Little help analyzing a syndicated multi family deal
Hi,
Through a syndication portal, I got access to this equity deal (as part of the 86% pool). It's a 52 unit in a B class neighborhood in the Sacramento area. On top of checking the financials, I took a look on craigslist and other places to make sure the current rents were comparable to the one advertised in the analysis put together by the sponsor.
I am also fairly familiar with the area and know there's generally a strong demand. The sponsor is looking to bring the cap rate up ~1% and then sell in 2-3 years.
For someone who is not yet ready to go through the active way, would a passive deal like this be reasonable? I'm really not looking for a yes/no, to my "untrained" eye all the numbers seem ok (expenses don't seem under-estimated, the increase of ~250$/mo/door rent over 3 years seems reasonable considering the area, sponsor has some skin in the game and they have been in business in that area for a couple decades, ...), so I was looking to some more seasoned investor willing to share with me any clues as to how this deal might be bad (the only one I can think of is that returns might be very tight if a downturn occurs over the holding period, however since this one is not a class-A SFR property it should be more resilient).
I would be looking to invest about ~50k$ in this, which is a small enough portion of my net worth (< 10%).
Thank you.
Hi, I attended a REIA mtg & the speaker talked about Syndication deals. She stated the contract for ? mgmt was all over the place. One contract stated that all members would receive $$$ before mgmt & in another contract, it was the exact opposite. Definitely read your contract & how the $$$ is shared with fellow investors.
I attended a Rich Dad event in Scottsdale, AZ & Ken McKelroy spoke. Ken stated on his syndication deals, all the investors got paid first, then his company would start sharing afterwards. This is the reason Ken had 500+ Accredited investors wanting to invest with him.
Thanks for the reply, and good point. This would be the plan to distribute the payments:
Distributable proceeds from operating cash flow and capital events are to be distributed in order as follows:
1 - Senior debt service payments
2 - Then, to all deal-level investors pro-rata and pari-passu until such investors have earned a 9.0% annual preferred return (compounded to the extent unpaid)
3 - Then, to deal-level investors until their initial capital balance has been reduced to zero;
4 - Then, 25.0% to the Sponsor and 75.0% to deal-level investors until such investors have earned a 19.0% annual internal rate of return (IRR) (compounded annually)
5 - Then, 50.0% to Sponsor and 50.0% to deal-level investors
@John B. We don't buy in California. CA is not a great state to invest in, from a landlord perspective. It does not mean you should not invest in CA, but you need to be aware of it. Before you invest, it is really important to understand some of the basic rules of thumbs in the industry, so you can quickly identify questions that you might want to ask the deal lead.
For example…
Market cap rates, what should working capital be, economic vacancy rules, typical leverage, etc.
Rules of thumb can be different in each market. Hopefully someone on BP can provide you with some basic rules of thumb for the area you are considering to invest in.
Good luck!
@John B. I have also started as my first investment with participating in a syndication deal. I've done a few by now. So speaking from personal experience, do your own due diligence. Ensure that not just the numbers but also the area, the property and the potential are there and make sense to you! Analyze the job growth, population growth, major employers in the area. Then, perform your own calculations, using their actual numbers only! You can get a spreadsheet from BP Tools area. ( You may have to be a Pro or a Plus member to get one - don't remember for sure.) Only after you have done research and feel comfortable with it, you will gain the necessary knowledge to make an informed decision with this or any other investment.
Feel free to PM me if I can be of any further assistance.
Good luck!
@John B. First, I would check into the sponsor. Request a list of three references and call them to ask how their experience has gone. How many deals? Have they been repaid? Did the sponsor meet projections? Etc. I like the fact that the sponsor is putting up 14% of the equity, that shows a lot of confidence and alignment of interests with the investorrs. However, it is possible the sponsor is raising that money as well (using OPM) and has a much smaller piece personally. You should ask the sponsor how much he/she is putting up personally. Also, if they will be guaranteeing the loan or have anything else at risk.
I agree with @Tamiel Kenney that you should have an understanding of the market area. The sponsor should be able to provide you with a market study and/or an appraisal showing the actual rents and cap rates in the immediate market. A good appraisal will also do a write up of the largest employers, job growth, and general economy of the MSA in which the deal is located. Are the numbers getting stronger? If not, then think how this could affect the deal projections of rent growth and sales price? Are there new developments planned that will siphon off renters? Hopefully, the appraiser has researched this but you should do some research as well.
If the sponsor and market both check out, then ask the sponsor about the improvements that will allow the rent to be increased by 28% (I calculated based on Year 3 rent of $1,150/unit and your stated $250 growth) at a cost of $6,000 per door. I assume some of this cost will go to the exterior for aesthetic improvements (paint, landscaping, signage, etc) and some will go to deferred maintenance (new roof, new boiler, repairs to mechanicals, electrical or plumbing systems, site drainage, sewers, etc). So this would probably leave something substantially less than $6k per unit for the interior improvements.
Again if your sponsor has done a deal like this before and been successful, then I would put more faith in their ability to achieve the higher rents.
Finally, look at the numbers. Regarding income, 3% vacancy looks too aggressive, especially with a 28% rent increase that will require most of the units to be leased to new tenants (I find that the old tenants either can't afford the new rents or don't want to pay that much more than they currently do). What does the appraisal use as a vacancy rate? If it is much higher (5-7% which is typical) I would ask the sponsor why he used such a low vacancy. I would expect more concessions to get the units leased in a reasonable period or the vacancy should be higher. Ask the sponsor if the RUBS is existing or would be done by them and if so, what is the cost of submetering?
Looking at the expenses, I like that the taxes are increasing at a healthy rate, in line with the value increase of the property. A 40% OER in year 3 seems reasonable.
Below the line there is $13,000 annually of replacement reserves. This may be required by the lender (I assume it will be GSE debt) but in any event is good.
Sales price is at a 5.75% terminal cap rate which is aggressive in some markets but I like the fact that it is 100 bps above the going in cap rate, this is conservative and I would assume there could be some upside here if the market remains stable.
Cost of sale is low (3%, I assume this represents just broker commissions) but the additional costs (atty fees, title costs, etc) shouldn't affect returns dramatically. May be worth a question to the sponsor as to what the 3% includes.
Numbers look good (subject to the vacancy rate question and the improvements budget review). So if the market checks out and, most importantly, if the sponsor's track record is solid, I would invest.
Thank you everybody, in particular @Brian Moore
The implications of cap rates in MF deals are something I'm still trying to learn. I see most syndicators always project exit cap rates aggressively lower than the going-in cap rates (~2% lower is standard from the financials I'm seeing), which obviously increases the IRR quite a lot.
This deal was particularly interesting to me because of 3 things:
1) I know the area, as I used to live near Sacramento and I know it's a very interesting market that it's appreciating just by taking in all the incoming population burned out by the bay area pricing, and the employment opportunities are interesting
2) The debt terms of this deal seem very good
3) The exit cap rate lower than the in cap rate: with this one, I still don't understand if the syndicator is trying to be conservative and predicting a market downturn, or if there is something else I'm not aware of. I'll ask.
@John B. The Sacramento multifamily market appears strong. In fact it has the highest annual rent growth among 30 top metros per the Yardi Matrix report for July 2017.
I can't send a link but you can got to http://wc4.net/t?r=3303&c=3837721&l=408666&ctl=4BE... to subscribe.
Excellent points have already been made in this thread. However, the exit cap rate issue seems to be left outstanding.
To be conservative, the exit cap rate should be HIGHER that the entry cap rate. Unless there is a significant change that improves the quality (not quantity) of the assets NOI. Or you are making a call on the market direction.
You can partition the total return to analyze how much is attributed to cash generated during the hold period and how much is due to gain on sale. To me, it's always easier to project what NOI will be next year rather than what cap rates will be in 3, 5, or 7 years. So I lean towards deals that offer good current CASH returns and pay less attention to IRR or total returns.
You can find lots of information about cap rates for your market in particular. I like the fundamentals of Sacramento, but not sure how much I'd want to bet on cap rates continuing to go lower.
Below is a chart with national ave cap rates for MF. They have been going down. But would you rather bet they continue to go down or revert back up towards the long-term mean of 6.5%?
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Broker Florida (#BK627618)
- Brightleaf Properties, LLC
Thanks @Sean Myers
Underwriting that Sacramento deal simulating a cap rate increase to 6.5% brings me to an IRR barely above 0%, so I guess it's good that I don't go underwater :-)
Of course, that is true until it's just the cap rate to suffer and not the actual rents with vacancy and discounts, otherwise the debt service might become hard to cover...
Thanks for sharing your wisdom!
Update: after doing a bit more research, I became more skeptical about this deal: most of the comparables MF in the area over the past couple years have sold, stabilized or value-add, at an average cap rate of 5.3%. So, after all, the conservative exit cap rate might not be as conservative as I initially thought, and it appears the sponsor is overpaying the property.
After asking more questions to them, it seems the syndicator made an aggressive offer to the owner in order to buy the property off market, and that explains the low purchase cap rate of 4.7%.
Considering that the cash flow in the deal is not ideal, basically the only thing I like about this is the location (which I strongly believe will guarantee extremely low vacancy) and the convenient mortgage terms that easily allows covering the debt service. Everything else, most importantly the acquisition price, might be a bit higher.
This would be my very first syndicated deal so I'm trying to be very cautious!
Gianluca,
Although there are general frameworks to think about, it usually boils down to 3 major things:
1) Market - is the market (city) and submarket specifically growing at or above natl averages (population / jobs) to support higher rents. Review rent growth in the area recent history and projections. Identify the catalysts for future growth.
2) Deal - is the deal conservatively underwritten. Review the assumptions. Simple and easy to understand business case. Experienced sponsors under promise and over deliver. If something looks to rosy I get concerned.
3) Team - track record and integrity
Here's a top 10 list of things to think about when vetting a sponsor.
https://www.biggerpockets.com/blogs/9145/53959-vet...
Instead of just investing right away, what if you reviewed several deals in your specific niche area to get familiar with these 3 things and established your own criteria. Then put your criteria to the test when evaluating deals. I think your confidence level would soar by having knowledge going in on what is acceptable for you given your risk tolerance.
Mediocre deal at best
You might as well put all that money into a dividend stock that yields 2.5% and call it a day
just LOL @ spending large amounts of time and resources to retrieve a single digit return when you can accomplish the same thing with dozens of other kinds of investments with virtually zero time and effort
If you all were able to negotiate a massive 35%-40% off the asking price, it would instantly turn into a good deal though. Time for yall to test your negotiation skills
First of all, thanks for your reply, answers like yours are exactly what pushes me towards wanting to learn more.
May I ask what is terribly wrong, in technical details, with this deal? Yes, cap rates in this area are extremely low so the deal is not looking too favorable in terms of cash flow. However, the debt terms are very favorable and the sponsor is planning to significantly increase the NOI (~250$/month per door) through internal and external budgeted renovations. This in itself should bring the value of the property from $5,600,000 to $7,200,000 (and this is considering a more conservative exit cap rate of 100 bp above the enter one), so at the end of the day the increased value would make the investment IRR in the 15-20%.
I have a considerable amount of my portfolio in the stock market and believe me, no 2.5% dividend yield stock is going to deliver that performance over the next few years, especially considering the current inflated P/E ratios in the market, unless we gamble on ridiculous appreciation, so I fail to see how your comparison is fair. At best, that stock is going to have an IRR of 6-8%.
Please notice that I am absolutely not trying to argue with you and I just genuinely want to understand what is your point: are you saying that, in order for this to be a good deal, I should be completely ignoring the exit value the increased NOI will bring to the property, and just focus on the actual increased cash flow the increased NOI will bring me? Because that would indeed mean that the only way to achieve a better performance, regardless of the value-add strategy, would be to buy at a considerable discount (not really feasible in this area of CA).
As a novice, understanding this would be priceless.
Thanks!
Originally posted by @John B.:
First of all, thanks for your reply, answers like yours are exactly what pushes me towards wanting to learn more.
May I ask what is terribly wrong, in technical details, with this deal? Yes, cap rates in this area are extremely low so the deal is not looking too favorable in terms of cash flow. However, the debt terms are very favorable and the sponsor is planning to significantly increase the NOI (~250$/month per door) through internal and external budgeted renovations. This in itself should bring the value of the property from $5,600,000 to $7,200,000 (and this is considering a more conservative exit cap rate of 100 bp above the enter one), so at the end of the day the increased value would make the investment IRR in the 15-20%.
I have a considerable amount of my portfolio in the stock market and believe me, no 2.5% dividend yield stock is going to deliver that performance over the next few years, especially considering the current inflated P/E ratios in the market, unless we gamble on ridiculous appreciation, so I fail to see how your comparison is fair.
Please notice that I am absolutely not trying to argue with you and I just genuinely want to understand what is your point: are you saying that, in order for this to be a good deal, I should be completely ignoring the exit value the increased NOI will bring to the property, and just focus on the actual increased cash flow the increased NOI will bring me? Because that would indeed mean that the only way to achieve a better performance, regardless of the value-add strategy, would be to buy at a considerable discount (not really feasible in this area of CA).
As a novice, understanding this would be priceless.
Thanks!
Yes, I give answers the same way I would verbatim to a friend. You were right in the the deal doesn't cash flow right.
I trade a lot. In fact, trading is #1 for me, followed by real estate. The thing is that I happen to be a lot better at real estate than trading. I wish it were the other way around.
So to answer your question, let me explain. I did not even look at the technical details at all that much, because all i had to see was the asking price, and how many units the complex had total. For over $130,000 a unit, everyone involved in the deal better be getting a new Ferrari along with the purchase. The asking price is just a pie in the sky type of number that the seller is hoping to nab. There is no "deal" to be had here.
The only plus to the property is if appreciation continues to rise a lot, but let me ask you this - if appreciation in this area is what you're looking for, then why not get some real estate that is being relatively undervalued while you're at it? There should be better alternatives.
In order for this to be a good deal, there is really only one thing that needs to improve, and that is how low the purchase price is. It's all about the PRICE. There's not going to be an issue with the rentability of this property or it's NOI. It's simply the price.
If you think it will sell for $6.5 million easily after you guys improve the property, and you only had to pay $5 million total, then you have a great deal. If you only had to pay $4.5 million, then you just gave yourself a $500,000 cushion.
Successful real estate all boils down to two things - common sense, and how big of a CUSHION you are able to ensure for all of your deals.
Thanks for your patience, I now understand much better your reasoning (nitpick: the purchase price is actually ~107k/unit, not 130k, unless I am missing something).
Yes, the purchase price is significant, and that's mostly because Sacramento is growing at a very steady pace, people keep moving in the area because they get priced out of coastal California.
When I inquired about this, the sponsors said they had to make an aggressive offer to the owner in order to buy the property off market, and that explains the low purchase cap rate of 4.7%.
In any case, good food for thought, so thanks again.
Originally posted by @John B.:
Thanks for your patience, I now understand much better your reasoning (nitpick: the purchase price is actually ~107k/unit, not 130k, unless I am missing something).
Yes, the purchase price is significant, and that's mostly because Sacramento is growing at a very steady pace, people keep moving in the area because they get priced out of coastal California.
When I inquired about this, the sponsors said they had to make an aggressive offer to the owner in order to buy the property off market, and that explains the low purchase cap rate of 4.7%.
In any case, good food for thought, so thanks again.
alright hold on. maybe i saw something wrong, but what is the asking price again? and what is the loan amount and loan terms you guys are getting?
Originally posted by @Jason Chen:alright hold on. maybe i saw something wrong, but what is the asking price again? and what is the loan amount and loan terms you guys are getting?
No worries, I'm afraid the picture I attached with the financials has a very low resolution.
The purchase price is $5,600,000 for 52 units, the loan amount is $3,700,000 secured at a 30-year term with a 30-year amortization period, interest rate is fixed and rate locked at 3.85% for 5 years.
The sponsor is raising a total of $2,500,000 in equity (they are also buying in ~15% of the equity), so the additional $600,000 raised are going in closing costs and fees (~300k) and budget for renovation (~300k).
Because of the favorable debt, the DSCR seems particularly good (I have been comparing this deal to other crowdfunded on the web and boy those are risky, some barely get to 1 with an interest only loan!), it never goes below 1.3 even from the very beginning (of course an end of the world situation could always happen and vacancy skyrocket, but realistically that's not likely to happen in Sacramento at this time).
Originally posted by @John B.:
Originally posted by @Jason Chen:alright hold on. maybe i saw something wrong, but what is the asking price again? and what is the loan amount and loan terms you guys are getting?
No worries, I'm afraid the picture I attached with the financials has a very low resolution.
The purchase price is $5,600,000 for 52 units, the loan amount is $3,700,000 secured at a 30-year term with a 30-year amortization period, interest rate is fixed and rate locked at 3.85% for 5 years.
The sponsor is raising a total of $2,500,000 in equity (they are also buying in ~15% of the equity), so the additional $600,000 raised are going in closing costs and fees (~300k) and budget for renovation (~300k).
Because of the favorable debt, the DSCR seems particularly good (I have been comparing this deal to other crowdfunded on the web and boy those are risky, some barely get to 1 with an interest only loan!), it never goes below 1.3 even from the very beginning (of course an end of the world situation could always happen and vacancy skyrocket, but realistically that's not likely to happen in Sacramento at this time).
this deal might be decent. please give me some time to analyze things later today when i have more time
i thought the asking price was 7.3 million or something
one thing i still know for sure, is that the total purchase price needs to be lowered
Originally posted by @Jason Chen:
this deal might be decent. please give me some time to analyze things later today when i have more timei thought the asking price was 7.3 million or something
one thing i still know for sure, is that the total purchase price needs to be lowered
Thank you Jason, I really appreciate you taking the time to share your opinions on this!