Many aspiring apartment building investors are eager to buy their first apartment building but many times they don’t have the requisite 20% financing that banks and commercial lenders require. There are certainly creative ways to overcome this obstacle, however, it should be stressed that there is no one answer or magic solution that will apply to every deal.
The apartment building buyer should first and foremost evaluate the property to make sure that the property will “debt service”. This simply means that the total income produced from the property will be able to pay for all of the annual expenses including the principle, interest, taxes and insurance. In addition to covering all of these expenses the property should also show a profit as well. Banks require a debt service coverage ratio of 1.2 or 1.25 on most apartment building investment deals. After determining that the apartment building will have a positive cash flow and a debt service coverage ratio of at least 1.2 the investor can than look for creative ways to raise cash for the down payment.
For example’s sake we will assume that the investor is looking at a 15 unit apartment building that has a purchase price of $1,000,000.00. We will also assume that the property will have a debt service coverage of 1.25 with a 30 year, fixed rate, commercial mortgage that has a fixed rate of 6.5%. We will also assume that the apartment building buyer has about $75,000.00 in cash to apply towards the down payment. The buyer now needs to raise about $125,000.00 to reach $200,000.00.
In my opinion, the best method to raise these funds is to seek out other investors and form a limited partnership. If the apartment building investor has no experience with limited partnerships then he or she should consult a qualified real estate attorney who can facilitate the partnership and prepare the legal paperwork. In brief, the investor will act as a general partner and the other investors will act as limited partners. The limited partners have a limited liability and they are responsible only responsible for debts incurred to the extent of their registered investment and they have management authority. Therefore he general partner will make the decisions about the property and undertake the management and the limited partners will share in the profits of the investment according to the extent of their original investment and as outlined in the partnership agreement. The limited partnership is a flexible and useful method for the individual investor to raise capital and invest in larger sized projects then he or she would normally be able to without actually borrowing more money.
The difficulty the new investor will face with raising money in a limited partnership will be convincing limited partners to come on board and invest their hard earned money in your project. For this reason it is necessary to have clear and accurate financial projections. It will also be more difficult to find partners if the investor has little or no experience with commercial real estate investments. For this reason, the investor may want to consider approaching family, friends, or other business associates to find qualified partners. Another avenue to explore would be to network at investment clubs.