Creative (Or Maybe Not?) Selling Prices for Loan - Issues?

Question

Hi,

I am eager to begin investing in multifamily real estate for the long-term cash-flow, but lack any significant capital to do so, especially in my area (Los Angeles).

I've been trying to think of creative ways to acquire my first couple of properties. Here is one of many ideas. I'll probably post the others after seeing how this goes.

Please take the time to point out any potential issues you see with my logic. I greatly appreciate all feedback and advice that more experienced individuals have to offer.

*I can get approved fairly easily for a loan with favorable terms at 65% LTV. The seller does want cash, but does not NEED 100% cash today. Why not have the seller agree to sell the property at 60% of value to a newly formed partnership that takes out a loan for 65% LTV. The seller will have a stake in that newly formed partnership (reason for selling at 60% value), giving them access to a portion of the cash-flow until they've been paid out say 110% of their asking?
I kind of took this idea from the "earnout" concept when purchasing a company.

I may be forgetting something crucial here, but if that is the case, guide me in the direction I'm trying to go please.

Perhaps such strategies aren't uncommon amongst investors, but they sure aren't used by the average person.

Thanks,

Matt

Matt F. · Answer

Very helpful insight Bill.

At this point, I think the deal structure described in your second post is what I'll research in more detail.

Thanks.

Bill Gulley · Answer

1. I do see quite a spin in your prsentation as he is still on the note and walks away from his collateral and management leaving him in a very bad position. You can'tjust say you're getting xxx dollars. If he is getting that refi loan and walks away it's the same thing really that Don was pointing out....

2. The way these deals get paid off really hinges on the management abilities of the new owner to increase profits and having such increases cover the financing to buy out the seller. Multi-family units can certainly be improved by management, but it's limited without making significant improvements to a property and justifying much higher rents. It also taks additional capital for improvements.

If you have an older owner who has let a property go down hill and wants out, maybe you could improve things to increase revenues.

With a C-Store for example, you can change suppliers, run specials, add to the product lines, change how employees interact with customers, advertise, consolidate purchases with other stores and the list goes on to improve profits by management. In other words, more avenues to take than renting a 2 bedroom unit.

Matt F. · Answer

Thanks for the replies guys!

Don,

Let me try to address the issue you raised in your example. It is a valid point, but in my head at least, I see it as slightly more.

Basically, what I'm actually trying to offer is the opportunity for the seller to "forget" the property, get $600,000 in cash upfront, plus 50% of cash-flow until they have been paid a total of $1,100,000 (premium for waiting...arbitrary number).

The seller could potentially refinance the property themselves to get cash, but that would mean they had the intention of keeping the property.
My idea assumes the seller is trying to get out, but would accept less than 100% of the amount they want upfront.

So rather than "....My 50% is worth $175,000 plus I have received $600,000 cash. So for the priviledge of selling my $1million property for $775,000 I have also ceded control of the property to you."
The opportunity I see is for the seller get the responsibility off of their shoulders, get $600,000 in cash upfront, plus 50% of cash-flow until they have been paid a total of $1,100,000 (premium for waiting...). So they have $600,000 cash, $175,000 equity in property, AND 50% cash-flow to a certain dollar amount.

Your example seemed to miss that last part. It was still a good perspective nonetheless, and I may be the one missing something.

Bill,

Just curious, why do you think it would be easier to do a deal like this on C-Stores, grocery stores, etc. than for multi-family properties?

Bill Gulley · Answer

Good point Don, but initially you don't do it at 50/50, the buyer inside the corporate structure acquires a % for management, and a % for financing the owner's equity from the original partner. The note payment is assumed from operations with equity established to each based on their ownership. The new partner has the option to continue to purchase existing shares or ownership over the term or when additional financing can be obtained, like a couple years out with the retiring partner.

For example, yoy take management at 10% which is earned from running the business, that is an expense to the seller, but he can become inactive as well.

In the ops agmt, the new guy can pledge collateral and buy say 30% of the seller's equity, note for shares/interest. The second year management can go to buy addional interests, at the end of year 2 you have 50%. The old partner sells the 50% again financed from the income and the new buyer refinances cashing out the seller as much as he can and the remaing amounts remianed financed.

In the end the seller gets what he wants less management expenses, but he was also out of the management responsibility too. It is a heck of a deal for a buyer using income from a business to buy out the old owner, but it is done as many want to retire and have no other way out. I think it might be more difficult for multi family, but I've set this up for C-Sotes, grocery store and small shops all with real estate. Inventory is a seperate issue to address in such deals, you can't sell the seller's beginning inventory to pay the amounts owed...lol

Don Konipol · Answer

Because the way the numbers work the seller has given equity away. Unless you bring a particularly impressive combination of knowledge/experience to the deal, 110% leverage is virtually impossible to do.

Example, I have a property I thing is worth $1,000,000. you offer to give me $600,000 and 50% ownership. the equity in the property is $1,000,000 less the $650,000 loan or $350,000. My 50% is worth $175,000 plus I have received $600,000 cash. So for the priviledge of selling my $1million property for $775,000 I have also ceded control of the property to you. Why can't I just get thje $650,000 loan myself and keep 100% of the equity and total control?

Now if the seller is desperate, can't qualify for a loan and you can, the deal might be of some interest. I don't think at these numbers though. And you entail the risk of a $650K loan without total control of the property. Even this would be a very hard deal to do. Mechanics of lender lending money based on your credit when you own 50% or less of the property may be a non starter.

Bill Gulley · Answer

Yes, it's common for selling a business by sharing net income and can apply to real estate as well if you have a willing seller. Both of you will be on the hook for the refi. You'll need to assume the debt. Your buy out amount agreed to in your corp documents/operating agreement. You can be paid for management or have it as sweat equity paying it off. Transfer the property and you may have a seasoning requirement with your lender, if you go commercial you'll have better luck with that issue.

I have done many commercial deals this way as it allows an installment purchase with little down. I also suggest you not "over do" the assignment and sell-out so much in the operating agreement and make it pretty well standard verbage at the option of either partner. The accounting is taken care of in the owner's equity accounts. Other agreements may be made after the fact as needed. If your operating agreement appears to be a sale your refi might be difficult to obtain, so it's best to keep things simple.

It's not hiding an intent to sell as there can always be such intent, it's how it is optioned as if it is being done now or could be done in the future. Might bring this issue up with your attorney....good luck.

Matt F. · Answer

Additional details:

By multi-family, I am referring to 4-12 unit buildings. The prices are usually listed in the $1,200,000 - $3,000,000 range.

Creative (Or Maybe Not?) Selling Prices for Loan - Issues?

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