Rental Property Investor · Park City, UT · Member since 2016 · 678 posts · 531 votes
What is the norm with regard to option fees for feasibility and earnest money related to MF apartment deals?
Regarding option fee, I think I got lucky on my last deal at $300 for 30 days. The current deal I am working has an agent pushing for much higher for much fewer days.
I have heard that in a lot of MF deals that earnest money goes hard right away....or very soon. True?
I realize every deal is different and all things are negotiable. Just trying to learn more of what the "typical" scenarios look like.
There is really no option fee, like in residential, but with earnest money going hard Day 1 it's kind of the expensive version of the same thing. I'm only speaking of the 50+ unit deals but in most of the primary markets around Texas hard money Day 1 is a must to be competitive. In secondary markets it is common now too because people are chasing yields out there now too but you can possibly get away without it. Depending on the market, sometimes it can be up to 2-3% of the purchase, like in DFW. Obviously you will want to do your due diligence to make sure you will be extremely likely to close. Not all of your earnest money has to go hard and not all of it has to go hard Day 1. How you structure that depends on you, depends on the deal, etc.
There is really no option fee, like in residential, but with earnest money going hard Day 1 it's kind of the expensive version of the same thing. I'm only speaking of the 50+ unit deals but in most of the primary markets around Texas hard money Day 1 is a must to be competitive. In secondary markets it is common now too because people are chasing yields out there now too but you can possibly get away without it. Depending on the market, sometimes it can be up to 2-3% of the purchase, like in DFW. Obviously you will want to do your due diligence to make sure you will be extremely likely to close. Not all of your earnest money has to go hard and not all of it has to go hard Day 1. How you structure that depends on you, depends on the deal, etc.
Hi @Michael Le. Thanks for your response. I'm dealing with the secondary markets and smaller (15-20 units) deals. We are utilizing standard commercial TAR contracts and we have indeed been including fees for unrestricted rights to terminate (feasibility period).
Your comment about "Obviously you will want to do your due diligence to make sure you will be extremely likely to close." is the kicker. Not sure what your experience is, but what I have been trying to balance is the amount of upfront cost prior to appraisal. We have been dealing with some bullish sellers trying to get top dollar at seemingly ridiculous cap rates. Even if the purchase price works for us because of the upside I am somewhat concerned about the property being able to appraise and having to bring more cash to the closing table. Not sure there is much to protect against that.
The best you can do is to involve your partners ahead of time. You need your lender to give you a strong indication towards whether or not they can give you the loan proceeds you expect. And you need your GC to give you the thumbs up regarding the physical aspects of the property, at least the visible parts. You won't scope the sewer lines prior to going under contract but the GC can tell a lot about the other parts of the property. Of course all of this will cost money so I wouldn't do it unless you felt good about the property during your initial tour.
Anything 5+ units is a commercial deal, not a residential one, and there are some different rules for those kinds of contracts.
There is no option period. Instead, you have a feasibility period to give you time to do your due diligence, like getting the leases, reviewing financial records, etc. Unlike the option period, the feasibility period can be 30-40 days for smaller deals. (Or more, or less)
There are no standard terms for the feasibility period. It's all pretty negotiable with the seller. You do have the right to terminate the contract during the feasibility period. You also have to give some of that fee back to the seller if you terminate. You also have the option of paying a separate fee as independent consideration for the right to terminate. This fee is credited to the sales price at closing and given to the seller if you terminate. It really doesn't make much difference one way or the other.
I sold a six-plex in the Heights a couple of years ago. It was a total rehab job, so the sales price was pretty low for the Heights. We did a 40-day feasibility period with a $5000 earnest money deposit. If we had canceled during the feasibility period, the seller would have received $1000 of that and the remaining $4000 would have been returned to my buyer.
@Tony Castronovo I agree with others, that there is typically to option fee/period. The competition/market will dictate the due diligence period and when your earnest money becomes hard. I push for 60 days, but usually that is a negotiation point. The last deal that I did was a 120 unit DD and we had a 20 day DD period before the earnest money became hard. The deal before that was a 45 day, but then we had a financing contingency as well that lasted 90 days. Crazy hot markets like Dallas are going to have really short time periods.
Thank you @Todd Dexheimer. Yes, I misspoke regarding "option fee". Essentially, I was referring to that fee which allows unrestricted right to terminate. In the standard commercial TAR (Texas Association of Realtors) contract this is specifically called out and related to the feasibility period.
We terminated a MF deal a couple weeks ago (my first commercial contract) and I think I got lucky that I only paid $300 for a 30 day feasibility period. I believe the seller's agent was not very familiar with commercial properties. And this fee probably seemed in line given her experience with single-family homes. Now we are working with a more experienced commercial broker who is asking for $2000 for 30 days.
Now whether you consider a separate fee or a portion of the EM that goes hard after x days I think is really about the same thing. But I suppose in very hot markets there could be full/partial EM hardening on day 1?
Yep, its just another freely negotiable part of the total offer. If Seller has $2k for 30 days, and another offer for a higher price, but longer DD and more EM, then they evaluate that component as well as percent down, etc.