Your strategy makes sense. What is your property management background.

Also, where do you find LPs? Are we talking a few rich guys or a bunch of upper middle class professionals?

The GP/LP split seems favorable - are you putting up any of your own money for equity? No money down and a 25% cash flow and carry with no hurdle rate is a great deal.

I have absolutely no PM background. For me, a strong business and management background has made up for my lack of experience in the trades. For example, I had no construction background when I started flipping and building houses -- luckily, I've been able to surround myself with people who have these skills.

The bulk of our investors will likely be well-to-do professionals putting in between $100-300K each -- lawyers, doctors and other investors who meet the "accredited investor" threshold, but who aren't so wealthy that they don't know what to do with their money. I wouldn't mind getting investments from some of those guys as well, but the ones I know would rather put their money into businesses (angel, VC) than real estate -- that's what they know well.

I'll definitely be putting in some of my own money (likely around whatever the average investment is from our investors) -- this way, our investors will know that we personally have "skin in the game" and aren't going to take stupid risks or walk away from the deal should times get tough.

Thanks for the write ups Aces

You mentioned maybe pursuing a vacant building. Since commercial properties are priced on NOI and cap rates how would you value a vacant building or a property with a negative NOI due to high vacancy or some other reason?

Something like: ((potential gross - expected expenses)/cap rate) - rehab costs = purchase price

Where you would obviously get some sort of big discount either by a very high cap rate or just a discount on the PP? Or do empty buildings value more like a residential property?

Also do commercial mortgages follow a similar structure to residential such as 30 year terms? Similar rates or higher since I assume no one is personally guaranteeing the loan? Down payments around 20%? I imagine banks would be very hesitant to have to take over a commercial property even more than a SFH. Is there a commercial property foreclosure/short sale market?

Do expenses for 50+ unit buildings tend to be less then the 45-50% estimate smaller properties because of scalability?

Do you mind talking numbers on the deal you invested in? Not your specific investment, but the overall purchase price, equity required, financing terms, etc. Also, if there was rehab involved was that an additional equity investment, or covered in the financing, or a some combination? Lastly, what was the length of the investment and ROE?

You say the deal didn't meet expectations and mentioned something about 2008; was it a matter of buying and selling the property at different points in the "apartment cycle", i.e. you were buying at when similar properties were selling at X cap and sold at a higher cap? Or was there a failure to keep costs contained during the project? Or were the rent/expense projections unrealistic?

For properties where the NOI would indicate a value that's inconsistent with common sense (for example, NOI = $0 because property is vacant), sellers will typically create a pro-forma for where the property should be performing, and will then try to sell at close to that number. The buyer, on the other hand, will typically start with the pro-forma value and work backwards based on anticipated renovation costs, lost rent through stabilization, etc.

Basically, both sides will make up numbers that work for them, and if they get lucky, they'll find a middle-ground that works for both sides.

It's quite possible that experienced apartment investors and brokers do something more sophisticated than that, but if so, I haven't seen it...


Mortgages for apartments tend to top out around 80% LTV (20% down), and typical terms are 15 year amortization with a 10 year balloon at about 1 to 1.5 points above residential rates. From what I've seen, you can typically extend to a 20 or 30 year amortization for an extra half-point to point in interest rate.

And the nice thing about most of the federal (FNMA) loans is that they're assumable, so if you sell in the first few years, you can get a premium on the purchase price because if rates have increased (as the buyer is taking over your loan and getting your rate).

From what I've seen, they're still in the 45-55% range, but a little bit higher (up to 60%) isn't uncommon.

Again, I'm certainly no expert, but that's what I've seen in my limited experience...

I was very much not involved in the day-to-day aspects of the deal, so I couldn't go into too much detail about the rehab stuff or the day-to-day management stuff, even if I wanted to. But, here's the gist of the numbers and the pro-forma:

180+ Units
5.5M Purchase Price
$150K Renovation Reserve
$150K Closing Costs, Prepaids, Inspections, etc
$165K Syndication Fee (the operators get 3% at closing for putting the deal together)

So, it was about $6M all-in on the acquisition and rehab. And I believe they put 25% down (around $2M including closing costs) and got a 75% loan (around $4M).

Pro-forma had an exit at about $7M with about $300K principle paydown over the hold term. After all selling expenses, I believe the pro-forma profit target was about $900K after 3-5 years.

Pro-forma annual cash-flow distribution scaled from about $120K to about $200K from year one through year five.

So, according to the pro-forma, on a five-year exit, the investors would have made about 75% of $750K in cash-flow and 75% of $900K in profits, for a total 5-year return of about $1.25M -- or about 13% annualized return for the investors.

In reality, we made nothing in year 1, about $80K in cash-flow in year two, and between cash-flow and sale in year three (it was sold in the third year), we made about $180K. So, the return was about $260K in three years, or about 4% annualized returns for the investors. We were given a preferred return, so the operators wouldn't have made much (if anything) on the deal -- but we renegotiated towards the end to give them some profits to keep them motivated and moving forward.

Honestly, I thought we were going to lose money throughout much of the investment, so I was thrilled with those returns.

That said, had we not sold in 2011 and were still holding it, I imagine we'd have a ridiculous amount of equity right now. If only I had a crystal ball...


During the 2008-2010 housing cycle, there was a ridiculous number of single family homeowners who were renting out their houses to try to avoid foreclosure. This drove market rents down, and especially hit the apartment market pretty hard in a lot of areas, as renters much prefer single family homes over apartments when the costs are about equal.

Thanks for the detailed response.

Who managed the property? Was a third party brought in, or did the operators handle it? If the latter did they receive a fee for doing so?

What about any tax benefits that accrue from the property? How are those distributed? Can you talk a little about segmenting depreciation, and would you do that if you end up doing a big rehab/turnaround deal? It seems to me that could be a nice selling point for investors with high earned incomes.

Lastly, when you pro-forma a property do you expect rents to more or less track inflation? (generally speaking of course)

The operators hired new property management -- both off-site management oversight and on-site leasing and maintenance. This was part of the operators' job, and that's what they were getting 25% of the cash flow and profit for.

I don't know for certain (other than I didn't get any tax benefits). I believe there were either one or two very large investors in this project who got the tax benefits. This is speculation, but that might have been in return for their signing for the loan. Typically, with these large commercial loans, it's required that one or more people with a total net worth greater than the loan amount sign the loan as the "sponsor". It's a non-recourse loan, but these signatures are still required.

I can't speak for others, but I typically won't factor in inflation in my pro-forma. The main reason is that, while gross rents will certainly rise over time, so will expenses. And to guess which one with outpace the other is pure speculation -- so I prefer to leave inflation-related changes out of the pro-forma.

Others with more experience may do this differently, though I haven't seen it with any of the deals I've reviewed so far.

Question:

Looking at projected rents on Redfin etc for the Westside in Los Angeles, you almost never see even a 1% rents vs purchase price on SFH, duplexes, triplexes etc.

SFH are going for $800k that could probably rent at the most for $5k. Are the people that are buying and renting these out net losers in the long run?

I just don't see how cash flowing property in high-priced areas like this could ever be profitable unless they bought in 2009 or in the 90s.

These investors either don't know what they're doing or they're banking on appreciation. In my opinion, banking on appreciation is no more than gambling -- unless they have some non-public information that is driving their location decisions.

That said, there have been plenty of real estate "gamblers" who have made a lot of money on appreciation. There have also been a lot who have lost everything.

Thanks for the answer. Even the place I live I rent for $2150 for the front house of a 2-house property (our small backyard's back wall is the front wall of their house). At current levels, the house could probably go for $800k+, but the landlord is getting only $4k of rents. He bought back in the 80s, however. I know someone would scoop it up if it went on sale (Westside RE is hot right now). But the most they could reasonably raise rents is to $6k total, so I don't know how that ever makes sense, from a pure financial sense.

I just don't get how Westside RE as an investment ever makes sense when prices and rents are anywhere near where they are.

In those types of markets it is way better to learn flipping. In my opinion investing in a property that doesn't cash flow, hoping for appreciation, is straight up gambling. And I'd add that some of those "bought 15 years ago, cashing out for a fortune" guys didn't do nearly as well as they think they did when factoring in inflation and expenses.

Aces,

Let's talk about what kind of returns would justify the risk/work of an apartment re- positioning like you are looking at doing. If it were me I would need a greater return to do an entire gut rehab vs. the deal you provided numbers on earlier itt. i.e. a pro-forma of 13% annualized doesn't justify the risk and doesn't provide enough margin of safety imo to take on a project of that scope. Do you have an example of deal you are trying to follow?

Another thing that springs to mind is the general partner fees in a re-positioning vs. the deal you posted. It seems like there would be a lot more work and expertise brought to bear on the type of deal you are talking about. In your experience are the deals structured similarly?

The deal I discussed earlier didn't involve any work on my part. I was a passive investor in the project, so the 13% was (would have been) completely passive (had to be given that it was coming from my retirement account).

If I were the one running the deal (the operator), I would get a decent percentage of the cash flow and profits (likely 20-30%) without having to put any money in.

So, there's the no work, passive return side of things and the all work, no financial investment side of things. Each is a great deal should the project go as planned. I agree that had I been doing the work and only returned 13%, that would have been horrible...

I don't have enough experience to talk about how deals are *typically* structured -- I've read through a lots of prospectus' but not enough to say that I know what's typical.

That said, consider that in a repositioning, there is more work, but there also tends to be a lot bigger upside as well. So, even with the same structure, the additional work should (in theory) be rewarded with additional profit/income.

When you say prospectus, I assume you mean private placement memorandum?

Setting aside the operator/general partner percentage, if you were a passive investor looking at a gut rehab project what type of annual returns would you require to justify the risk, everything else being equal? i.e. On the project you passively invested in a pro-forma of 13% was compelling enough to invest in what seemed to be a fairly stable project (at least relative to a gut rehab) based on the projected NOI increase over time. What would the number need to be for you to invest in a gut rehab?

I'll often receive some documentation of a proposed project prior to receiving a formal PPM...the operators are attempting to gauge interest before they spend $10-20K on a PPM.

I typically call the informal documentation the prospectus and reserve the term PPM for the thing that the lawyers help put together.

Keep in mind that with apartments and other large syndications, investments are typically equity investments. This generally means larger upside potential, but also more risk on the downside. And it generally means the investment is longer-term, so I do my due diligence once, and I get returns for 3-5 years. This is about as passive as it gets, as I don't have to continually work for figure out where to put my money a couple months down the road.

With a single family investment (you mentioned a gut rehab, but if I'm just a passive investor, it doesn't matter the scope of rehab), I'm generally going to make a debt investment (i.e., a loan), so the rate of return is fixed and the risk is reduced. With these investments, I typically expect to get my money back within 6 months, so it's more work to ensure that my money is constantly working for me. For these types of loans, I'll typically expect 10-14% interest, depending on who the borrower is and how risky I view the project to be.

But, like I said above, whether it's a gut rehab or a basic cosmetic rehab really doesn't matter -- in my experience, the risk comes from the person doing the deal and the specific numbers, not the extent of the rehab.

I live on the westside too and all my experience (just through renting, I've never bought real estate) is the same as you. In fact, if I wanted to live here forever, it's probably better to never buy a house and just stick to renting if you are looking purely at financials.

When I was asking about returns on a gut rehab project (my quote above) I was looking for an apples to apples comparison of the return on equity you would require to do a project like: (first quote by you) a potentially vacant building that needs a complete rehab or completely mismanaged.

Basically, I am trying to steer the conversation to what you are looking for as you try and take on a much more intensive repositioning; what are the potential returns, risks, etc.

You make some good points re: debt position in a SFH rehab vs. equity in a commercial syndicate risk vs. time; and I suspect you are trying to, at least partially, transition into longer term syndicate deals so you can better leverage your time vs. a (hopefully!) steadily increasing amount of capital you need to keep deployed. Makes sense to me; but I think we misunderstood each other.

Ah, got it...sorry, I was confused on what you were asking...

I honestly don't know the answer to your question. I can't evaluate it from a strict ROI standpoint, as again, the 13% assumed I was a passive investor and as an operator in the deal, I'd be trading time/effort for profit, not a financial investment.

As a passive investor, it doesn't matter to me if the project involves great amounts of rehab or not, as I'm not putting in time/effort. Certainly, if the repositioning makes the project higher risk, I'd want higher potential returns to account for it, but I'm not convinced that the amount of rehab is proportionate to the amount of risk (though there are definitely some relationships).

As an operator in the deal, I would certainly require much higher profit potential for a big repositioning than I would for a relatively turn-key property.

Hopefully that better answered the question...if I'm still missing the point, let me know -- as my wife tells me, I can be a little dense sometimes...

Maybe my question is bit silly... but do the things in this thread apply outside US?
I will move to Spain and I don't know if reading this thread is worthwhile...

Of course different factors must affect different areas. In London for example, it is considered a bit of a safe haven. This has made plenty of foreigners invest here which in turn has made the housing market very expensive. I am not sure how to look at this. It could be overpriced or it could be solid. I do not know if foreigners will stop investing here. It does not look like they will in the near future as I am not sure where they would put their money. Rents are also high. I think we can still use plenty of advice from here and from OP.

I wondering if anyone here has some ideas on how I can get financing now while I am not working. I am looking at purchasing a 4-unit building for around 80k. I have roughly 110k in cash. My last job contract ended at the end of February. I tried to get financing for the rental this past week but my credit union won't move forward until I have 30 days of pay stubs to give them. In a perfect world, I would get financed now before getting a new job so I can use the free time I have now to fix up all the units. Thoughts?

Perhaps a bank would consider loaning you 70% ($56k) if you deposit that amount or slightly more into an escrow account as collateral?