Concept - a way to get a lot of ownership in deal WO more equity

[Sean Wilkinson]

This is my first forum post here so hello everyone! I just wanted to get some feedback on a Strategy I have been thinking about for either 1) getting much more ownership in a JV large multi family deal, or 2) getting into larger Multifamily with less cash.

Here is the concept - target large Multifamily properties that 1) have been on the market awhile to where the seller would be fairly motivated. 2) properties that have been held for a long enough time that the sellers should have significant equity or be making a large profit in a sale.

Typically buying large Multifamily as a sponsor you give up 70% of the ownership to whoever brings in the equity... but say you request the motivated sellers to put a large amount of their sale proceeds back into the deal on a preferred return basis and count this as equity YOU bring to the table! Then you hold that for a few years, do a value add play on the property through better management and upgrades and you refi out and payoff the sellers fully. Now you are sitting with much higher ownership as a sponsor (if not fully owned), with much less equity.

This could also be a very attractive way to raise capital! Say you know a creditable person that could leverage their name to get agency debt. Then you have sellers put in 75% of the equity need and your creditable partner put in 25% of the equity. You then give a pref and a 50% upside on the deal to your partner and keep 50% of the upside as the sponsor for bringing in the other 75% of the equity (though it was simply the sellers doing for wanting a quick sale). Your partner now has 50% of a deal that took only 25% of the equity need... would be hard to turn that down. Win-win-win! Sellers are able to sell and maintain a good investment for the next few years. Investor gets more ownership for less equity. You get more ownership as the sponsor. What are your thoughts on this strategy?

[Don Konipol]

@Sean Wilkinson

You’re missing some key points. I’ll just address your first strategy. If you’re giving a preferred return to the seller for placing some of his sales proceeds in the deal, then that cash is coming from the cash flow due the equity investors, so the equity investors will be getting a smaller return and won’t invest. Further, why would the seller of the property invest on terms worst then the equity investors? I’m afraid your lack of experience and knowledge shows; your highly theoretical “find motivated sellers” etc, just isn’t the real world. Most sellers who are motivated are motivated because they have properties that they are having difficulty with. What makes you think you’d have a solution to the problem?

Further, your assumption that sponsors receive 30% equity for putting the deal together is very unlikely, although with some very experienced sponsors and some very naive investors it may have happened. I can tell you that we receive a 4.5% acquisition fee, we receive 8% of the cash flow as an asset management fee, and we receive 20% of the capital gains after the investors receive a preferred return. We also invest in10-15% ownership in the deal at the same terms as the investors. I do know some sponsors that do receive 10% equity as a sponsor for no cash investment, but they don’t receive the acquisition fee (which for us is paid by the seller as I hold a brokers license in five states), or an asset management fee.

Raising capital requires compliance with Federal, state securities laws, or both. Attorneys fees run a minimum of $10,000, and usually more for a Reg D exempt offering. It’s near impossible to raise capital without a professional web platform giving potential investors access to deal information, secure money transfer, financial status, and the ability to interact with other investors. A major criteria knowledgeable passive investors look for is how much hard cash the sponsor is putting into the deal. Since there are probably 5,000 real estate deals floating around at any one time seeking investors, and all the projections look rosy, investors have developed some eliminators to narrow the selection. Once an investor decided on type of property, location, minimum return, etc. the eliminators are likely to be sponsor investment, sponsor financial alignment with investor results, upfront dilution, equity dilution, and most importantly, sponsors track record. Your thought that investors are going to regard someone else’s investment as your “equity” is just plain lack of knowledge and experience on your part.

Here’s the bottom line; if there is some new wrinkle or strategy involved in real estate syndication, myself or others like me putting together real estate syndications for the last 20 years would have likely thought of it.