Apartment Purchase with 35 People

[Justin Yurong]

I've been working on putting together a deal with my friends, family, coworkers, etc. They would all be considered sophisticated investors. As of right now, I have an informal commitment of funds of $180,000 with 35 total investors (including myself). 

The quick and general idea is to purchase a small apartment building (5-16 units) in the Fresno/Clovis area of California, and everyone's ownership interest is proportional to the amount of funds they contribute. I wanted to structure it as an LLC, so that each investor would have limited liability unless they are going to be a guarantor on the mortgage.

I'm in contact with a commercial mortgage broker and lender, and it seems like lenders may require 60% or more of the LLC ownership to be guarantors (12 people, for this particular group). Ideally, it would be me and 1-2 other investors to be guarantors of the mortgage, not 12.

Has anyone had any similar situations? Have you found a better way to structure the entity so that not so many people would be guarantors risking their personal assets? Or, have you found ways to negotiate with commercial lenders to accept less guarantors?

Any piece of advice helps.

[Chase McArthur]

@Justin Yurong

Are these investors accredited?

[Shawn Krieger]

Hey @Justin Yurong I work for a prominent mortgage brokerage who is known for their work on complex structures I’d be happy to help share my advice

[Justin Yurong]

@Chase McArthur They are not. They would be considered sophisticated.

[Angelo Wong]

@Justin Yurong - 35 seems like a ton of people for only $180K. Why not use like 3 investors at 60K each?

The average investment size is only $5K. It's going to be so much headache to juggle 35 people's questions, and you're going to need to deal with a MFH in Fresno on top of that.

To answer your question...I think a better structure is to get bigger investors in the deal, instead of 35 people for such a small sum. It also makes more sense, because this is probably going to be the first of many issues you're going to have with 35 people.

And don't get me wrong - I'm not against 35 people in a deal...but the deal should be fairly large to support that much overhead. Keep in mind you're going to need to send 35 K-1's at the end of the year and if you have a CPA do it...your margins better be enormous.

[Chase McArthur]

Ok that being the case, you need to tread VERY careful. While it is legal under Reg D, there are hoops of fire that you will need to jump through to protect yourself and your project. The amount of disclosure that you will be required to disclose is going to cost you an arm and a leg and a half in legal documents. Otherwise you could find yourself in a proverbial sh*t storm. 

Secondly, I am having trouble wrapping my head around the kind of returns that will be gained from so many hands in the pot. 

Could you give us some numbers?

[Justin Kane]

yea be careful how you promote this under reg d law, and our min subscription rates dont go below 25k for the very reason of the headache so unless you formed as a single entity for financial managment and subscribed with all 180k as 1 constituent then i wouldnt allow it

[Justin Yurong]

Thank you all for your input. I appreciate it.

@Angelo Wong The reason there are so many people involved is because I haven't found people wanting to contribute 50k+ (at least, the people who I have a prior relationship with). There were a few interested in investing over 50k, but they were people I did not have a prior relationship with. I'm starting out with people I know and already have relationships with, as advised by the attorney structuring the entity. Also, the CPA/bookkeeper costs are already factored into the calculations. The margins aren't necessarily enormous, but they're enough to satisfy the current investors in the group. 

With my current group, what would you recommend? Anything helps. I always appreciate hearing the negatives, but I would love to hear your pieces of advice on how I can make this happen.

@Chase McArthur Thank you for your advice. Luckily, I've built a relationship with the attorney structuring the entity and he is interested in using the initial legal costs are his "investment amount" into the deal. 

While there are many hands in the pot, everyone essentially earns the same return that the building returns. I'll give you the example with the building I'm about to offer on tomorrow under this structure.

Number of Units	8
Asking Price	$ 398,888.00
Purchase Price	$ 380,000.00
Price Per Unit	$ 47,500.00
Down Payment	$ 114,000.00	30.00%
Loan Amount	$ 266,000.00
Interest Rate	7.000%
Term (Years)	20
Closing Costs	$ 13,300.00	3.50%
Repair Budget	$ 30,000.00
Initial Legal Costs	$ 15,000.00
Reserves	$ 7,700.00
Total Initial Investment	$ 180,000.00

This is a general example of how an acquisition would look like. Say the building cash flows around $1,800 per month after all expenses, which is likely what this building would cash flow when using market rents. If the initial investment is 180k, the cash-on-cash ROI is 12%.

Let's say one investor had contributed 18k into this deal. This means they would be a 10% owner. Out of that monthly cash flow of $1,800, they are entitled to $180 every month (10% x $1,800). For this particular investor, their cash-on-cash ROI would still be 12% ($180 x 12 / $18,000). Did that make sense?

@Justin Kane Thank you so much for your reply. Would you be able to further explain what you mean by subscribing all 180k as 1 constituent as a single entity for financial management?

[Matt M.]

@Justin Yurong

35 people in a $380k property? Yikes. That’s going to be way to many chiefs and not enough Indians. You couldn’t pay me to get involved in that.

[Caleb Heimsoth]

@Justin Yurong. Legality aside this is a bad idea. Way too many investors and not enough property

[Ruel K.]

@Justin Yurong I agree with the posters that 35 investors is too many. Besides, with an ROI of 12%, that means you get your money back in at least 8 years (100 / 12), if I am not mistaken which is a long time. In MF deals, the typical rule of thumb for an investor is to get their money back in 3 - 4 years.

[Justin Kane]

ill buy this property, 1 person.. myself! cash.. 

[Todd Dexheimer]

I would start talking with the 35 and let them know the minimum investment will need to be $25k. You may have a few drop out, but to get to $200k, you only would need 8 out of the 35 to say ok. If your investors don't have $25k, then it is too risky to get them involved. Also, is it really worth it for you to do all this work, just to make a few bucks? You would be better of taking your money and buying a single family or duplex. 

The thing you have to consider is that by bringing in investors like you are talking, you will be offering a security and will need to follow Reg D rules. It will be necessary to contract with an attorney to set up a 506(b) and file the correct documents. This will cost you between $10k-$20k in attorney fees. In my opinion a $500k raise is the minimum to justify those costs.