Is there a better finance strategy for large purchases than this?

Question

Someone once told me that he "builds or purchases and repositions" at 75% of FMV. Then, after 3-12 months, he refinances at 100% FMV and they lend him 75% of the value, meaning that he got all, or most, of his money back in the first year.

Does anyone use, or has anyone else heard of, a better strategy than that?

Mike Dymski · Answer

Sure, but we are likely reaching the point where I have to leave this to the experienced sponsors on BP because I don't want to be that guy who provides advice on the sponsor side of the transaction.  I am mainly familiar with the deal structures in which I am a passive investor and that only covers a small percentage of the possible structures.

#2 - You pay $50k as the sponsor, you raise $950k from private investors and you finance $4 million with the bank...$5 million total purchase price.  You and your private investors are making a 20% down payment (for illustration purposes).

If this were an equal joint venture with proportional (pari-passu) return of capital, you would own 5% (your $50k divided by the total $1 million down payment) and the private investors would own 95% ($950k divided by the total $1 million down payment).  Researching markets, fostering relationships with brokers, finding and vetting deals, obtaining experience, raising capital, arranging bank funding, vetting management companies...the list goes on...is hard work; so, the deal structure is set up so that the sponsor gets compensated for that work with a 70/30 split rather than proportional.  So the sponsor participates in the 70% along side of the private investors according to how much of the down payment they participate in plus the sponsor gets the remaining 30%.

Many of the structures are more complicated than this with a priority of how cash flows are distributed but I kept it simple here.

Account Closed · Answer

Sounds like the BRRRR strategy......I think

Patrick Philip · Answer

@Mike Dymski Can we go through #2? This property costs $5 million. I am the purchaser. How much am I paying in cash? How much is the bank paying? How much is the "deal sponsor" paying? How much is another private investor paying?

Mike Dymski · Answer

#1 - $200k property x 25% down payment = $50k down payment

#2 - Deal sponsors who raise private capital for most or all of the down payment can provide 70% (rather than proportional) of the equity to the private investors.  So, the deal sponsor has 5% ($50/$950) of the 70% = 3.5% plus the deal sponsor's 30% = 33.5% total ownership.  Let me know if you need clarification on that sentence.  Sponsoring a deal and managing people's money is hard work; so, there is sponsor compensation (such as the 70/30 split and other fees) built in to the deal structure.  The 70/30 split is just one simple example of a multitude of deal structures.

#3 - With apartments, you don't have to wait or hope for a rise in value...you purchase a property where you can create the rise in value by improving the NOI (net operating income).  The NOI of an apartment largely determines it's value.  You also do not have to sell to realize that value...you can refinance, pull our your invested capital (and then some on this example), let the property continue to cash flow and use the refinance proceeds for the next deal.

I was not necessarily recommending this strategy...just adding onto the BRRRR strategy from your initial post and describing the next level of leverage beyond that strategy since that was your question.

Patrick Philip · Answer

@Mike Dymski 1. How can you buy a $200k property for $50k?

2. 50k + 950k = 1mm. This is 20% of 5mm, not 33.5%.

3. I am not interested in real estate investing for the eventual resale of the property. I am interested in cash flow only. I would just as soon put it in the stock market or some other private business rather than investing for the rise in property value.

Mike Dymski · Answer

You can take $50k and buy a $200k property that you own 100% or use $50k, raise $950k in private  equity and buy a $5mm property that you own 33.5% (70/30 investor/sponsor split for illustration purposes...there are many structures).  If the value of both properties go up by 10%, you make $20k on scenario 1 (10% increase x $200k value x 100% ownership) and $167.5k on scenario 2 (10% increase x $5mm value x 33.5% ownership).  You collect fees along the way under scenario 2 as well for acquiring, managing and disposing of the property along with your share of the cash flows.  Bottom line, your IRR and cash-on-cash return can go way up when you leverage OPM.  BRRRR on steroids.

David Dachtera · Answer

@Patrick Philip,

Well, banks are "flush with cash" these days, but no, they do not have unlimited funds.

Also, when banks lend, they impose certain restrictions on the loans, the borrower, the collateral, the terms of the loan, etc. so the note can be sold in the secondary market or be insured by government-sponsored agencies like Fannie Mae, Freddie Mac, etc.

Private lenders ("OPM") typically don't write loans to sell them, and typically are interested in the deal rather than the borrower's details.

Using OPM down usually means putting some kind of partnership, joint venture, etc. together so the source of the down payment is less of an issue or a non-issue to  the lender(s).

Dunno if that helps...

Patrick Philip · Answer

Why is that steroids? Don't banks have unlimited amounts of money? How does using OPM instead of bank loans help?

Or are you saying that they purchase with OPM instead of using their own cash?

Is there a way to do BRRRR when you finance the purchase in the first place? Or maybe use OPM for the down payment only?

Is there a better finance strategy for large purchases than this?

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