Commercial Apartment Complex - Private Investor IRR

19 Replies


I want to give a little back story before I state my question.  My partner and I came across a potential deal through some diligent searching and mailers throughout the last year (patience is a virtue they tell me).  We received a phone call from an older gentlement set on retiring and wanting out of his aparment complex with 34 units.  We got ahold of the financials and quickly realized this will be a a small goldmine.  He bought the property in the late 70's and hasnt done much renovating in that period of time outside of normal wear and tear replacments meaning we went in one room and it still had shag carpet and popcorn ceiling, you get the idea.  He stated he hasnt raised rents in a decade because he feels for the tenants which is admirable but not a very good business/cash flow position to hold.  This project has value add all over it with rents well below the median for the area so we are talking about aquiring an underpriced undervalued property that will require mid tier renovation and rent increase to median that would put us with close to $1m equity and favorable cash flows within the first three months after acquisition. So to my questions....

Our vision all along has been to utilize private capital along with our own at a 50/50 split in order to make the downpayment and finance the remaining traditionally which seems pretty straight forward. 

What is an average rate of return for a private investor? We plan to offer at least 2% more to beat the market and retain investors.

Do you calculate the return for the investor based on the cash flow after expenses per month?  For instance we bring in $10,000 cash flow in January so the investor (paid first) would pocket $1150 per month and $11500 annually while my partner and I take the remaining.

Upon sale of the property, what is a reasonable return to the investor based on appreciation we gained over the life of the acquistion? Meaning we want to provide a "bonus" to the investor above and beyond the 11.5% return guarantee once we sell.  For example we purchase for $1.28M and sell for $2.5M. 

The deal would look like this:

Our Capital - $100,940

Private Captial - $100,000

Purchase Price - $1.128M

Private Capital Rate of Return - 11.5% (preferred)

Plan to return $100k back to investor after 2 years when we plan to refinance.  This would be $23,000 in return over two years for the intial investment.

Thanks in advance for your assistance/guidance.  Love the wealth of knowledge this site offers!


@Ian McDonald first you need to work on your math.  If you have 10k in cash flow per month, why is the investor only getting $1150.  Where is the rest going?  The last time I looked there were 12 months in a year.  $1150 x 12=13,800.

Why would you want to all the work, bring in over half the money and still do a 50/50 split?  What are you getting paid for all of your work?

I also recommend that you never use the word guarantee.

How are you planning to buy a 1.128 mil property with $200,940 including closing costs, cap ex reserves, first years insurance, funding the operating, etc.

@Jeff Greenberg Good catch, been running numbers all weekend and got foggy.  12 months not 10.  

I should have been more specific in that the 50/50 split is only on the down payment, NOT on the return.  We are doing all the work on this, the investor provides capital.

On the guarantee thanks for the advice. 

On your last question.  We have an owner financing agreement with the owner that is more interested in a monthly income in retirement. On the capital reserves we are waiting on a the report from general contractor and inspections to assume and a rational number here but we have over $400k to allocate from for reserves.  First year insurance is included in our expenses and will come out of our capital up front.  This is a fully occupied property so operating expenses will be covered by rent roll.  



Details in this one are hard to comment on. You mentioned putting 50% of the equity in and a 50/50 split, but later mention that you are not giving a 50/50 split. What are you giving? 11.5% preferred return is really generous. You are going to pay you investors 11.5% return before you take any money? 

To answer one question: Typical sponsors on syndication's aim to pay out between 10-20%+IRR. That big spread is due to risk, experience and various other reasons.

Originally posted by @Todd Dexheimer :

Details in this one are hard to comment on. You mentioned putting 50% of the equity in and a 50/50 split, but later mention that you are not giving a 50/50 split. What are you giving? 11.5% preferred return is really generous. You are going to pay you investors 11.5% return before you take any money?   

The 50/50 split is on the initial down payment only.  The 11.5% is certainly generous and the preferred status isn't set in stone.  My main question is what is the average return for and investor if 11.5 is really generous?

@Todd Dexheimer

The syndication return info is useful.  We are only seeking one investor syndicate on this one $100k of our own capital and $100K of their capital @ a 11.5% return on their investment.  Preferred is something my partner and I discussed on this deal in particular but is not set in stone.  

Hey @Ian McDonald , not trying to come off harshly but my question is very basic, are you really ready for this?

"Do you calculate the return for the investor based on the cash flow after expenses per month? For instance we bring in $10,000 cash flow in January so the investor (paid first) would pocket $1150 per month and $11500 annually while my partner and I take the remaining."

That is such a basic question it kinda scares me for you?  Will you hire a management company?  If not, do you have any experience with this type and/or size investment?  Do you fully understand what you need to bring to the table totally for this deal in the form of equity?  Just a few questions to start.

I'm probably way off base with my view of this, just please make sure you are educated especially since you are taking investor money.  You screw up you first deal with this person and there likely won't be a second.

@Ian McDonald management company (and their expertise). A good management co should underwrite your operating budget. If you're lacking experience you've likely missed some expenses (payroll + management fee, pest control, bad debt, vacancy, common area cleaning, dumpster, snow removal, and the list goes on...). Not to mentioning raising rents over a 3 month period means you're throwing nearly everyone out. What's your year one vacancy number? In short there's a lot to this you probably haven't considered. Beefing up your team will help.  I learned all this the really hard way. Be better than me!!

On financing: every dollar invested should be pari passu (treated the same). If it's truly a deal the pref should be 7 to 10% max. If it's a million dollar deal then the split 50/50 split is ok. 

Lastly, watch out for the little old man that just wants to retire and offers you some seller financing. It could be a good deal but that's a big red flag until proven otherwise.  Give me a shout and I'll tell you some really good little old man stories that will blow your mind! :)

Not sure about your market, but your rehab seems crazy optimistic. Three months to rehab and re-lease 34 units? What about the current tenants? Have you seen the current rent roll? Are they all month-to-month? In my state, you can't just kick people out because you want to rehab their unit when they have an existing lease. What if ever tenant renewed in the past three months and signed a 12-month lease? Then you're stuck for at least 9 months. 

Once a unit is rehabbed, are you sure you can lease it right away? How strong/weak is the market? What if it takes a month or two to lease the new unit?

Is $1.1M really the purchase price? Does that include your rehab costs? If so, that seems incredibly low which either means you're buying the building at an absurdly low price or underestimating your rehab costs. 

You'll want to hire a property management company for this deal most likely. If you're going to kick out 34 tenants, some of whom have been there for 10 years, be ready for some blowback. They are going to be mad. If you're really unlikely, you could end up on the local news being named as an evil landlord. I've seen it happen (not to me, but in Austin). 

As for your actual question, @Ivan Barratt is absolutely right about the pari passu treatment and pref. For every dollar flowing to investors, your investors get their pref payment first. If you can't pay them the whole payment that month (which is likely to happen during a value add), the unpaid amount rolls forward to the next month. This continues until they are caught up on pref payments. Until that happens, you won't make a dime. Now, this is all pretty standard but not the only way this works.

Once you have cashflow after the pref is paid, the dollars will be split 50/50. Now, most investors will want this to be a return on their investment, not a return of their investment. They probably don't want their investment back unless you refi or sell. 

All of this can be negotiated, and there are an infinite number of ways to structure deals. If your investor is mature, he'll probably know what he wants to do. 

@Bryant Patterson for the preferred return during renovation. In my contracts it specifically states that there is no preferred return during the renovation phase. We specify that as a year or 18 months or whatever we are projecting, then the preferred clock starts. If we have a large reno and are expecting a loss or close to break even, we state that there will be no payments made as well. That way if we do make money in say Q1, but will loose the next 3 quarters, we can put Q1 profit into reserves. Many ways to skin the cat

We solve to a ~1.5x equity multiple to the investor which is typically 18-26% IRR on a 2 year hold. Cumulative pref of 6-8% depending on the equity profile.

@Todd Dexheimer and @Rob Beardsley Interesting approaches on the pref. Do you get much pushback on this from investors?

@Ian McDonald If you only need to raise $100k, I would suggest asking the seller to do a second loan for the difference, if the lender will allow. This allows the seller to still make some money on the deal and keep all his equity. Ask him what he plans to do with the proceeds as this is causing many would be sellers to hold on to their properties.

If you absolutely want to raise capital, an 8% preferred return is pretty typical. Accredited investors typically like to see a 15% IRR, but you can get away with anything as low as 10% depending on the investor. You'll also see an equity multiple as a metric investors use, but this depends on the hold time as well. The return is calculated on the actual investor return. They don't care how much the property makes, they care what they will make.

@Todd Dexheimer and @Rob Beardsley realized I wasn't clear on my previous question. When you say the pref return doesn't start until renovations are complete, are you not issuing any returns during this time or simply stating that you won't hit the preferred return mark until renovations are over? I initially read it as if you weren't issuing any payouts.

Ian, do some research on the difference between a preferred return and IRR, they are two different types of returns and can very much affect your returns. Especially if there is a hurdle rate in a irr which will return all of the investors money with a preferred rate before you see a dollar in distributions.

It sounds like you want a waterfall distribution of some type so I will give you a few examples:

Waterfall 1 - preferred return -

1) to investor preferred return on capital compounded quarterly at 10% annum

2) return of capital split 50/50 with the investor and Gp (or what ever the percentage is in contributed capital)

3) Split 50/50 for the remaining capital ( or what ever term is negotiated since they are taking a preferred return this will likely not be a dollar for dollar split)

Waterfall 2 - undivided IRR w/ Hurdle

1) to investor until 9% irr is received ( this returns both the contribution and return on capital)

2) 90/10 split or what ever the appropriate math would be in this situation.

IRR used this way, which is very common in PE funds, is not very favorable to you in this circumstance since you are putting up about half the capital. In a PE find the General partner only invests approximately 1% of funds, thus they are not worried about returning capital early on, which waterfall 1 will do earlier on.

Typically on syndicate properties there is already stabilized ( lower returns ), value add ( higher returns), totally vacant or ground up development ( highest returns).

In terms of risk versus return the stabilized is generally the least risky, followed by value add, followed by totally vacant or ground up development.

An exception to that is experience of the sponsor that is the syndicator.

You could have a safer asset going in but a bad sponsor runs it into the ground versus an experienced sponsor turning around successfully a difficult property. Larger pref return and other projections to induce an investor to invest means nothing if the returns never materialize.

I have found there are generally 3 types of investors to invest with sponsors.

1. Those that need the money TODAY. They are trying to quit the job or want money to go work fully today generating income. They are more suited to a fully stabilized property throwing off cash flow day one. Typical pref is 6 to 8%. Unless stabilized property is bought at a really high cap rate going in where compression can happen over the years the sponsor is basically a glorified PM taking small fees and has almost no upside as a promote on the back end. I generally stay away from offering these type of properties to investors. 4 to 5 years ago you could buy high cap rate and let compression do it's thing. Now you have to create the value instead in most cases.

2. Those that want a hybrid model of maybe a 4% pref while the property is being stabilized fully for a value add deal. They can live with some return in exchange for getting 8% pref in 1 to 2 years when the property is hopefully fully stabilized and get more equity growth on the back end.

3. Totally vacant or ground up development. Depending on the size of the project could be anywhere from 1 to 5 years before seeing any return. There generally is great equity growth on the back end which typically gives an overall greater IRR than the other 2 options. These investors tend to like these projects because they do not need the cash today. They would just pay more taxes on it so hope to take in future years when tax law changes might be more in their favor. ( Retired developers like to do these investments as they do not want to do the day to day stuff anymore).

So there are all flavors of the rainbow when it comes to investors.

If an investor is giving a sponsor with what appears to be somewhat limited experience 100k then that investor better be worth many millions because they are taking a punt on the project. Could go very bad, average, or really good so it's a crap shoot. This way if some or all of the 100k is lost it will not take the investor under or substantially hurt their net worth and liquidity positions.    

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