Reserve Accounts

15 Replies

Who typically keeps the reserve account in a large multifamily transaction, buyer or seller?

Could you expand on your question a little?

In my mind, the reserve account is something that generally applies to a buyer trying to get a bank loan for a multifamily ... but I want to make sure we're on the same page.

Sure, every large multi-family has a reserve account for CapEx, R/M. I am hoping that the "experienced" investors that have negotiated alot of large deals can chime in. All opinions are welcomed and appreciated!

@Jim Biggs

Reserves are typically set aside out of net income (along with debt service and taxes) and belong to the business.

If you are purchasing the business as a going concern (XYZ Properties Inc.), the the reserves come with the business (unless the existing owners drain them into retained earnings and pay them out as dividends first).   The reserves, and any other retained earnings, will be priced dollar for dollar into the purchase.

If you are simply purchasing an asset (i.e. the 24 unit building at 123 Some Street), the reserves still remain with the business and you only get the asset.

Medium greenapartmenthires 1024x1024Roy N., Louer Louer Ltd. | 1.506.471.4126

The CapEx reserve account is a component of the owners loan--just like an escrow account for taxes and insurance. When the owner makes a capital improvement, they submit the paid invoice, copy of both sides of the check used for payment, and a lien release (if required) to the lender and they reimburse the owner / borrower for the capital expenditure.

When the property is sold, the lender liquidates the unused balance in the reserve account to the seller / borrower.  The buyer then gets a new reserve account with their new lender and the process starts all over again.

Medium praxis capital logo cmyk stacked 900pxBrian Burke, Praxis Capital, Inc. | [email protected] | http://www.PraxCap.com | Podcast Guest on Show #152

@Roy N. :

@Jim Biggs

Spot on roy!

Jim,

In my experience of buying and selling large and small multi unit buildings in Los Angeles, I have never heard of a buildings reserve account being transferred in a sale. However as is true of most things the local custom will determine the terms of the transaction. I hope this helps! Good luck!

@Brian Burke

Here I was thinking balance sheet and forgot all about "forced" CAPEx accounts with lenders.  We've never had a lender insist we place reserve funds in escrow with them, just prove that we had funds and how we were going to sustain the reserve.

Medium greenapartmenthires 1024x1024Roy N., Louer Louer Ltd. | 1.506.471.4126

@Roy N. you'll typically see this on larger Multifamily, or with larger loan amounts. I don't have it on any of mine that are smaller than 100 units, but do have it on all of my 100+ unit properties. It's a pain, but a fact of life, so I live with it if I want to play in this sandbox.

Medium praxis capital logo cmyk stacked 900pxBrian Burke, Praxis Capital, Inc. | [email protected] | http://www.PraxCap.com | Podcast Guest on Show #152

So I take it that it is possibly a point of negotiations?

Originally posted by @Jim Biggs :

So I take it that it is possibly a point of negotiations?

 Maybe, but probably not. You can try shopping around with different lenders and see if you find one that doesn't require it, but those that do require it are unlikely to flex (and most do over certain property and/or loan sizes).  It is possible to negotiate the monthly amount to be deposited to the reserve account, but you can only negotiate it so far. The amount will be dictated by the property condition report and the lender's minimum, whichever is more. If the PCR indicates an amount too high, you can attempt to rebut their findings with contractor reports and estimates, etc to try to get the amount down.  Sometimes this works, sometimes not.

Medium praxis capital logo cmyk stacked 900pxBrian Burke, Praxis Capital, Inc. | [email protected] | http://www.PraxCap.com | Podcast Guest on Show #152

@Brian Burke

We are not playing in a sandbox that big {yet}.  Though it would be a pain to have to go through you lender for access to reserves, I understand the lender's desire to control the funds and, extensibly, give greater opportunity for success to the venture.

   

@Jim Biggs

Whether the reserve is held in trust with the lender or by the vendor, it belongs to the capital of the business and not the asset itself.   You're not going to buy a building and find bags of $100.00 bills locked away in the mechanical room.

Medium greenapartmenthires 1024x1024Roy N., Louer Louer Ltd. | 1.506.471.4126

@Jim Biggs I think the real question you need to consider is if the asking price plus deferred maintenance adds up to a reasonable amount for the property. If they are asking $2.5M for the place and it needs $1.5M in CapEX over the next five years, is the property really producing the income necessary to justify a $4M outlay? If it's only producing like a $3.5M property, then I would look to get a lower selling price.

Perhaps you don't have the financial means for covering that $1.5M in need over the next five years. And if the lender is requiring it, then you won't be able to acquire the property. But if the seller were willing to turn that reserve over to you (let's say $750K), you'd be able to.

If I were the seller, and I thought I had a reasonable chance of selling for more than $1.75M, I wouldn't be willing to give up the $750K to you. But it never hurts to ask, does it?

Medium webuysmallmultifamilesRonald Perich, We Buy Small Multifamilies | [email protected] | 314‑896‑0669 | http://webuysmallmultifamilies.com

A lot of this comes down to the track record and net worth of the buyer. Also the type of loan they are going for.

My experience is if you want non-recourse with standard carve outs the lender is going to want to structure with the most security for themselves.

If you were in their shoes and had a 20 million net worth investor putting 20 or 25% down on a property getting non-recourse then the lender has to feel really good about the income stream of the property, the quality of the location (dirt value) ,and build quality of the structure. They can't access the assets of the investor buyer because it's non-recourse unless a carve out is violated. So the lender either forecloses or has to do a workout on the loan.

The non-recourse debt more of your cash flow is trapped due to heavy reserve and escrow requirements accounts for the lock box.

Local banks do not usually have those requirements for a loan but they also require personal guarantees.

No perfect loan out there. I tell my clients to make a sheet on a scale from 1 to 10 of how important each item is.

Pre-pay penalty

Down payment percentage

Second mortgage allowed - Lender only mezz debt or seller second?

Amortization

Interest rate

Term

Liquidity and net worth requirements

Required loan covenants

Full recourse, limited recourse, non-recourse

etc.

From there the buyer discovers what is a deal breaker on a loan and what is not.

    

Medium allworldrealtyJoel Owens, All World Realty | [email protected] | 678‑779‑2798 | http://www.AWcommercial.com | Podcast Guest on Show #47

Burke,

Would mind sharing how much (percentage amount) the bank makes you put into reserves?  I have been searching similar threads I am trying to calculate how much I should be holding back each month for reserves on a small apartment complex.  I am would like to be conservative but I don't want to time up money for no reason.

Assuming you respond thanks

541‑508‑9672 | OR Agent # B201216231