Question on Earnest Money & Limited Partners

[Adam M.]

Hello! 

Genuinely seeking thoughts from the community here so please keep discussion open and positive :) ! 

Our firm has done many deals in the past with our own capital however we are now looking at taking down multifamily deals with limited partners for the first time, especially as our portfolio is pretty illiquid at the moment.

I myself as executive officer am doing everything I possibly can to make sure I learn about every nuance of the syndication process to make sure things go smoothly before even thinking about submitting any LOIs. As folks know once that timer starts ticking you have got to move! 

We have many soft commits from our LPs excited to work with us seeing as we have typically said no in the past (either we were not ready to take on investor dollars/wanted to build more of a solid foundation first) so we are excited to generate great returns for others that we have been able to do for ourselves for several years. 

That being said as I still have concerns as we explore syndications further: two being being earnest money and timing.

Let's say we're looking at a potential deal that has a purchase price of $13MM, so we would probably need to raise $5.5MM-ish  with a fixed rate agency loan product like a Fannie/Freddie and including renovation cost.

In a typical 1% EMD scenario we would need to come up with $130,000 shortly after executing the PSA. Seeing as sponsors use LPs to help them take on larger deals all the time, how do sponsors typically work with the EMD requirement? Is it included in the raise/LP equity and how does that work seeing as you usually send that in let's say 3 days after executing a PSA? Doesn't the raise happen only after you have executed a PSA?

If there are any other GPs out there that have worked through this problem I would really love to hear from you as I continue to build my knowledge about syndication timelines and execution. 

Many thanks and happy Tuesday! 

[Taylor L.]

EMD is a type of risk capital. Risk capital providers will expect to be compensated for the risk they take on. It's not part of the LP equity raise, you need it right away in order to get the deal under contract. Terms are negotiable. Many EMD providers will want GP and LP equity for their contribution.

As the name implies, risk capital carries significantly more risk than LP equity. If the deal doesn't close the EMD is often lost. Regular LP equity, should the deal not close, should be returned to investors in full.

Hard earnest money on Day 1 has become a common practice, meaning you can't get it back unless you can demonstrate fraud by the seller.