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Multi-Family and Apartment Investing

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Adam M.
  • Investor
  • Texas (DFW & West Texas)
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Question on Earnest Money & Limited Partners

Adam M.
  • Investor
  • Texas (DFW & West Texas)
Posted Jan 30 2024, 06:26

Hello! 

Genuinely seeking thoughts from the community here so please keep discussion open and positive :) ! 

Our firm has done many deals in the past with our own capital however we are now looking at taking down multifamily deals with limited partners for the first time, especially as our portfolio is pretty illiquid at the moment.

I myself as executive officer am doing everything I possibly can to make sure I learn about every nuance of the syndication process to make sure things go smoothly before even thinking about submitting any LOIs. As folks know once that timer starts ticking you have got to move! 

We have many soft commits from our LPs excited to work with us seeing as we have typically said no in the past (either we were not ready to take on investor dollars/wanted to build more of a solid foundation first) so we are excited to generate great returns for others that we have been able to do for ourselves for several years. 

That being said as I still have concerns as we explore syndications further: two being being earnest money and timing.

Let's say we're looking at a potential deal that has a purchase price of $13MM, so we would probably need to raise $5.5MM-ish  with a fixed rate agency loan product like a Fannie/Freddie and including renovation cost.

In a typical 1% EMD scenario we would need to come up with $130,000 shortly after executing the PSA. Seeing as sponsors use LPs to help them take on larger deals all the time, how do sponsors typically work with the EMD requirement? Is it included in the raise/LP equity and how does that work seeing as you usually send that in let's say 3 days after executing a PSA? Doesn't the raise happen only after you have executed a PSA?

If there are any other GPs out there that have worked through this problem I would really love to hear from you as I continue to build my knowledge about syndication timelines and execution. 

Many thanks and happy Tuesday! 

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Taylor L.
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  • Rental Property Investor
  • RVA
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Taylor L.
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  • Rental Property Investor
  • RVA
Replied Jan 30 2024, 07:20

EMD is a type of risk capital. Risk capital providers will expect to be compensated for the risk they take on. It's not part of the LP equity raise, you need it right away in order to get the deal under contract. Terms are negotiable. Many EMD providers will want GP and LP equity for their contribution.

As the name implies, risk capital carries significantly more risk than LP equity. If the deal doesn't close the EMD is often lost. Regular LP equity, should the deal not close, should be returned to investors in full.

Hard earnest money on Day 1 has become a common practice, meaning you can't get it back unless you can demonstrate fraud by the seller.

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Brock Mogensen
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  • Real Estate Syndicator
  • Milwaukee, WI
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Brock Mogensen
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  • Real Estate Syndicator
  • Milwaukee, WI
Replied Jan 30 2024, 07:40

Generally EMD is paid by the GP team. There are creative ways to bring on another GP to provide the "at risk capital" and in return receive GP equity or pref equity.

That being said, the easiest way to do it (if possible) is to have GP cover the EMD. And just build in contingencies to protect it.

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Adam M.
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  • Texas (DFW & West Texas)
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Adam M.
  • Investor
  • Texas (DFW & West Texas)
Replied Jan 30 2024, 07:44

@Taylor L., Thank you so much for your reply-- I really appreciate your guidance here.

When starting out would you advise a sponsor start off with their own capital for EMD? We would probably have to sell something to be in that position for a large transaction.

That was a great point about LP equity being different to risk capital. In less competitive environments where we don't necessarily have to bake in hard EMD to get awarded a deal, could we perhaps do a clause in the PSA that says something like: return EMD if DD and finance contingencies are not met? That way we would protect ourselves/the LPs in the event of a failed raise or financing falling through.

We would be more than happy to give an EMD provider a higher share of the deal (of course), just wonder how common it is that LPs actually do this... 

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Adam M.
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  • Texas (DFW & West Texas)
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Adam M.
  • Investor
  • Texas (DFW & West Texas)
Replied Jan 30 2024, 07:49
Quote from @Brock Mogensen:

Generally EMD is paid by the GP team. There are creative ways to bring on another GP to provide the "at risk capital" and in return receive GP equity or pref equity.

That being said, the easiest way to do it (if possible) is to have GP cover the EMD. And just build in contingencies to protect it.

 @Brock Mogensen Thank you so much for your reply! This is fantastic: It might be worth partnering with another local GP (I know a few reputable ones through our success in our market) to help carry us through as well as lowering our share in the asset. We would be bringing the deal after all.

Great advice! 

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Carrie Prado
  • Northridge, CA
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Carrie Prado
  • Northridge, CA
Replied Jan 30 2024, 22:11

Hello, I've recently extended out my business to include EMD lending as well as funding for double closings. I'd like to be an option and a resource to your company if that's alright.