Need advice on multi-partner investment deal!

[Harry Campbell]

So I have an opportunity to be a part of a small group that is buying a 3 unit apartment building. I have done a lot of research online in the past, and purchased a condo for myself a couple years ago. I'm looking for advice from anyone who has experience in real estate or more specifically multi-partner real estate investment property transactions.

I did not do any preliminary research on the property until the investor brought it to me the other day. The offer on the property has been accepted at 475k, it is a 3 unit one story building, with 3 1 bed/1bath units. The units are all currently rented out for 1267/mo, not sure about the make up of the tenants or how long they've been there. The outside of the units are in ok condition, not good, but not bad. I am not too worried about the rental part, the units should rent fairly easily if there is a vacancy, the area is pretty desirable and the rents are around the current going market rate. The principal investor has secured a 10 year fixed loan at 3.8% with 30% down, which seems like an awesome rate to me.

Now the part where I have little experience and need some advice :) There will be 3-5 investors including myself and the principal investor. We will need about 150k for down payment, closing costs, etc. I am looking at putting in 20k, the principal investor will be putting in 30-50k. Now I like the fact that he has a stake in the deal and he is not just putting everything together, but he does take a management fee of 20% before profits are distributed to the investors, does this seem appropriate? The projected cash on cash return in the first year is 8%, with principal addition it would be 12%. I don't expect much though from the first year as we will probably need to build a small reserve account, etc. I think the 20% fee sounds reasonable to me. I will be taking a look at the property this weekend and we are doing physical inspections next week. Is there anything I am missing or that I need to consider?

Thanks for the help!!

[Jon Holdman]

I'm missing how anyone makes any profit on this deal. Perhaps there's a resale opportunity here that isn't described, but if your profits are coming from cash flow, don't worry. There won't be any.

You say cash on cash will be 8% the first year. Based on $150K total investment, that implies profits of $12K a year, or $1000 a month.

We can pretty much stop right here. Total rents are $3800 a month. Subtract 50% for vacancy, capital and expenses and you're down to $1900 a month. A $332,500 loan (70% of $475K) at 3.80% for 10 years has payments of $3,334.89 a month. That's a loss of almost $1500 a month. Even if you mean its a 30 year amortization loan with a 10 year balloon, your payment is $1549 a month, leaving only $351 a month in cash flow. About a third of what you're being promised.

Now, sometimes deals like this get gussied up with "negative taxes". The promoter says there is a passive loss that you can use to offset other income. This deal will certainly generate a passive loss. From the $1500 a month cash flow loss above you have to add back on the principle parts of the payments but then you subtract depreciation. If you really have a 10 year note, the principle is a big chunk of each payment. I get a passive loss of only about $264 a month for the entire project, which would be $35 for your share.

Paying $475K for $3800 a month in rents is a guaranteed loser from a cash flow basis. There may be other ways to make money (fix and resell, condo conversion), but on a cash flow basis, this one is a loser.

For a project like this to be legit, there is a LOT of paperwork needed. Your investment in this project is a "security" and is covered by SEC regulations and your state regulations. The promoter would be doing this as a "regulation D" security, which, with the proper paperwork, allows raising these kinds of ammounts.

If $20K is 10% or less of your available nest egg, an investment like this might be something to consider. Not this one, which looks bad to me, but something like this. If that $20K is a big chunk of your nest egg, stay away from anything like this.