How to Creatively Make Deals Work During COVID-19
Here are 3 tactics that can help make your deal work that I've discovered. If you have any others you have found that are helpful, please share!
1. Reallocate your Funds
During the pandemic, lenders have increased the reserve required to finance a property. Today, lenders have increased their required reserves, which amount to 9 to 12 months of debt payments. To cover that amount of money, some sponsors raise more capital. As an example, instead of raising $3M, they raise $3.5M, if $0.5M amounts to 12 months of debt payments. However, that could impact your returns because you’re raising more capital than the deal actually needs, and may dilute your investors.
One creative way that I discovered to make the deal work is to use some of your capital expenditure (CapEx) budget to pay the debt, assuming you don't have an immediate need of 100% of the budget. For example, if you've budgeted $750,000 for capital expenditures, which might include renovating units, improving landscaping and new paint, etc., you can reallocate some of that money and use it for your escrow requirement. After 9 to 12 months you'll have the money back in your CapEx budget because the lender will be taking your funds from the escrow account. This way, you are not diluting investors and don't need to raise more than you need in the 12 months after closing. Just be sure you're not using 100% of your CapEx budget because you'll always have some unexpected expenses.
2. Adjust your Fees and Splits
Another creative way to make a deal work is to consider reducing your fees. For example, instead of taking a 2% acquisition fee, you can charge only 1.75%, so investors can receive a yearly return that makes sense. You’ll still be making money on the deal, albeit slightly less. However, you must remember that 1.75% of some dollar amount is far better than receiving 2% of zero dollars, so if the deal doesn’t make sense with a 2% acquisition fee because investors make only 5% cash on cash, it might be better for you to lower your fees so the deal is lucrative for your investors. It’s the same with equity splits. Instead of having a 70-30 equity split, where 70% of the income goes to investors and 30% goes to the sponsor, you could have an 80-20 equity split, which reduces your income. While you will be making less money on your deal, you will at least have a deal that works.
You can also decide on the split at the time of sale. You can keep the same equity split or change it – it’s up to you as a sponsor. Just play around with the numbers to make sure that the deal works for everyone. The point is to not be fixated on specific equity splits or fees, because with some adjustments, you’ll be able to make any deal work if you’re willing to be flexible.
3. Getting a Collection Guarantee
When you’re underwriting a deal and you approach it conservatively, you take into consideration that rent collections may drop in the next 6 to 12 months. The reason is simple: as unemployment increases around the country, more and more people are not going to be able to pay their rent. However, if you approach the seller and ask to look at the average rent collections over the past 3 months, say for example, the 3-month average was $100,000, you can require that the seller provide you with a collection guarantee.
With collection guarantee, if rent collections fall below a certain threshold (in our example, $100,000 average amount over the next 10 months), then the seller would pay you for the difference between your actual rent collections and a certain threshold ($100,000 3-month average in our example). This approach was applied during and after the great recession of 2008, and it helped make many deals work. The seller can put the money in escrow, and it will be released to the buyer after a pre-determined time period.
