Risks in Selling Equity in Multi-Family Properties to Investors

[Daniel Spear]

Hello:

I have been talking to a multi-family property owner who has said that he is considering selling equity in his property to an investor for a guaranteed return. This seems like a great way to leverage your cash flows to get immediate equity out of a building. It is also an interesting way to create valuation for a building. Basically, you take the existing mortgage amount and add however much it would take to keep the investor whole in his or her return.

What are the downsides of this approach? I imagine that the legalities are complicated and if the building fails to cash flow at the expected amount or the owner needs to sell and cannot get the assumed equity out of the building then the investor might be unhappy. What sort of risk premium is typically applied to this sort of practice?

[Lennon Lee]

Originally posted by @Daniel Spear:

Hello:

I have been talking to a multi-family property owner who has said that he is considering selling equity in his property to an investor for a guaranteed return. This seems like a great way to leverage your cash flows to get immediate equity out of a building. It is also an interesting way to create valuation for a building. Basically, you take the existing mortgage amount and add however much it would take to keep the investor whole in his or her return.

What are the downsides of this approach? I imagine that the legalities are complicated and if the building fails to cash flow at the expected amount or the owner needs to sell and cannot get the assumed equity out of the building then the investor might be unhappy. What sort of risk premium is typically applied to this sort of practice?

 Hi Daniel,

First and foremost I'd like to say that there is no such thing as "guaranteed returns". If this owner is offering you or anyone else a guaranteed return then I'd run the other way.

You are right about the legalities of such a deal. I do have to say that I've never done a deal like this before but I have experience working with syndications on large apartment deals that are structured following SEC's Reg D guidelines. From what you are describing we are looking looking at a structure where the owner is selling shares of the entity that owns the property in exchange for equity from an investor that will expect a return on his/her investment while being passive. If that is the case then I'm pretty sure that what he is offering are securities and therefore such deals must comply with SEC regulations.

I'm not an attorney so this is definitely not legal advice, your best bet to get clear on this is to talk to a real estate attorney first and also consult with an SEC attorney.