location and amenities of the property, and your hold and sell or refinance strategy. This summary needs to be concise – ideally no more than 5 pages describing the property, sales price, how much improvements will cost, and planned financing. You need to show what the property is worth at the beginning and how much it will be worth after your value adds are done and rents have been raised in so many years. As soon as you can you want to entice investors with the return they will be earning. The equity multiple is the best to sell high priced properties today. This metric tells investors how much their cash increases over so many years. And, Lastly a summary of the property financials and bios of your team.
CUTTING EDGE COMPONENT #6 – APPLY FOR THE RIGHT LOAN THE FIRST TIME – In my book, I talk about the 7 prequalifications that all commercial loans have. They are the quality of the borrower, the property income, location, tenant quality, lease quality and property condition. All it takes is for one of these to not qualify and your loan is not going to close. So be sure to screen the lender to make sure you and your group qualify before you start the loan. If you don’t get a loan commitment on your first try – this could take 45 days to find out, the seller might not give you the time for a second try.
CUTTING EDGE COMPONENT #7 – REHEARSE YOUR PITCH for INVESTORS AND LENDERS – Become an expert at selling returns and risks to investors and based on facts why your business plan for the property will succeed. Be sure to rehearse your presentation in front of your spouse, best friends, your kids or even you dog. You want to be overprepared!
Tip: When raising investors, more often than not, one of them doesn’t wire their funds prior to closing. Human beings are not the most reliable force in the universe and often change their minds if there’s too much time involved. So it makes sense to raise more funds then you need and have a deadline when participation ends and all contributions are put in an escrow account. And be sure to put in writing that the funds are not refundable unless the deal does not close for any reason such as financing.