I'm Raising Private Equity - My New Model Threw Me a Curveball.

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I'm Raising Private Equity - My New Model Threw Me a Curveball.

Nate Pattee
Real Estate Investor · Scottsdale, AZ · Member since 2017 · 15 posts · 3 votes

Officially my first BP post. Really hoping not to get booed off stage…

My experience to date at acquiring large multifamily properties, raising private equity, executing asset management strategies, then exiting the deals as expected, has been better than I could have hoped.

The challenge with every one of those deals is that they were short 12 - 24 month deals, a model I’m changing moving forward.

My new model will have me acquiring the same type of deals but holding them for 10 years.

During a few initial conversations with investors, the first question I get is a relatively new one (compared to raising equity for short term deals), which is “how do I get my money out before the 10-year deal horizon?” Makes sense. 10 years is a commitment and I’ve got to recognize investor’s needs.

I want to avoid a forced liquidity event (sale or refi) in an effort to keep my basis low in the deal.

So, what are a few options I could consider that would give investors a way out before the end of my 10-year deal? What challenges will I run into down the road with those options?

Boo if you must, I can handle it.  Thanks, Nate!

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Brian BurkePro Member
Investor · Santa Rosa, CA · Member since 2012 · 2k+ posts · 7k+ votes
9y

@Nate Pattee Welcome to BP and congrats on your early success! 

Your decision to plan for 10 year holds is prudent, given where we are in the market cycle.  At some point it's very likely that there will be an adverse cycle, and if that cycle happens at an ill-timed planned exit point of a 2-3 year hold you'd be in trouble.  Ten years allows you time to ride the cycle and exit at the next market cycle peak.  Just be sure to underwrite conservatively so you can actually survive to make it to the other side.

The downside to the 10 year hold is that many investors resist a commitment that long.  You either need to find a way to provide liquidity or find investors that can tolerate parting with their capital for 10 years (and yes, those investors are out there). 

Most investment sponsors provide liquidity by refinancing the property in year 2-5, after adding value to the property, and taking cash out to return to the investors.  In many cases you can get 50-75% of their capital back, sometimes more.  The only other liquidity available to the investor is to sell their interest to someone else, which is easier said than done.

My advice would be to underwrite your deals with a mid-term refinance and only get into deals that perform well with conservative underwriting even with a higher loan balance.  Or look for investors that are looking for long-term commitments.

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  • Joel OwensBusiness Member
    Moderator
    Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
    9y

    Look up Brian Burke on here.

    I know of companies that buy commercial LLC interests but of course do so at a discount. So when an investor wants out early likely there will take a haircut which will dilute their anticipated returns down to non-optimal level.

    10 years to ask an investor to hold money is a decade. That is a very long time horizon for most investors.

    I guess it would come down to the amount of cash invested versus the investors net worth. If the investor is worth 10 million and you are asking for 1 million held for 10 years that is a different conversation than holding 50k or 100k of their money for 10 years.

    My deals I have much shorter horizons for returns but I do the commercial retail development space.

    My investors do not make anything until the property is constructed or the lease executed and then get more equity upside on the back end.

    Some passive investors want mainly all high cash flow today, some want some cash flow right away and then some equity  upside, and then others do not really need the cash flow today and are fine getting some in 6 months after initial investment and larger equity gains on resale down the road.

    So you have to match up what you are trying to do with the type of investors who will go for that model.     

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  • Nate Pattee
    OP
    Real Estate Investor · Scottsdale, AZ · Member since 2017 · 15 posts · 3 votes
    9y

    Thanks Joel for the feedback.  

    I'll check Brian out.

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  • Scott Meitus
    Contractor · Minocqua, WI · Member since 2016 · 44 posts · 12 votes
    9y

    Assuming that the deal is increasing in value, either through higher rents, lower expenses or a catalytic event (like the announcement of a major development or infrastructure project nearby) you can probably refinance the asset a few years down the road and pull at least some invested equity out of the project.  Of course, the terms of the new loan must make sense as well.

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  • Nate Pattee
    OP
    Real Estate Investor · Scottsdale, AZ · Member since 2017 · 15 posts · 3 votes
    9y

    Thanks Scott - I was hoping to avoid increasing my basis by way of a refinance.  I also want to consider an option that doesn't rely on the lending environment or marketability of the deal for sale.

    Thanks for the feedback though!

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  • Marc C.
    Buy-and-Hold Rental Investor · Santa Fe, NM · Member since 2015 · 438 posts · 352 votes
    9y

    Why are you so worried about increasing your basis? Refi'ing every 5 years provides the best return percentage in most cases. 

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  • Brian BurkePro Member
    Investor · Santa Rosa, CA · Member since 2012 · 2k+ posts · 7k+ votes
    9y

    @Nate Pattee Welcome to BP and congrats on your early success! 

    Your decision to plan for 10 year holds is prudent, given where we are in the market cycle.  At some point it's very likely that there will be an adverse cycle, and if that cycle happens at an ill-timed planned exit point of a 2-3 year hold you'd be in trouble.  Ten years allows you time to ride the cycle and exit at the next market cycle peak.  Just be sure to underwrite conservatively so you can actually survive to make it to the other side.

    The downside to the 10 year hold is that many investors resist a commitment that long.  You either need to find a way to provide liquidity or find investors that can tolerate parting with their capital for 10 years (and yes, those investors are out there). 

    Most investment sponsors provide liquidity by refinancing the property in year 2-5, after adding value to the property, and taking cash out to return to the investors.  In many cases you can get 50-75% of their capital back, sometimes more.  The only other liquidity available to the investor is to sell their interest to someone else, which is easier said than done.

    My advice would be to underwrite your deals with a mid-term refinance and only get into deals that perform well with conservative underwriting even with a higher loan balance.  Or look for investors that are looking for long-term commitments.

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  • Marc C.
    Buy-and-Hold Rental Investor · Santa Fe, NM · Member since 2015 · 438 posts · 352 votes
    9y
    Originally posted by @Brian Burke:

    @Nate Pattee Welcome to BP and congrats on your early success! 

    At some point it's very likely that there will be an adverse cycle, and if that cycle happens at an ill-timed planned exit point of a 2-3 year hold you'd be in trouble.  

    Most investment sponsors provide liquidity by refinancing the property in year 2-5, after adding value to the property, and taking cash out to return to the investors. 

    My advice would be to underwrite your deals with a mid-term refinance and only get into deals that perform well with conservative underwriting even with a higher loan balance.  Or look for investors that are looking for long-term commitments.

    All very well said. The only issue is if you buy now and improve now, but in 2020 we're in a recession, right when you sort of "promised" investors you were going to refi them back out their investments. The real estate lending spigot can be quick to turn off or become unworkable when the market first changes. So one must be very careful in not seeming to promise investors anything of the sort. You don't want to say, "We'll refinance in year 3 and get you back at least 50% of your initial investment back." You can say, "Our goal is to refinance the property in 3-5 years, subject to market conditions and the availability of funds." And you must disclose this as a key risk disclosure in your offering documents: "Sponsor may be unable to obtain suitable new financing at any point in the future, so a lump-sum return of investor's initial capital may not be possible until the property is sold." Elsewhere, you could say, "Return of our investors' initial capital in as little time as possible will always be a goal of our company, but it is in no way guaranteed." 

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  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    9y

    @Marc C.   pretty sure attorney will put that in the  500 ways to lose your money document you must put together for these deals  LOL.... great points. 

    early outs are usually at a discount and are certainly not liquid

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  • Brian BurkePro Member
    Investor · Santa Rosa, CA · Member since 2012 · 2k+ posts · 7k+ votes
    9y
    Originally posted by @Marc C.:

    Yes!  Absolutely true.  This would be in the PPM, likely in more than one place.  It should also be part of the conversation with the investor, not just a hidden provision buried in a document that not everyone takes the time to thoroughly read.  It's always best to under-promise and over-deliver.  Not because that sounds good, but because someday you will have to have a real conversation with your investors about the success or failure of this planned refinance event and it's much easier to have a conversation where the message is good news.  Set yourself up to make your life easier -- life's too short to spend it making excuses. 

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  • Brian Adams
    Syndicator of Large Apartment Buildings · Glen Mills, PA · Member since 2009 · 1k+ posts · 1k+ votes
    9y

    @Nate Pattee, you have received some good advice already and my friend @Brian Burke's advice is spot on.

    Just want to echo that a deal lasting 10 years is a long time to lockup the investors money so you might have some challenges bringing in capital.

    0Reply
  • Nate Pattee
    OP
    Real Estate Investor · Scottsdale, AZ · Member since 2017 · 15 posts · 3 votes
    9y

    A sincere thank you for all who contributed, really appreciate your opinions.  My original question was about how to get an investor out of the deal before a 10 year horizon.  

    Here's what grabbed me from our conversation:
    - Find investors that are aligned with my model's capital expectations and I've found my answer 
    - Help investors understand that getting out of the deal before 10 years is possible, but likely will be at a cost/discount
    - Keep the option open for a refinance mid project but leave that decision to me 

    Thanks All!
    Have a great week - Nate

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