Why not Take Loans Instead of Raising Capital?

Question

I've been wondering recently about the advantages of borrowing money over raising money from investors. After financing 75% of the purchase price for a multifamily from a bank, many syndicators raise money from themselves and other investors to cover the remaining costs, in fact I've never heard of any strategy other than raising money.

Why not get the additional capital from another bank, credit union, or other lender? It seems like interest rates would be lower and the process more standardized. Has anyone ever heard of borrowing the entire capital stack or have any insights on the pros and cons of raising money from investors?

Brian Burke · Answer

What bank would make that loan?  Banks are a conservative group of folks. They aren’t in the business of taking on much risk.  If they loan you 75% of the value of a property, they can foreclose on you and sell the property and recover most, if not all, of their money.

If they loan you 100%, and subsequently foreclose, they will suffer a substantial loss.  Equity investors are willing to take that risk in exchange for higher rates of return, i.e. 14-18% versus the bank’s 3.75% for the “safe” portion of the capital stack.

Todd Dexheimer · Answer

Why not get the remaining money from banks? They are a cheaper options as you mentioned, but they would be in 2nd position and highly levered, so they won't lend more. Raising money doesn't further leverage the property, since your investors are your partners

Rick Martin · Answer

@Shafi Noss in addition to what the others point out, you never want to be over leveraged - especially at this point in the cycle. Meeting the minimum DSCR requirements (1.25 NOI/Debt) would be a huge challenge as well.

Michael Le · Answer

By private loans I assume you mean private money lenders for single family investments. In this case there are a couple of reasons:

• The private money lenders generally lend based off 60-70% of the after repair value of the property minus any repair costs... not 100%. So not too different than a bank. This is so they could fire sale the property and get their money back if need be.
• And to follow-up with the above point, SFR is more liquid and they could in a few short weeks sell the property off quickly if they need. You can't do that with large multifamily.

Alina Trigub · Answer

@Shafi Noss

The strategy you're proposing works relatively well for SFH and smaller properties flips. You do end up paying the HMLs higher percentages plus points. It will not however work for buy&hold large MFH.

Best!

Greg Dickerson · Answer

As Brian said not only will banks not loan you 100% but most lenders (like agencies) will not allow seller financing as the down payment (some small lenders will) or second mortgages on purchase.

Rick Martin · Answer

@Shafi Noss, @Todd Dexheimer took the words out of my mouth. Thanks.

Shafi Noss · Answer

Thanks for the responses everyone. @Brian Burke's point about banks lending only enough to be covered by collateral answers my question. I hadn't thought about that but it's so clear when pointed out.

To me this raises 2 more questions, which I may need to research myself.

The first is why are private lenders willing to take the higher risk/return investment while banks aren't? I'd guess it's something like banks are set up to deal with the large loans systematically but not the small loans. They're larger institutions so they have a financial reputation to uphold. I can also see the argument that they have more to lose, but it seems like long-lived institutions like banks could afford to take high risk investments as long as they were profitable in the long run. Not sure how to think about that.

The second question is from @Rick Martin. Aren't you still fully leveraged, just borrowing from a different source? Of course that difference might be critical. Curious to hear your thoughts on why investors are safer leverage. Is it because they're paid with a pref instead of with collateral?

Stace Caseria · Answer

On the surface, it might appear like raising money would be more complicated than "just getting a loan." And for some it may be. But with the huge influx on private investor capital into the syndication arena, finding investors is likely easier than it's ever been. Also, platforms like this, podcasts, social media and meetups help bring investors and sponsors together.

Why not Take Loans Instead of Raising Capital?

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