Multi Fam New Construction Advice

[Christopher Dockins]

Hi All! Here's a overview of what I've got in the works - would really appreciate any insight or advice you might have. Thanks for reading!

I own a triplex on a large lot in central phx with entitlements allowing for an additional 13 units to be built. I have CDs submitted to the city and expect to have approval by the end of year. I have a lender who's provided a commitment letter for the construction loan, however, I'll need to bring in cash to pay off first position on the triplex and off the construction lender (depending on financing and market conditions at time of perm loan). My goal is for this project to be a long term hold.

Recently I've been looking for different resources to find a service or mentor who can advise on the dialing in my proforma, and advise on deal structure if indeed I need to bring in cash (i.e. based on proforma how can I pay off investors without reducing equity).

Would love to hear how experienced investors think about this!

Thanks,

Chris

[Stuart Udis]

@Christopher Dockins  As I understand your post, the lender is looking for an additional cash/equity contribution. I suspect somewhere in the 20-25% range of the total project costs? Since the existing building is only a 3 family dwelling it would make sense  more equity would be required for the 13 unit construction phase. 

You mentioned you do not want to reduce equity. Lenders generally don't want to see LP equity have the appearance of debt. From a lenders perspective the project will have the appearance its overleveraged and  lenders are generally more comfortable with the LP equity sharing in the economics of the underlying real estate. There are certainly ways you can structure your operating agreement that reads more like true equity with earn out clauses that allow for you to redeem the membership interest. I would just be careful not to make the agreement read  like you are paying a fixed rate for the LP participation. Depending on how long you hold your LP's equity you may be able to negotiate better terms  (A year +1 day from completion can sometimes get you LTCG tax treatment for your investors)  but speak with your CPA.

Another strategy to consider is leaning on imputed equity, if available. You mentioned this was originally a 3 family building and are now expecting approvals for an additional 13 units. This should increase the value of the land considerably. Not all banks are willing to treat imputed equity towards the borrowers cash consideration and  merely purchasing the property well or discounted will not fly but if you can show extended ownership or even better real value was created through entitlements some banks will treat some or all of the increased value as equity. Often times its a matter of how good of a story you have to tell. If its a  by-right project you will likely will receive less credit but let's say you had to go to battle with a neighborhood and come out victorious with your approvals, that's the type of narrative that can be used to your advantage. 

It's  a strategy I personally rely heavily on to reduce my equity requirements. One of my recently funded project was an auto assemblage with base zoning that would have allowed 6 single family homes. I worked with the community for well over a year going to countless meetings, multiple project revisions etc and ultimately obtained a variance to build 18 condos and 12 townhomes. The land's value increased by $1.1M and my construction lender was able to finance the construction at 86% LTC because of the imputed equity. Remember bank debt is generally the cheapest form of capital so I would start by seeing if there's a way to use imputed equity in lieu of investor capital