Hedging Against Risks From Aging Mechanicals

[Christopher Freeman]

Hi all,

I am currently exploring the possibility of buying a 6 unit multi-family. We are fairly confident that we can negotiate a favorable seller financed deal. One risk that we have identified are that the heating systems are very old (27 years), and we are apprehensive about their reliability. We do not currently have the funds to absorb a failure of the heating system, but there's enough income to budget 10k annually for capex and still hit a 10% cap rate, so it's something we could remedy within the first year or two.

I reached out to a business contact and asked if he would secure contingency funds in exchange for a percent of AFFO (basically, we'd pay him a portion of the income in exchange for the right to use him as a private lender in the event that one of the systems failed before we replaced it). He proposed that instead we give him an equity stake and work on the property together. I already have a business partner, so that would bring the total number of stakeholders to 3. We have not discussed how the equity and financial obligations would be divvied up yet. Open to negotiation.

While we would give serious consideration to the above arrangement, my question for today is whether or not there are other risk management techniques that we could use to protect ourselves from the mechanical risks and keep our interest in the property whole.

Thanks,

Chris