Multifamily Syndication: Basics Explained

 

Today, I want to explain to friends, family, and anyone that is not familiar with multifamily syndication – the basics of what my partners and I do when we put a deal together.

In real estate, as well as just about any industry a syndication is when a group of people or companies put their resources together – whether it be time, money or expertise to achieve a goal that would be difficult for each person to do on their own. For investors, this is a very effective way to pool their financial and intellectual resources to invest in projects much bigger than they could buy and run by themselves.

As it relates to buying into a multifamily deal, when you invest with a syndicator, you own a percentage of the property along with the other investors in the deal. This means all the great benefits, such as accelerated depreciation and preservation of capital, are enjoyed by all the investors in the deal.

There are many types of real estate syndication deals. You can join a syndication putting up a new building that is to be constructed, cashflow deals when wants to make an exit, or value-add deal, which is what my partners and I specialize in. This mainly consists of forcing the appreciation of the property by driving net operating income.

In these scenarios, there are typically properties that have either fallen prey to mismanagement, have deferred maintenance, or have some big upside play where the property can be repositioned. In any case, the value-add properties we target are all cashflow deals. We are not buying deals for appreciation only.

Now, you may be wondering, how does a syndication work. To get to that, let me first talk about the three main participants of a syndication deal. The people putting the deal together are called the Deal Sponsor. They are also referred to as the General Partner, Syndicator or Operator. Then you have the passive investors, known as the Limited Partners. The final part if the Property Management team. Aside from the structure, there are many supporting functions that go to work to put the entire structure together, like the lender, the SEC attorney, the real estate broker, the accountant, the title company and others.

While there are many players and moving parts, the Deal Sponsor is the one that keeps it all together. They need to identify the market, work with the lender to get the financing locked in, execute the business plan, make sure the renovations are getting done, staying in constant contact with the property management company, and keeping the investors up to date.

The Limited Partners, or the investors, provide the equity in the deal. They are bringing the cash to get the deal done. These people are typically accredited investors and do not have day-to-day operational responsibility. Rather, they rely on the Deal Sponsor to make sure they are doing what they said they would do for the return they targeted at the time they funded the deal. With that said, they usually have very limited decision making in the operation of the property, which reduces their personal liability if a lawsuit crops up. Additionally, they are not on the banknote so if things go very bad for the property, their exposure is what they originally invested and not the entire amount of the property itself.

The Property Management group is of vital importance to the overall success of the deal. A strong management group knows the local area, knows the market’s strength and weaknesses, and has the know how to fill the units with quality tenants. They are also great at running teams of renovators and making sure the tenants are kept happy where they live. This group works closely with the Deal Sponsor in not only running deals, but also identifying opportunities, assisting with underwriting, and working on due diligence and new property on-boarding.

So, let’s recap. So far, you’ve learned what a syndication deal is and its benefits, you learned a few types of multifamily deals and the participants of these deals, who are deal sponsors or syndicators, limited partners or investors, and property managers.

When it comes to the overall deal strategy, there are 4 main parts: Market, Asset, Business Plan and Deal Exit Strategy.

THE MARKET: The first part of any value-add strategy is the definition of the market. Typical target markets are in high growth metropolitan statistical areas, or MSAs with above-average job growth, a growing population, and employer diversification. The sponsor will also look at how the market rents are growing without any major renovations as well as the number of new units coming online and their absorption by the marketplace. All these things are indicative of a good market.

THE ASSET: Once the market has been identified, the search is on to look for the right asset in that market. For many, they are looking for stabilized properties with conservative underwriting with room left for a value-add play. Perhaps the deal is operating at 82% occupancy and the expenses are very high, but the roof, mechanics, and foundations of the property are still in very good shape. These sorts of deals provide the least amount of risk. The best deal is a property that is not very old and does not require so much work that it would kill the budget and exceed the cost per unit it could sell it for.

Once the property is selected, the due diligence is performed. This includes a deep review of the physical property that usually covers everything from the roof to the individual units down to the boilers and electrical systems. You want to make sure that all are in top shape and there are no items that could throw the deal off, like Federal Pacific breakers and aluminum wiring. Aside from the physical, get the accountant to review the financials and verify that the rent income lines up to what is being reported in the statements provided by the bank and the management company. Usually, the deal is cash flowing and there is enough actual income from the deal to support the note and the expenses. This is what any good sponsor will underwrite the deal on. They will base the numbers off what they are today and not base it off of what MAY happen in the future. Sure, you can create a model of possibility, but this is not what you submit to the bank. Rather, this model of possibility becomes part of the business plan, which will be discussed next.

THE BUSINESS PLAN: After the Letter of Intent, the LOI, purchase agreement and close, now is the time to execute the business plan. In this case, the business plan is created by what you not only found during the due diligence process but also what is seen on the competitive landscape. The ultimate goal is to increase the net operating income (NOI) by increasing income or reducing expenses. This will include interior renovations, rebranding the property, adding amenities such as reserved parking, coin-operated laundry, and vending. Other considerations will also be to improve the overall tenant experience like giving new tenants a small gift basket when they move in and 24-hour building support. Reducing expenses is the other lever used to boost NOI. This can be done by hiring new property management, getting new property insurance, or installing technology to improve boiler efficiency if heat is paid by the landlord. The deal sponsor tracks all the improvements for not only the accountant but also to inform the investors on how the property is progressing.

THE DEAL EXIT STRATEGY: As the business plan is executed and the property is stabilized, the deal is held for as long as defined to the investors before the Deal Exit Strategy. Typically there is a 10-year hold with a 3 to 5-year refinance to return at least 60% of the investors’ initial contribution while still holding equity in the deal. The return really depends on where the current market cycle is – whether in growth or recession – and if it makes sense to refinance and/or sell.

Once the business plan is complete, this is where the Deal Sponsor and the Limited Partners cash out and everybody wins – if the property and the Sponsor performed to make the deal a success.

Now, how do syndicators make money with these deals? The Deal Sponsor makes income from the pre-defined split with the Limited Partners. This split varies on a deal and the Deal Sponsor’s background. There is also an acquisition and asset management fee the Deal Sponsor received for landing and launching the deal as well as the ongoing management of the property.

The sponsor’s main component of income from a syndication deal is the split with the Limited Partners. Depending on the operator, you may see a straight split or a waterfall structure. Some Deal Sponsors have a 70/30 split in favor for the Limited Partners plus a 9% preferred cash-on-cash return. Both the Deal Sponsors and the Limited Partners have equity in the deal for the life of the syndication.

A second form of revenue for the sponsor comes in two common fees; an acquisition fee, and an asset management fee. The Deal Sponsor will receive an acquisition fee which is a percentage of the property price paid to the sponsor at the time of close, while the asset management fee is the ongoing fee that the sponsor collects for their daily activities in overseeing and managing the asset. It is common to see a 2% rate for the acquisition and the asset management fee. All these splits and rates vary by Deal Sponsor. It depends on the sponsor, the market, and the opportunity itself.

Anyway, this is meant to be a high-level view of a syndication setup, the groups involved and how money is made in this deal. Are you syndicating deals now? How does your breakdown look? Let me know in the comments. I’d love to hear from you.

If you liked this content, go ahead and give it a thumbs up and share it. Also, check out the Bulletproof Cashflow podcast on iTunes or Stitcher, and subscribe to our YouTube channel. We are working on getting new content out all the time to help you build your success in the world of multifamily.

Be great.

But…I Don’t Have Any Money

 

I do a lot of meetups and talk to many that say they want to get into real estate and multifamily real estate. There is always a recurring theme of reasons why they don’t start up their real estate dream. It’s either “I’ll wait until the crash,” “I’ll wait until my kids get into grade school so I have more time,” and my favorite one, that is “I don’t have any money”.

Then, they go back to watching the news or some reality show only to wonder why that rich person on TV has it so easy.

I’ll tell you something I discovered about the self-made wealthy: They are rich today because they took the time to understand how money works and how to use tools such as bank leverage, to multiply their money. They also took time out to network with others that have money. They dedicated their time to learning how to become masters at one single thing and filling in what they are not good at with a strong team. They didn’t spend time watching TV, going to sporting events or clubbing on the weekends, unless they used these activities as opportunities to network with others or to 10x their relationships. They trained hard knowing that at some point in the future, they could spend their time doing the fun things later.

You see, all of us have been sold a lie. We were told to work 40 hours a week for 45 years and save our money for retirement. While you are doing all this, you buy a house, spend your weekends chilling, and start it all again on Monday. For many, it’s living in fear for those 8 hours because you just don’t know if you are the next one to get canned. But it doesn’t have to be this way. If you believe in yourself, you have the potential for more.

I spent years doing the single-family and small multifamily thing early on. Later, I dedicated my time to studying real estate, getting in front of banks, finding amazing partners, and putting together a team that helps me run my business. Now, the only thing I do is large multifamily. The motivation in all this starts with the definition of “why”. I want to leave a legacy for my family when I’m gone – not just in terms of money but also in terms of education. My “why” is strong enough for me to pull me forward even at the end of a long, exhausting day. Maybe your “why” hasn’t appeared yet or you are not sure of it. For some, it takes years to find their “why”. But when you do, you won’t shake it.

When you set aside the reasons and focus on your “why”, there will be no “buts” or “someday”. I started in real estate using my own money and the rest from the bank. Today, we have investors that put money into our deals and the debt is provided by the U.S. government via agency debt. If you believe you can do the same thing, you will. It just requires to modify your priorities and focus on what you want to change in your life.

Anyway, have you defined your “why”? Are you still trying to discover it? Let me know. I’d love to hear from you.

If you liked this, go ahead and give it a thumbs up. Also, check out the Bulletproof Cashflow podcast on iTunes or Stitcher, and subscribe to our YouTube channel. We are working on getting new content out all the time to help you build your success in the world of multifamily.

Be great.

When Do You Buy For Appreciation?

 

The other day, I did a talk about forcing appreciation and I mentioned how I only buy for cash flow. This led to a barrage of questions around buying for appreciation. So, I thought I would answer it here.

As a recap, there are two basic ways a multifamily deal makes you money: 1) Through Cash Flow and 2) Through Appreciation. Before I go on, I’ll color in some details of each.

In a cash flow deal, there is typically good net cash flow when you walk into the deal. In this type of deal, you are basically looking for income from rents and other income minus expenses to have cash at the end of the month. Expense items include insurance, the mortgage, taxes, any utilities and other costs associated with the property. We are always looking for this number to be trending positive on a month by month basis, but sometimes there are negative months or you just break even. This could be indicative of other problems, such as you have an overrun on expenses or you are just not collecting enough income. I covered ways of addressing both scenarios in my other podcasts, so be sure to check them out. Regardless, in negative and zero situations, you want to get that handled because if there is no cash flow, it makes for unhappy investors and unhappy owners.

In an appreciation deal, you are relying on drivers outside of your control to bring up the value of the property over some long period of time. The thing to note is that it may be subjective and even speculative. These deals are banking on the local area to drive the overall value of the property. Maybe there is a new revitalization happening like a new arts and entertainment district, there is limited space to build in a hot area, or there is an economic driver that increases the demand of the area. The appreciation strategy is driven by the region and market you are buying in. Meaning, not every market will appreciate. The most extreme places are New York City and Los Angeles, where the cap rates are very low but people buy anticipating that in 5 years from now, that $1MM triplex will be worth $1.4MM. In these cases, there is very patient money and these investors are looking to park their money in the hopes to score down the road.

With that out of the way, the reason to buy for either cash flow or appreciation depends on your motivation. As I mentioned, if you are looking for a long term gain, appreciation is your best path. If you are looking for cash in the short term, month over month, you need to be targeting cash flow.

If you are syndicating deals and the objective is to make money in the short term you need to be investing for cash flow. The property needs to be cash flow positive and in a position where you can bring up income and reduce expense to maximize the net cash.

But, if you are looking to invest for appreciation, then the strategy is much different. In this case, you are looking for an asset where there is a great deal of change and improvement. If you are using investor money, they would understand the strategy and get on board. If there is some cash flow, you can always provide some very small return, but the score will be on the back end when you go to sell the deal off.

And this is the part where things get risky. Because appreciation is based on speculation, that big score when you sell it is not guaranteed. If you are putting your investors’ money into a deal, you better make sure you know your market and what goes on in that market. That is why places like New York, Los Angeles, Chicago and more recently, Miami have turned into appreciation markets. Buyers in those areas KNOW it will appreciate over time and will go without cash flow – or even negative cash flow – for a score at the back end. If you plan on applying an appreciation play in markets that have not moved all that much, be careful. Your job as a syndicator is not to lose money.

These days, the focus of my partners and I is cash flow. We may expect some appreciation, but we do not bank on it. We bank on running the property well, making improvements to drive income and doing a refinance to pull money out of the deal to return to investors and pour into the next deal. There is nothing wrong with buying for appreciation, it’s just not what we do.

Anyway, what strategy do you prefer? Let me know in the comments. I’d love to hear from you.

If you liked this, go ahead and give it a thumbs up. Also, check out the Bulletproof Cashflow podcast on iTunes or Stitcher, and subscribe to our YouTube channel. We are working on getting new content out all the time to help you build your success in the world of multifamily.

Be great.

5 Affordable Ways to Force Appreciation in your Multifamily Deal

 

As value investors, we are always looking for multifamily deals we can get into, improve and drive revenue to increase the net operating income. This is referred to as ‘forced appreciation’, when you, as the investor, are actively working on the property to improve cash flow and reduce expenses.

This is different from ‘natural appreciation’ where the market is driving the increased value of the property. Basically, you are selling the property for more than what was paid. You have no control over this type of appreciation and it is not always guaranteed.

Forcing appreciation in a big way, such as installing new low-flow toilets to drive down water expenses (if you are paying for water) or increasing rents is not always possible. Perhaps you don’t want to invest in the plumbing work or you are already close to market rents and can’t push them higher. Regardless, there are still ways you can improve NOI and force appreciation in other ways and reserve the cost intensive tactics for later.

Here are 5 affordable ways to force appreciation in your multifamily deal:

1) Install Coin Operated Washers & Dryers: If your multifamily deal has a basement or storage area that is not in use, install a coin operated washer and dryer. It is not only a huge benefit for the tenants as they won’t need to go to a laundromat, you will also benefit from the income on the machines. If you have a small multifamily apartment building, something less than 30 units, you can probably get away with installing your own units and having the management company pick up the coins on a regular basis. Reach out to a few of your local laundromats and ask them if they are willing to sell their used machines. Depending on where you are located, you can charge $2/cycle on each. If you have enough tenants, it can add up quickly.

2) Offer Doorside Trash Valet: Depending on the asset and the market, you can consider either having your cleaning people put this in place or bring in a company that does this on your behalf. Not only will it keep the hallways clean, tenants won’t need to walk their trash to the dumpster on those cold, late nights. Many outsourced companies will split the profit with the property owner, so the barrier to implement is low. Again, this will vary depending on where the property and where it is located.

3) Add Storage Units: Tenants are usually short on space and will often pay for additional space if you offer it. If you have a dry basement, you can put up walls and doors and rent the space to the tenants. If you have space outside, you can have a steel structure put together on the premises. There are professional companies that put up prefabricated storage units and they are not expensive. Tenants have been known to pay an extra $30 to $50 per month for each unit – and all that cash goes straight to the bottom line after you cover the build cost.

4) Install Energy Saving Systems: Aside from LED lighting and motion sensors, you can also install systems for your furnace or boiler that will only activate depending on the temperature outside. There is usually some cash to kick up for the install, but it will pay for itself in two months if you are providing heat for your tenants.

5) Install Security Cameras: While this is not an income-generating investment, it does increase the overall value of the property. The active cameras will keep an eye on your investment while giving the tenants some peace of mind. In some cases, they may even make the difference for the tenant to move into your building versus one that doesn’t have such a system.

Anyway, what are some low cost or affordable ways you are driving income or reducing expenses? Let me know in the comments. I’d love to hear from you.

If you liked this, go ahead and give it a thumbs up. Also, check out the Bulletproof Cashflow podcast on iTunes or Stitcher, and subscribe to our YouTube channel. We are working on getting new content out all the time to help you build your success in the world of multifamily.

Be great.

Four Things To Do When Market Rents Decline

 

According to the U.S. Apartment list, five large cities saw a decline in the median rental rates over the past 12 months: Baltimore, Chicago, Pittsburgh, Portland, and Seattle. No city or region of the country is safe from declining rents. As landlords, we need to track our local market and make adjustments to maintain as high an occupancy number as we can.

When the collapse and resulting recession hit in 2008, rent growth froze. For some regions of the country, any increases were hard to push because people started looking for other means of housing, also call a Shadow Market in Housing. And the shadow rental market exploded. The owners of new and empty houses and condos pulled tenants from traditional multifamily. To be competitive against this situation, management needed to make retaining good tenants along with marketing to new tenants a priority.

When rents continued to fall in 2009 and 2010, there wasn’t’ much to do to increase rents. The country was still reeling from the collapse. With such high vacancy, tenants had plenty of units to choose from and demanded bonuses and incentives which often appeared as a reduction in price for rent.

Fast forward to 2019. Depending on your region of the country, you could make small concessions to getting a renewal, such as a $100 Amazon gift card or a $100 AMEX Cash Card. You could even do a grocery gift card from Kroger or Walmart for renewing tenants to stay another lease term. We usually do a choice of carpet cleaning, painting of a room or even a small capital improvement to get the tenant to stay. Anyone of these things is far less than the cost of turning a unit, dealing with the vacancy and lease renewal costs from your property management company. This typically only works for Class C units.

Aside from improving the tenant experience and getting them to stay in the unit, here are four things to do when you think rents start falling in your local market:

1) Verify the Falling Rates: Look at your competitors in a 5-mile radius by looking at Zillow or Cozy. Have they reduced their rent over the past several months? Keeping an eye on what the local market is doing is important not only if you think rents are dipping but also if they are increasing. One reason they could be making their way up is that your competitors are improving the property and you may not be. Or they may be offering a free 40” TV as opposed to 30 days free (which is much less expensive). If the landlord has a good tenant on the hook, they may cut the tenant a deal and give them an 18-month lease for a slightly lower rent rate. Depending on the asset class and what is going on in the economy, people will be more cost-conscious. For instance, you can offer a $200 gas card as an incentive if gas prices are on the rise. Of course, ‘charm pricing’ is always important as people will perceive a big difference if we list an $800 unit for $795. Keep this in mind as you price your units.

2) Multiply your Customer Service: Taking care of your current tenant basis is important to hold the line on vacancy. This means staying on top of service requests and work orders. Rent growth is already a losing battle when vacancy is on the rise. Don’t compound the problem by slacking on tenant requests. If you are using property management, something which I strongly suggest, they should be on top of the requests. You just need to make sure things are getting done.

3) Build a Marketing Strategy: I’ve put out a great deal of material on the various marketing tactics you should consider when targeting a given demographic. You should also consider what your local market is doing to pull those prospects in.

For instance, if you are in a heavily hit market with an oversupply of 2 bedrooms, you may want to consider turning your 2 bedroom unit into a 1 bedroom by locking or sealing off the door to that second bedroom. This tactic will get you some additional occupancy. You may also consider giving away two months free with a lease with the first and last month of the lease being the free months. You can also add basic cable or wireless internet for 6 months so you can get them in the door.

4) Stress the Urgency with Your Team: As the leader of the group, you need to communicate your vision to your property management and construction team. They need to understand that the goal is full occupancy. You need to outline the plan for the team at large so they understand that keeping vacancy as low as possible is critical. Weekly meetings with each property manager to go over critical issues, cost control initiatives, and new move-ins are also recommended. Keep the meetings to no more than 1 hour and always have an agenda so the property manager has time to prepare.

An economic slowdown or depression will cause people to substitute expensive rentals for cheaper ones, putting downward pressure on rents. History has shown that it would also cause people to move in with family or take on a roommate, further decreasing demand for multifamily rentals. Additionally, anything that makes buying a home more cost-effective will make rents lower as well because people will perceive buying a home as a cheaper option. As houses become cheaper, those tenants will move out of a rental and become homeowners, decreasing demand for rentals.

Anyway, what do you think? Have you ever applied these tactics? Let me know in the comments. I’d love to hear from you.

If you liked this, go ahead and give it a thumbs up. Also, check out the Bulletproof Cashflow podcast on iTunes or Stitcher, and subscribe to our YouTube channel. We are working on getting new content out all the time to help you build your success in the world of multifamily.

Be great.