Raising Capital For Value-Add Multifamily

[Anthony Palmiotto]

Hello BP, I am currently looking at a value-add multifamily deal that is 13 units. I would be purchasing this in a syndication. Let's say I want to hypothetically spend about 7k/door on renovations to get my pops in rent. My question relates to the $91k (13 units x 7k) I need.

I have heard Rod Khleif and others mention that you should always raise the renovation money along with your initial equity raise. My two concerns with this are:

1. Because I'm raising this extra equity up front, my cash on cash returns are lower than I'd like in the early years even though my cap rate and project IRR are where I need them to be.

2. This is sort of dead money because I am now paying a pref return on this money even though it's not being put to work on a count of I can only renovate units as they turn over.

The other options are to renovate units with the property cash flow which seems like the wrong way to go about it - and that still doesn't alleviate the problem of property renovations eating into CoC returns though it solves the problem of "dead money".

The last solution I can think of is to raise the money year by year as you need it which presents other problems. The obvious being that, because this is a syndication, the members equity will constantly be changing and I'll have to keep amending operating agreements and such.

Can any experienced syndicators weigh in here and let me know how they approach this and if I am misguided in my analysis of this?

[Brian Burke]

Generally you would raise the capital up front, and yes it does impact the CoC return slightly. This is pretty typical in value-add deals...not the strongest cash flow (sometimes none at all) in the first year and it ramps up from there.

Funding capX out of cash flow is just a bad idea because the cash flow in the early years is already compromised due to the lower rents and if you don't have the money to do the improvements you never get out of the rut.

There is another solution and that is to raise all the money in the beginning but don't call all of the capital at once.  As a simple example let's say you are raising $500K from 5 investors each investing $100K.  And let's say the capital improvements are $100K.  You would subscribe all $500K and call for $450K initially (to get you started) and when you are halfway through you call for the last $50K.  In this example each $100K investor would fund $90K at closing and $10K when you are ready for it.  No modification is needed to the operating agreement and as long as you are calling for capital pro-rata from the investors their ownership percentages stay the same relative to one another.

Having explained all that, if it were me I wouldn't do it.  I'd just raise it all up front and be done with it, and get your improvements done as fast as possible.  You should be able to do them all in a year or so.