Entertaining a small 10% buy in on 15 unit complex - need advice!

[Nick Kaihoi]

Hello BP,

I had a deal 'fall in my lap' and although I'm still gathering details, I'll put what little I do know about it here for your review. I'm meeting with the primary investor today to gather more info, however, what I really need to figure out is what I don't know and more specifically, what questions I need to ask. I've already consulted with my lawyer which was very productive but am hoping I can gain some additional advice from all of the fine people here on BP. Additionally, I have equity in several of my other rentals but am curious on what other options are available to me for financing. 

15 unit
Appraised last year at $1.5M by 3rd party
Unknown how many total investors - best guess at this point is 5 (40%, 20%, 20%, 10%, 10%)
Solid class B/B+

10% investor wants out
10% investor had the property appraised recently at $1.9M

Obviously I need to meet the other investors, figure out why the 10% owner wants out (sounds like personal differences), what the long/short game plan is, income/expense, any debt that is being carried, rental history, hopefully I can get a copy of the Operating Agreement prior to the vetting period, and speak with the seller to negotiate price and terms. BUT, what else should I be asking about??

The primary investor is someone I've "known" for almost a decade but we've never really gone beyond a friendly hello when we would see each other. A friend of a friend situation. That person is aware that I don't have experience in commercial properties (I have 5 SFH, 3 of which are rented) and is willing to coach me and help me get into the game. I wholeheartedly believe this person is genuine for reasons I won't get into here, you'll just have to trust me. With that said, I'm not looking for a slam dunk, I'm looking for an opportunity to grow, learn, and am willing to "pay" for it by way of an average deal as opposed to a great deal. Although, we all want a great deal, right?!

Thanks, BP!

[Brian Karlow]

Nick 

How is the 10% structured in terms of the over all deal? What are the details of the investment payback? (i.e. 10%of the profit at the exit and a preferred rate of return during the hold period?) 

Brian 

[Steve McGrane]

Hey Nick!

  Are you getting any part of the monthly cashflow?

  Are you responsible for any part of the management or maintenance?

 If no cashflow, are you just getting a straight repayment on a monthly basis?

In other words, what's your risk/reward?

- Steve

[John Woodrich]

It sounds like you are most interested because you want to gain experience doing this.  From this standpoint I am not sure what you are uncertain about.

The first think you will want to do is look over the financials, see what cash flow it has been kicking out, and see what the tax consequences of it are.  Many of these have cost seg studies completed so most of the tax benefits are stripped out the first few years so the later years are cranking out taxable income.

Next the operating agreement will detail out the income allocation, rights of each member, and your right to distributions.  It also should have a provision related to transfer of member interests which typically states that the transferring members are responsible for paying any fees which usually involves additional tax and legal fees.  They will also likely make you sign to adopt the operating agreement so if there is something you don't like there isn't much room for change.  As a 10% owner you don't really have a say.  If the majority didn't want to kick out distributions for taxes you would have to pay your own.

As far as financing goes I have only seen these done with cash.  Your purchase price should obv reflect the debt, a minority member, and marketability discount.  I don't see how that building appreciated by $400k in one year so I think he is pushing smoke.  Interest rates have also gone up so I would expect the price an investor to pay to be dropping.  To be clear - if it was worth $1.5M and had $1M of debt there is $500k of equity.  A 10% interest is NOT worth $50k because of lack of control and lack of marketability.

Last - like buying any other property you will have to do you due diligence on the condition of the building and make your determination if you think the cash reserves are enough to cover the deferred maintenance.  Unlike investing on your own, the partnership may decide to replace the roof and make a capital call asking for more money from you to cover your portion.  I would only recommend this if you were comfortable that there isn't a hidden maint liability and if you had the means to meet capital calls.  If financing is needed to get in the door this may be an issue.

From an investment standpoint this is similar to owning a stock, you put money in and hope you will get a good return.  You have some say in management but like owning a share of 3M your vote doesn't always matter.  These are not investments I am personally interested in getting into but they work for many people.

[Nick Kaihoi]

Thank you to all that have responded so far. It has helped me formulate additional questions that I need answers to and with any luck, I will have those answers in the coming week. I'll make sure to keep you all posted!

As @John Woodrich said, I also don't know if this type of arrangement is something I am interested in because of lack of control. Truth be told, when I received the initial phone call I didn't even ask any questions, I simply said I wasn't interested. However, I called back within 60 seconds because I realized that if I don't ask any questions, I have no idea what I just said no to. It was then that I realized I could be paying for education - if this is the type of education I want. 

[John Woodrich]

@Nick Kaihoi you will learn if you continue to go through this process to purchase but you don't necessarily need to purchase.  Control and lack of marketability are big for me.  We can schedule a call after the tax deadline if you would like.  This may be an Ok investment for someone looking for a passive investment but I think you are willing to put in the time and could probably do better on your own.