Starting out with a big fish on the line....HELP!!!

[Thomas Usher]

My situation looks like a new investors dream deal on the surface. A 250 unit apartment, with owner financing that currently cash flows. The rents are well below market and the complex needs about 750k worth of renovations. The owner wants 10% of the 7.2 mill value of the property as a down payment. He will carry a loan at 7% interest for the rest. His current loan is has a prepayment penalty that is fairly large so he wants to carry the loan for at least 5 years. I am meeting with a PM to check the offering memorandum numbers against what their company usually sees in the area of the apartment complex. My initial estimates put me at approximately $100 per unit monthly cash flow after loans and taxes. 

I am getting all my ducks in a row BEFORE I start looking for investors. I do realize once the real numbers come in many things will change so I want to have as much lined up as possible in the next week so I can make a profitable offer. Any suggestions?

[Brian Burke]

@Thomas Usher I'm curious about what it is about this deal that makes it "look like a new investor's dream deal."  I think that new investors would think it's a dream because it's a large deal, has an owner financing component, and can be bought with 10% down.  What's not to like?!?

I'd argue that there is a lot not to like.  First, no new investor should jump into a 250 unit deal without experience working their way up through the ranks of property ownership or partnering with someone who has.  Imagine for a moment that the day you were born you came out of the womb as a full-grown adult.  No education, no learning how to socialize with the other kids, no development of life or career skills, no friends, no connections...and now you have to immediately get a job and live on your own.  How successful do you think you'd be?  Failure is nearly certain...it is childhood that prepares you for successful adulthood.  Don't move too fast trying to short-circuit the process.

This deal comes with built-in underlying financing with yield maintenance.  It's great that the seller is willing to upsize the debt by placing supplemental subordinate financing but you are stuck with that financing (at above market rates) for five years and you can't refinance out of it without huge penalty that likely makes in infeasible.  The reason that the seller is willing to do this is because no one wants the deal with that debt at its existing leverage level without the ability to re-leverage for an extended period of time.  The seller's best hope is a newbie that doesn't know better comes along and shifts his problem onto themselves or a 1031 exchange buyer that has a lot of equity to place and doesn't mind clipping a coupon for the next 5 years buys it.  It's OK to be one of those, but not the other.

6% physical vacancy is achievable in Houston if the property is C+ or better and the area is good.  2% loss to lease is likely light if rents truly are 20% below market.  If you try to raise to market too quickly you'll empty that place out quickly so you'll bleed off loss to lease over a number of years.  Sounds like there wasn't a factor for credit losses, concessions, and non-revenue units.  You also can't forget property tax reassessment that can crush the deal if the current assessed value is below market.

Bottom line: you are playing with the big boys.  If done right its very profitable and if done wrong it can crush you so badly that you might not ever recover.  Most people that lack experience wouldn't know the difference between "done right" and "done wrong" until its too late.  Proceed with caution.