When I bought my 12-unit apartment building (read the entire gut-wrenching discourse here), I put the entire deal together with a handful of investors.
In fact, I ended up not putting any of my own money into the deal and got paid $15,000 at closing.
Let’s talk about how to pay yourself when doing deals, especially when you have other investors involved.
How to Purchase Real Estate With No (or Low) Money!
One of the biggest struggles that many new investors have is in coming up with the money to purchase their first real estate properties. Well, BiggerPockets can help with that too. The Book on Investing in Real Estate with No (and Low) Money Down can give you the tools you need to get started in real estate, even if you don’t have tons of cash lying around.
When you’re putting together a deal to buy an apartment building with investors, you’re doing a lot of hard work: chances are, by the time you have a building under contract, you’ve looked at many others.
You negotiated the deal and did the due diligence. You brought the investors together to raise the equity and you secured financing for the rest. You’re doing all the work to raise the value of the building, and then you try to sell or re-finance for maximum profit.
You’re adding value to your investors, and you’re doing all the work. Many people who go through the trouble of syndicating a deal don’t compensate themselves appropriately, when in fact it’s perfectly reasonable to do so.
There are three ways you can pay yourself when syndicating an apartment building deal:
- Upfront at closing;
- While you own the asset; and
- When you dispose of the asset.
Getting Paid When you Purchase the Building
If the deal allows it, pay yourself an acquisition fee at closing. How much? Whatever the deal allows and whatever seems reasonable to you and your investors. The broker gets paid 3% – 6% of the purchase price. Wouldn’t it be reasonable to pay yourself 3% for putting the deal together?
Say you’re buying a building for $1M. A 3% acquisition fee would be $30,000 … not a bad pay day, right?
Paying yourself an acquisition fee increases the overall cash required to close. This of course reduces your investor’s returns. You need to work the acquisition fee into your projections and see if you can still achieve your desired returns for the investors.
In general, you should try to pay yourself something at closing. Shoot for 1%-3% if possible. If the deal doesn’t allow for it, either don’t pay yourself or find another deal!
Getting Paid While You Own the Building
There are two ways you can pay yourself while you own the building.
The most obvious one is cash flow distributions. You should retain at least 20% equity in the property for being the managing member (with your investors getting at most 80% for putting up the cash). This will then entitle you to at least 20% of any cash flow distributions and profits from appreciation.
The other way is to pay yourself an “asset management fee”. This concept is borrowed from money managers who are paid a small percent (1-2%) of the assets they manage. You, too, could pay yourself 1% of the total cash invested. This would be paid out before any kind of preferred rate of return distributions for your investors.
In our example of a $1M building, let’s say you raised $300,000 of equity and cash to purchase the building. A 2% asset management fee would be $6,000 per year, or $500 per month while you own the building.
Getting Paid When You Sell the Building
When you sell the building, you need to pay closing costs and sales commissions. You need to repay the outstanding loan and the initial investment to the investors. Whatever is left over is called the “Net Proceeds from Sale”.
If you own 20% of the building, you are then entitled to 20% of the Net Proceeds. That’s one way you get paid at closing.
You can also pay yourself a “Capital Transaction Fee”. This would be a small amount (1% – 2%) of the sales price that would be paid to you at closing.
If you sold the building for $1.5M, a 2% fee is another $30,000.
Keep your Investors in Mind
Regardless of how you decide to pay yourself, make sure you disclose how you’re compensated to the investors up front. This is usually done in the LLC operating agreement and/or the Private Placement Memorandum (if you have one).
Also make sure that your compensation is reasonable and that your investors achieve their projected rates of return. If you are the only one being paid and the investors are not, it will leave a sour taste in their mouths and they’re not likely to invest with you again.
You are providing real value to your investors and are doing all the work, so don’t be afraid to compensate yourself reasonably when you buy the building, while you own it, and when you dispose of it.
In our $1M apartment building example, you paid yourself $30,000 upfront, $500 per month while you own it, and another $30,000 when you sell it. Plus you’re getting 20% of any profits.
Then do another deal!
Photo Credit: Gianni Dominici