seller financing + hard money DP. Is it doable for apartment complex?

Question

I have some questions about apartment complex deals

1) Are large apartment complex NOT following 50% rule?
2) Is it possible to combine seller financing with hard money DP for infinite COC return?
3) If there is X yr ballon term, is refinancing the only option at the end of X yr without selling and paying cash?

Here is one deal in Dallas to illustrate my points:

Loopnet ID: 15762709
# Price: $4,000,000
# No. Units: 163
# Building Size: 130,487 SF
# Price/Unit: $24,539.88
# Property Type: Multifamily
# Property Sub-type: Garden/Low-Rise
# Property Use Type: Investment
# Cap Rate: 11.10%
# Occupancy: 94%
# No. Stories: 2
# Year Built: 1981
# Lot Size: 8.08 AC

2009 Actual:
# Effective Gross Income: $1,163,301
# Operating Expenses: $719,266 (62% of gross income)
# Net Operating Income: $444,035

Finance: New 3rd party financing or seller financing with 20% DP
# Loan Amount: $3,200,000
# Interest Rate: 6%
# Amortized Over: 30
# Due In: 10
# Annual Debt Service: $230,220
# Down Payment: $800,000

Based on this loan term, cash on cash return = (444035-230220)/800000=26.7% Not bad!

Or, instead of putting down 800k by myself, obtain hard money 800k 15% for 10yrs. Deb service for this 800k is 800k*15%=120k
Is this a realistic hard money lending term?

Then, cash flow becomes 444035-230220-120000=93815 annual.

After 9 yrs, 93815*9=844335 
This should be enough to refinance in 10th years as 20% down, even assuming no rent increase or appreciation in this 10 years.

Isn't this a wonderful deal by putting down nothing and gain an apartment complex in your investment portfolio for retirement?

In this particular deal, since the units can be sold as individual condo, the owner has more option at 10 yr point, right?

To further generalize this seranio, any property with >8% cap rate can self-sustain for 10 years with 80% financing at 7% plus 20% DP financing at 15% and allowing 10th yr refinancing. Cap rate needs to be 11.45% if it is 7 yr balloon term.

Assuming all the numbers are real after due diligence, what do you expert think about my analysis/sceranios? Any flaw in the thinking process?

Jon Holdman · Answer

An apartment complex will follow the 50% rule at best.  It can be much, much worse.  This one is claimed to be at 62%, which likely means its worse still.  Nevertheless, that represents an opportunity to improve.

A seller claimed cap rate is only as good as the claimed expenses.  Theyâ€™re often understated.

Looks like the asking price is $24,539 per unit and average rent is $595 a month.  That looks like a good deal, assuming thereâ€™s not a bunch of work to do.  So, as far as an acceptable investment, this oneâ€™s OK.

The simple fact its on loopnet, the commercial equivalent of the MLS, is telling that this is retail price.  You NEVER want to pay retail price.

15% is reasonable for hard money.  10 years?  No chance.  Second position?  No chance.  Getting a lender to loan you 80% with 20% borrowed from someone else?  No chance.  30 years at 6% for an apartment building?  Unlikely.

Hard money might be for six months or a year, and only in first position.

Commercial financing is going to be at a higher rate, shorter term, and likely with a 3-5 year balloon.  They are going to want you to have some skin in the game.    Even if you were to do something like a 70% first loan, a 20% seller second and 10% of your own cash youâ€™re going to pay a higher rate still.

In addition to the cash to buy the property, you need reserves.  If I didnâ€™t have something like $100K after buying the property, Iâ€™d be very nervous.

Bill Gulley · Answer

This may not be an easy place to unload, so seller financing is offered. If he is motivated, I have done them where the seller AND buyer obtains a first for say 50%  then the seller cariees back the balance. It's easier to do in an LLC where you purchase his interest in the LLC over the term, You are the managing member and he takes a passive position. If your LLC is set up properly, taxes will be deferred for him and on future sales as well. With that kind of LTV on the first, especially if he is retiring. The LLC first mortagage can be on a non-recourse basis, your debt to the seller in the LLC can be non-recourse or with recourse if you need to sweeten the deal. While it's rather involved for a first deal, I can explain it and assist your attorney and CPA. initially. Having these as condos is a big plus, better check and see if they are deeded now or if they meet condo requirements for a minor subdivision, also, if they just meet requirements now, I'd do the conversion now as requirements can and probably will change and many issues may not be grandfathered. So, yes, you have options in ten years to meet a balloon payment and net some units out free and clear. For financing, you'll need to give a set off provision for future rents and you'll want a set amount as a release fee if you sell a unit off. Check this out as Jon suggested with careful due dilligence. Bill

Bill Gulley · Answer

Hi, no. The property is first placed in an LLC. Seller and you form the LLC as members. Both of you through the LLC obtain a small first mortgage up to 50% or what ever you agree to. He sells his interest in the LLC to you. He finances the sale of his interest in the company and you assume the payment of the first mortgage. He takes the cash from the loan, maybe you can keep some for operations in the LLC too. This is the sale of a business interest in an LLC that owns the property. Taxes to the seller are deferred through the financing. Also, if he is nearing retirement age, the seller can receive a retirement plan from the LLC in lieu of, instead of, part of the purchase price but providing him with similar income and at perhaps at a more favorable tax advantage. If something like this is done, the basis is lower for the property. If you sell the units, you may elect to do so as membership in the LLC at the lower basis and other considertion being paid to join the LLC. These are possibilities when the property is owned by the LLC and you sell a business interest instead of the property. The Operating Agreement defines the relationship between members, how they share profits and losses, how the assign captial and interests, they do not have to share eaually. The seller can be in a passive position, non-management position while you would be in a management position. In the event you fail to pay for the business interest, there would be a collateral provision so that he would be placed back into a managemnt position and you could be removed. This is plenty of information for the basics as the contingencies and agreements, terms, etc. could be very involved or they can be rather simple. What ever you agree to. Hope this clarified the strategy. Questions, just ask....maybe PM. Bill

Jon Holdman · Answer

Hard money lenders will typically only do firsts, and will only go to 65-70% of the value.

If the owner is willing to carry such a large chunk, perhaps you can persuade him to be in second position, and get a bank loan for a small first.  I'm not optimistic, since a bank is going to want to see some of your skin in the deal.

You could form a partnership.  Get some investors to invest in a company.  Raise the $800K plus working capital.  Have the company buy the property.

Bay H. · Answer

I also need to find out why the property is hard to unload.

Potentially two reasons:

1) Some deferred maintenance. Need to find out.

2) These 163 units are in a 250-unit complex with owner controlled HOA and management. I had been on one condo HOA board before. My take is that owner controlled HOA and management is a good thing for the property. Others may think otherwise? If I buy this property, I would be a majority owner on the HOA board so I should be able to have a say on management etc.

My team has some Web2.0 expertise. I'm thinking of applying these technologies to lower management cost. Not sure whether it is feasible with an HOA board.

Bay H. · Answer

Bill, thanks so much for your feedback.

There are many places in your post that I need to further digest.

You mentioned:
"the seller AND buyer obtains a first for say 50% then the seller cariees back the balance"

Could you please elaborate more?

Here is my interpretation or proposal based on your suggestion. Please grade me. :-)

Assuming the seller is already willing to commit 3.2M at 6% 30yr amortization for 10 years balloon, evidenced by his seller financing terms, I would propose to him to form a LLC for 2M (50% of price) and carry back the remaining 2M balance. My position in LLC is 800k. I will borrow this 800k from a local bank with 15% interest (realistic? generous?).

I haven't figured out tax advantage of LLC for the seller... but does what I described above align with what you are thinking as the base structure?

Bay H. · Answer

Jon, thanks for your reply!

80% with 30yr amortized 6% due in 10 yrs is the seller financing term provided by seller.

For 800k downpayment, what are creative financing options? Before I came to BP, all I know was that I need to put down 20% DP. Now, after joining BP, there seems to be many ways to come up with capital. So I decided to challenge myself on this one.

From what you described above, looks like hard money is not going to work?

How about creating a note using future rents as collateral for DP? Any chance?
With BP's collective wisdom, there must be a way?

Or, is there no room for creative financing in apartment complex down payment?

seller financing + hard money DP. Is it doable for apartment complex?

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