Splits and ROI when using OPM

8 Replies

Afternoon BP, 

I'm closing on my first small multifamily deal on the 30th of next month and am now sitting on a few deals with decent returns (on paper at least). When looking for funding how are the deals typically structured for private funding of small multifamily buy and hold properties? I see a lot of discussion on flipping splits and have my head around that but when I'm looking at buy and hold rental properties the splits aren't as cut and dry.

My second question is what kinds of numbers do you typically look for on deals that you are going to bring an equity partner in on? Obviously the higher return on a deal the better but there needs to be a cutoff somewhere on the low end. For example a 12 or 13% ROI looks great for an individual but a 40/60 split on that leaves the better half getting around 7% back. I imagine this is a case by case sort of thing but what are some weed out numbers to look for?

Thanks all for the read,

-Dave 

If you syndicate the deal investors are actually taking an ownership stake in the property, and you usually split the profits with the investor, and may even collect a few fees for your efforts.

There are a number of ways this can be structured but here is an example of a deal I invested in not to long ago... The sponsor received: 

- An Acquisition fee (1% of purchase price)

- An asset management fee (2% of gross collected rents), 

 - Cash flow and gain on sale was split 80/20, respectively between investors and sponsors. 

On smaller deals, acquisition and asset management fees may not always be feasible and you may have to just split the profits with your investors. (i.e. 70/30, 50,50, etc.)

As for returns, investors usually like deals where the IRR is in the teens (i.e. 15%). I know a group that I spoke with won't invest in a deal unless it can return at least 8% CoC return to investors based on in place numbers. That doesn't include appreciation or principal pay down, just cash flow.

But this ultimately depends on you and your investors criteria.

On the other hand, you can have a private money lender provide you a loan for a portion, or the total purchase price of the property. In exchange you will create a note where the property is the collateral for the loan and pays an interest rate. (i.e. 8%+).

The loan can be interest only or it may amortize. The lender has no equity, their return is in the form of interest. In effect, the private money lender is acting as the bank. 

Hope this helps!

Thanks for breaking that down @Thomas Castelli I think I'm closer to wrapping my head around how I'd structure one of these. I'm going to break it down some numbers below if you will entertain me to make sure I'm following. 

So lets say I'm looking at a property (4plex) that has these numbers 

Purchase price: $175,000

Estimated Repairs: $15,000

Total cash needed: $60,500

Annual Income: $33,600

Annual Expenses: $26,606

Annual Cashflow: $6,994 or around 11.5%CoC

IRR after 10 years: 49% it seems the longer you hold the higher this goes? This number isnt taking rent increases into account.

Looks pretty ok on paper (unless I'm missing something and it doesn't)

The breakdown for your first example would have the sponsor (who I'm assuming is me in this scenario) receiving:

Acquisition fee: $1,750

Asset MGMT Fee: $672 

80/20 split when sold in 10 years: around 25K

And since this is a smaller deal a more basic approach of 

70/30: 4895/2098 or 8% back to investor annually

Does this seem to check out?

Interesting stuff. I can see how scaling this for larger deals could work out pretty well for all parties.

Thanks again 

@David Edwards IRR and time have an inverse relationship i.e. higher IRRs are usually associated with shorter time periods (all else being equal).

@Thomas Castelli has give you a good breakdown. But if you're looking at smaller deals (sub-50 units), syndicating might result in a higher cost structure as you'll have to deal with lawyers and specialized accountants. That will eat in your profits big time. 

Depending your equity sources, you can look to structure the deal as a partnership to get similar results (actually, better) results with lower costs and hassle. 

Furthermore, you are considering a straight split of the profits. Good syndicators offer a preferred return (8-10%) below which Sponsors will not get paid a dime. This is to align investor-sponsor interests. For e.g. with a 15% IRR, two scenario will play out differently:

Scenario 1: 20/80 straight split - Sponsor/Investor (GP/LP) split: 3/12

Scenario 2: 8% preferred return, 20/80 split for returns above 8% - Sponsor/Investor (GP/LP) split: 1.4/13.6

As you can see, Scenario 2 is better for the investor BUT long-term if you make your investors happy they will keep coming back to you. Otherwise, they might do a deal with you and then bail.

@David Edwards most conservative investments offer 15-20% IRR or 70-100% return for 5 years. To get that you can get that a variety of ways:

90/10 split
80/20 split with a 8% pref
70/30 split
... etc

@David Edwards you could also do a waterfall. I have done is a preferred return witheither a look back or multiple hurdles so higher returns I get more and if deal makes less $ I make less

This is all great stuff and exactly why I posted in the forums!

@Omar Khan I've dug some more into IRR and its starting to make more sense, I'll be fussing around with excel to make sure I have my head wrapped around it over the next couple evenings. Does the IRR keep adjusting annually based on expected appreciation of the property as well or if not reinvesting the returns would you adjust the number the IRR is evaluated against? Your point about the smaller deals and steering things towards a partnership makes sense and since I'm looking primarily at small multifamily the most applicable. Both you and @Lane Kawaoka discussed straight splits and splits with with preferred returns. That portion of the math seems much more straightforward assuming you know the IRR and work backwards from there.

@Chris Seveney At a base level it makes sense to me to have the performance of the deal you brought to an investor determine how well you do. Do you have an example deal or just an example with numbers of that strategy you could share so I can get a better Idea of what that would look like?

Thanks again!

@David Edwards

As an example let's say you targeted a 15% leveraged IRR in the deal and you gave the limited partner a 10% pref. Typically the LP will want you to have some skin in the game. When running the model of your goal is to get the equity partner to a specific return. In one case I just did we had 10% in and the equity partner had 90%. We financed 60% of the deal and gave them a 10% pref with the waterfall being 30/70. Based on conservative returns our LP was getting around a 15% and we were getting around 25% which was our goal to get them to 15%. If you have a robust financial calculator a few number adjustment should on your model can easily get you to where you want to be

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