Using Investors to Replace your Apartment Down Payment?

Question

I've been investing in 1-4 unit investment buildings (buy and hold) and recently have begun to look into apartment complexes.  After reading a lot about creative ways to fund the down payment by partnering with private investors, a strategy that wasn't ever mentioned is as follows:

Fund the deal with a bank and provide the 20% down payment out of my own funds.  After one year, or long enough to show future investors that the numbers DO actually perform, open the opportunity up for investors as a second mortgage (in the amount of the 20%) and provide them a fixed return (8-10%), after of course running the numbers to ensure it still cash flows with this second mortgage.

The benefits are: 1) Less risky investment for investors because they can see the numbers performing in real time.  2) More confidence for me in not losing someone else's money (i.e. test it with my own first)  3)  I as the investor get my money back and can move on to the next deal.

Is this logical, has anyone done this before?  What considerations are there for doing this?  Would the bank care at all, as long as they are still getting their mortgage payment every week?  Would this simply be a Promissory Note that a local Real Estate attorney could draft?

Thanks for any feedback!

Chris Soignier · Answer

A fairly common practice in MF is to refinance the entire mortgage after the value has appreciated due to some combination of NOI improvement and cap rate compression.   The refinance would still likely be 75-80% LTV, but if the value has appreciated sufficiently, you can pull your entire initial equity out, it's a tax-free distribution, and you don't have to pay a higher rate for the 2nd position on the lien.

Pete Sailhamer · Answer

Yes, everything is purchased through an LLC.  Thanks for the tip Steve.

Bill Gulley · Answer

Pete, your three justifications aren't necessarily true or prudent, your "investor" is in at 100% LTV, being fully leveraged is a concern when you have vacancies, what happens if you have an insured loss where the property can't be leased, loss of rents doesn't go forever and may be lower than actual rents? Yes, you get your money, invest in another, then it is no longer available to you or your "investor".

Careful how you solicit that idea, you can be selling a security and a very poor one at that. Those that get investors involved at 100% rarely understand the risks for an investor, like what happens if you get hit by a bus (?) and failure to cover all the bases or not disclosing the facts has been seen as fraud, putting an investor in a high risk position while sharing the flowered side of interest benefits.

A savvy investor likely won't go there, an unsophisticated private party may, one who isn't aware of the risks and these operators that try such things will usually find problems when that investor's son, or daughter, or accountant or attorney finds out what was done.

A bank has nothing to do with you obtaining other financing, but fishing for money in this manner can become predatory dealing quickly even when you don't have any ill intentions.

Part of a solution might be to sell an interest in that property as a partner, but even that needs to be reviewed by an attorney. There are hundreds of issues that can effect that property value leaving that partner or lender without sufficient security. Your intentions to cover the debt are really irrelevant and in some cases are beyond your ability to control the situation.

Another solution might be lease financing, pledging the leases for your loan, but on a single family deal, 1-4 family dwelling, there won't be much to pledge after a first mortgage, maintenance, taxes, insurance and a vacancy rate is applied.

I suggest you bite the bullet and keep your equity, you can pledge that in your next deal with a bank or in a seller financed deal. Good luck :)

Levi T. · Answer

Your investors can't have more than 10% of the LLP for most bank to lend you capital, otherwise those who do, have to sign off on the loan, which is not what they want to do as they are limited partners, so you need to sell them less than 10% in total. In 12-24 months if you able to improve the performance of the asset you can refi the loan at 80% of the value and buy out the investors if your terms allow. This is everyday commercial type lending. If your getting it below market, good, that means your giving yourself a little more room to refi out vs having to force it. If your good at it, you will get it below value to the point you don't have to do anything, and can refi it in 12-24.

Mike Dymski · Answer

Pete, keep us posted.  A note at or down the road well after closing is still a note.  Need to ensure that your bank and 1st note agreement permit it.  I have not done this yet but am contemplating it for the future to have private lender (or investor) experience in the toolkit (even if I do not need the capital).

100% leverage can be a house of cards...you can turn off investor distributions but not debt payments.  You can mitigate risk by maintaining a lot of liquid assets on your personal balance sheet (plus having a W-2 income).  You can have $100 in property and $100 in debt but have $50 sitting in your brokerage account (and other liquid assets) and be fine.  Holistic view of your personal balance sheet.

Chris Viglietta · Answer

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Chris Viglietta · Answer

@Pete Sailhamer are you saying:1. using an LLC, use 20% of your own equity to2. buy the properties at a 20%+ discount (aka "distressed value) and 3. finance 80% LTV using a private money / hard money lender and then4. cash-out refinance the properties to pull out entire initial equityI'm facing a simiailr scenario and would love to learn the best way to pull off a deal like this when there are several cash-flowing properties for sale (with equity).** I should mention my long-term goal is to build a portfolio of properties (~5) to obtain a portfolio loan DP's on 1-3 apartment buildings. Additionally, I've heard you can convince seller's to carry 30% if you have a portfolio / track record.

Steve Vaughan · Answer

@Pete Sailhamer , are you holding title to these in an entity like an LLC or your personal name?  I ask because because it may be possible to sell a 'membership' in an LLC.  May open some more options for you.  Now, if you  intend to solicit investor funds and /or syndicate investors together there are many rules and regs. Consult a professional. Just an idea, not legal advice!

Bill Gulley · Answer

Investors can buy at a distressed value, the proper term for buying at a low price when the transaction fails to meet the requirements of a market value transaction. If that definition of market value is met, you never buy under market value, the price you paid is the market value.

Distressed sales may be from the motivation of the owner, the property condition, it may be under performing or there are issues of obsolescence, functional or external.

Cure the matter that effects the property, mismanagement, condition, functionality or obsolescence.

Going the route Chris mentioned can be done, it's not guaranteed as an over night method as it may take time to achieve a record that can be shown in the market and there will also be more emphasis on the management ability of the borrower. A bank will most likely look at my deals differently than they might yours, it's not all about the property.

Get with you lender,  map out your business plan, have your financials in line, a short bio of your experience and education and map out the course of action in line with their lending requirements. Financing will be the keys to the doors. :)

Pete Sailhamer · Answer

Thanks for both of your responses.  I really appreciate it, and reading your bios I can see you both have a wealth of experience and knowledge.

@Bill G.   My follow up question to you:  Does your answer change if the property is bought at a discount (i.e. 80% of value) or if there is definite potential to add value decreasing the total LTV around the standard 80%?  For example in the 3 properties that I have bought so far, each was purchased between 70-80% of the value with cash, and then I immediately did a cash-out refi (like you mentioned Chris), while the lender still had a 80% LTV with no money down on my part.

The reason for the brainstorm is that I'm guessing at some point banks won't want to lend to me after a certain dollar amount, so I'm researching additional ways to still finance a deal while giving lenders (and me) peace of mind.

Thanks again for your wisdom, I really appreciate it!

Using Investors to Replace your Apartment Down Payment?

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