How to structure a MF deal? Equity or Notes?

12 Replies

When I find a MF deal that we want to purchase, needing help of partners to help with downpayment and possible upfront CapEx money to address deferred maintenance on a property (roof, exterior, etc), what is the best way to structure the relationship?

I see two scenarios, one being a limited partnership or LLC where we are the general partner/member and partners who are helping us being the limited partner/member. The other being that we could create notes that are unsecured, essentially unsecured loans.

If done through an LP or LLC, what's the easiest exit strategy to return their investment over the course of a couple years, thus leaving us with the property, and allowing them to reinvest in another project with us down the road? Considering we are the ones finding the property, the deal, operating it, etc.

don't know anyone who would take an unsecured note

@Steven Picker I have friends that we've done deals with in the past that have been our private/hard money lender, but we've typically either refinanced after a few months after improvements have been made in the case of a primary mortgage or they have leant us money as a recorded secured second mortgage. Since I'm leaning more toward putting this not in our personal names for asset protection, I want to make sure that we are putting together a deal that is equitable to everyone. 

That's why being part of the llc thru a limited partnership would be best in my opinion out of the 2 scenarios

If the members in the LLC are passive, it would technically be considered a syndication and would require you follow Federal and State securities law (e.g. Rule 506 of Reg D).

@Chris McHaney lender will likely require some equity.  Most lenders don't allow for 100% debt. Unsecured notes will not be acceptable to most investors.  If you want to own the property outright one day you'll need to get educated on preferred equity and the cost of capital associated with it.

In dollar terms what't the size of your deal?

Notes:   'A' Note Debt (Senior Debt) - Lender holds a first lien position.   'B' Note Debt - Lender holds a second lien position.    Mezzanine Debt - Lender holds the Single Purpose Entity as collateral for their loan.   // All notes are secured. 

Thanks for all the feedback everyone. @Ivan Barratt , thanks for the comment on preferred equity. This is they type of thing that I am speaking of. A commercial lender we spoke to will do 80/20 LTV. Other stipulations were that there be no one in the second position (whether it be owner financing or friends loaning us money for down payment/initial capex costs). I understand why totally. I keep wondering how we can structure an LLC or LP to satisfy the lender, but yet still be able to allow our partners to contribute their funds to purchase the property. These are good friends of ours that would rather see us put the funds to use at a better interest rate for them than sitting in the bank earning almost nothing. Preferred equity sounds like a possible solution. Will keep researching.

you're almost there @Chris McHaney . Perhaps you just need to discuss this with an attorney and tell him what you're trying to accomplish.  I just meant to convey your friends and family can't be debt. they have to be equity. if you don't understand the difference that's ok. there's plenty of resources to get more education.  The opm isn't the banks problem. It's how you're structuring the opm as debt. hope that helps.

Absolutely, thanks @Ivan Barratt ! We've doing the smaller multi-families for many years, but the commercial side certainly has it's own language. Nothing that can't be figured out right? Looking forward to taking the next step in the journey. :-)

Both @Ivan Barrett and  @Percy N. are right. The lenders in most commercial multi-family deals, particularly if the loan is underwritten by Fannie Mae or Freddie Mac, won't allow subordinate debt and they will want to know the source of your funds prior to closing. The LLC or LP structure you describe is also a syndicate (in that passive LLC or LP interests are investment contracts/securities), so you will need to select an appropriate securities exemption (with the help of a securities attorney) and follow its rules in order to legally do this.

The lender will ask for an organization chart showing ownership interests of all of the participants and a copy of your LLC or LP Agreement before closing and will want a list of investors (with their signature pages) and their percentage interests. Further, they will want to underwrite any investor that purchases more than 20% of the interests for a Fannie Mae loan, 25% for Freddie Mac, and for CMBS loans it can be as low as 10%.

Your securities attorney can help you structure the company with your investors. As for cashing out investors, your investors may not like this as they may perceive that they put up all the money and you reaped all the reward. Syndicators do it, but sometimes investors complain. Your reward will come in the form of fees you earn for finding and asset management of the property, as well as a share of profits you generate during operations or on sale. 

@KimLisa Taylor @Percy N. Thanks for the advice. We should have an appointment with an attorney soon to discuss all of these items, and will certainly make sure all of this is discussed. Thanks for the input. Certainly want to make sure we do right by everyone involved. 

@Chris McHaney My company does large multifamily deals, and we always create a LLC for each deal. I'm not 100% sure of the legal side of thing as we have our own real estate attorney who structures the legal entities. Typically, we operate as the general partner and contribute 10% of the equity while the limited partner contributes 90%. When it comes to returns, things can get crazy, but nearly every deal involves returning profits pari passu which means at the same rate of contribution i.e. at the 90/10 split, every dollar in profit to investors is returned 90/10 as well. However, there is usually some sort of preferred equity (which is similar to an interest rate except it goes to the limited partner, not the lender) which gets paid before any equity is returned, and there is also typically a kicker for us if the property does well.

If you want to own the property outright at some point, you really just need to return their money plus whatever agreed upon return they desire. You could refinance them out of the deal and return their money at that. Beware though that unless you see extraordinary appreciation, you'll probably have to invest quite a bit to buy them out. I can't speak to the specifics of your deal without knowing more about it, but for every deal I've been involved in, disposition of the property is required to satisfy all parties. 

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