Raising Capital For Value-Add Multifamily

Multi-Family and Apartment Investing
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Raising Capital For Value-Add Multifamily

Anthony Palmiotto
Hard Money Lender · Sea Girt, NJ · Member since 2012 · 125 posts · 37 votes

Hello BP, I am currently looking at a value-add multifamily deal that is 13 units. I would be purchasing this in a syndication. Let's say I want to hypothetically spend about 7k/door on renovations to get my pops in rent. My question relates to the $91k (13 units x 7k) I need.

I have heard Rod Khleif and others mention that you should always raise the renovation money along with your initial equity raise. My two concerns with this are:

1. Because I'm raising this extra equity up front, my cash on cash returns are lower than I'd like in the early years even though my cap rate and project IRR are where I need them to be.

2. This is sort of dead money because I am now paying a pref return on this money even though it's not being put to work on a count of I can only renovate units as they turn over.

The other options are to renovate units with the property cash flow which seems like the wrong way to go about it - and that still doesn't alleviate the problem of property renovations eating into CoC returns though it solves the problem of "dead money".

The last solution I can think of is to raise the money year by year as you need it which presents other problems. The obvious being that, because this is a syndication, the members equity will constantly be changing and I'll have to keep amending operating agreements and such.

Can any experienced syndicators weigh in here and let me know how they approach this and if I am misguided in my analysis of this?

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Brian BurkePro Member
Investor · Santa Rosa, CA · Member since 2012 · 2k+ posts · 7k+ votes
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Generally you would raise the capital up front, and yes it does impact the CoC return slightly. This is pretty typical in value-add deals...not the strongest cash flow (sometimes none at all) in the first year and it ramps up from there.

Funding capX out of cash flow is just a bad idea because the cash flow in the early years is already compromised due to the lower rents and if you don't have the money to do the improvements you never get out of the rut.

There is another solution and that is to raise all the money in the beginning but don't call all of the capital at once.  As a simple example let's say you are raising $500K from 5 investors each investing $100K.  And let's say the capital improvements are $100K.  You would subscribe all $500K and call for $450K initially (to get you started) and when you are halfway through you call for the last $50K.  In this example each $100K investor would fund $90K at closing and $10K when you are ready for it.  No modification is needed to the operating agreement and as long as you are calling for capital pro-rata from the investors their ownership percentages stay the same relative to one another.

Having explained all that, if it were me I wouldn't do it.  I'd just raise it all up front and be done with it, and get your improvements done as fast as possible.  You should be able to do them all in a year or so.

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  • Ward ConvillePro Member
    Rental Property Investor · Hattiesburg, MS · Member since 2012 · 49 posts · 42 votes
    7y
    Another option without bringing in equity partners would be to see if the seller would owner finance a portion of the sale price in second position, say 30% and then get a first mortgage for 80%, so that you are effectively borrowing 10% more than the costs. Use this excess proceeds to fund your rehab expense. I did this a few years ago and left closing with 100k plus for rehab. My first lender was a private lender so they did not care that I was not putting anything down. This may not work with a bank that may require some skin in the game.
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  • Anthony Palmiotto
    OP
    Hard Money Lender · Sea Girt, NJ · Member since 2012 · 125 posts · 37 votes
    7y
    Originally posted by @Ward Conville:

    Another option without bringing in equity partners would be to see if the seller would owner finance a portion of the sale price in second position, say 30% and then get a first mortgage for 80%, so that you are effectively borrowing 10% more than the costs. Use this excess proceeds to fund your rehab expense. I did this a few years ago and left closing with 100k plus for rehab. My first lender was a private lender so they did not care that I was not putting anything down. This may not work with a bank that may require some skin in the game.

     What would a lender say about this? I assume a local bank would not like that.

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  • Scott Morongell
    Investor · Charlotte, NC · Member since 2017 · 791 posts · 479 votes
    7y

    @Anthony Palmiotto I agree with Brian Burke. There are obviously many ways to raise the capital and make your renovations. I personally recommend raising it all up front and being done with it. If your working with experienced investors they will understand the slightly lower returns in year one due to your strategy in place. 

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  • Ward ConvillePro Member
    Rental Property Investor · Hattiesburg, MS · Member since 2012 · 49 posts · 42 votes
    7y

    To do the strategy I mentioned above you need private money in first position and owner finance in second.  

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

    If you average 50% turnover you can do half of the units upon turnover in the first year.  

    As to the other 50% you have three choices.  One would be to renovate them in the second year.  

    Second would be to do an "occupied unit upgrade". It's tough to do a complete upgrade to an occupied unit so in this case you do the easier stuff like plumbing & lighting fixtures and appliances, window blinds, countertop resurfacing, pretty much everything but flooring and paint which can be too disruptive.  It's about two to three days worth of work.  Then you can raise them all the way to the same renovated rate.  If they stay, you get renovated rate already and can do the flooring and paint when they move, if they ever do.

    Third option is to push rents to near the renovated rate as leases roll.  This would likely push turnover higher than 50% and possibly all the way to 100%, allowing you to get to all of them in a year.  I tend to favor options 1 & 2.

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