Creative Deal

[MarkTorgerson]

I have an accepted offer on a 22-suite apartment. The deal is very strong. I have the bank carrying 85% financing and a VTB for 5%. The building still has debt coverage of 132% with these numbers.
I need a couple hundred thousand in cash to make it happen. I have brought in a money partner for the cash down and plus to help with the qualification process as he has great credit and deep pockets. I have asked for 50% of the deal with zero cash in. This still shows him a return on his cash investment of 36% for year 1 and increasing for following years (using 8% appreciation). He was grinding me a little on my equity so it got me thinking. What if we still set up the corp as stated above but with a shotgun clause that I buy him out after five years with a 25% year over year return on his cash investment. So basically after year 5, I give him $450,000 ($200,000 plus $250,000 return). Now I have full control of the building which would make a great condo conversion with very large profits. I also have a happy investor that got a fixed return of 25% on his money giving him lots of incentive for future deals. The risk is in the market remaining flat for 5 years which I find very unlikely. The city is a "farm team" city for best places in Alberta to purchase and I am getting in at a price per door that is lower than market.
Any comments would be appreciated.

Thanks
Mark

 

[Nir]

Hi Mark,

What is the CURRENT CAP Rate? - in today`s economic situation I do not include appreciation in my calculation but rather see it a as nice bonus if it appreciates. Therefore, CAP is key.

Your case is a little different as you plan on a change of use - condo conversion. still, would be nice to know the current CAP(?)

Regards,
Neil

 

[MarkTorgerson]

QUOTE (investmart @ Oct 23 2008, 05:09 PM) Hi Mark,

What is the CURRENT CAP Rate? - in today`s economic situation I do not include appreciation in my calculation but rather see it a as nice bonus if it appreciates. Therefore, CAP is key.

Your case is a little different as you plan on a change of use - condo conversion. still, would be nice to know the current CAP(?)

Regards,
Neil

The 132% debt coverage at 90% financing basically tells the story. The building cash flows very well. The Cap rate is 6.5%. And that is using the CMHC criteria for certain expenses, not the sellers. Their criteria is much tougher.

 

[ChrisDavies]

Doing a condo conversion is dependant on your ability to a) convert to condos and b) sell the condos. In a slower market your converted condos will sell slowly, so pick your timing very carefully. Personally, I`m not a fan of condo conversions.

 

[Nir]

Mark,

I wouldn`t count on anyone else calculating the estimated CAP for me. Plus 6.5% is not very good considering the size of the deal. HOWEVER, if the condo conversion is a sure thing then it really might be an AMAZUNG deal. Regardless, it`s a great experience that will bring you to a new level of sophistication. I, for example, am not there yet

Good luck!
Neil

 

[Thomas Beyer]

QUOTE (MarkTorgerson @ Oct 23 2008, 11:21 AM) I have an accepted offer on a 22-suite apartment. The deal is very strong. I have the bank carrying 85% financing and a VTB for 5%. The building still has debt coverage of 132% with these numbers.
I need a couple hundred thousand in cash to make it happen. I have brought in a money partner for the cash down and plus to help with the qualification process as he has great credit and deep pockets. I have asked for 50% of the deal with zero cash in. This still shows him a return on his cash investment of 36% for year 1 and increasing for following years (using 8% appreciation). He was grinding me a little on my equity so it got me thinking. What if we still set up the corp as stated above but with a shotgun clause that I buy him out after five years with a 25% year over year return on his cash investment. So basically after year 5, I give him $450,000 ($200,000 plus $250,000 return). Now I have full control of the building which would make a great condo conversion with very large profits. I also have a happy investor that got a fixed return of 25% on his money giving him lots of incentive for future deals. The risk is in the market remaining flat for 5 years which I find very unlikely. The city is a "farm team" city for best places in Alberta to purchase and I am getting in at a price per door that is lower than market.
Any comments would be appreciated.

Thanks
Mark
with one partner you can always negotiate that .. so YES, go for this buyout clause as an option .. if he goes for it !

8% appreciation is a bit rich .. what are you paying per door ?

condo conversion in a small town is VERY difficult to finance .. so do not count this potentially large profit into your consideration !

85% financing is very hard to get these days .. is it CMHC ? They usually use a DCR of 1.5 in small towns .. and 1.25 to 1.3 in larger centers .. Do you have a commitment letter or just "hearsay" ?

6.5% CAP is not very good for a small town unless there is the possibility of an immediate large rental upside with no spending .. is it ?

 

[willy]

To me, 25% seems kind of high if you`re assuming all the risk, guaranteeing his investment. 15% year over year is still a very nice return, if your client has risk aversion, and might motivate him to seek the greater rewards by sharing the risk.

I wonder how his investments in the stock market are doing lately.

w

 

[MarkTorgerson]

QUOTE (thomasbeyer2000 @ Oct 23 2008, 10:40 PM) with one partner you can always negotiate that .. so YES, go for this buyout clause as an option .. if he goes for it !

8% appreciation is a bit rich .. what are you paying per door ?

condo conversion in a small town is VERY difficult to finance .. so do not count this potentially large profit into your consideration !

85% financing is very hard to get these days .. is it CMHC ? They usually use a DCR of 1.5 in small towns .. and 1.25 to 1.3 in larger centers .. Do you have a commitment letter or just "hearsay" ?

6.5% CAP is not very good for a small town unless there is the possibility of an immediate large rental upside with no spending .. is it ?

Hi Thomas

The price per door is $75,000 each or 1.65M. Places have been selling in this area from $80,000 to $85,000 per door in the market.

This is indeed CMHC and they have seen the deal. As per the numbers, they will committ but need to look at our net worth and credit rating. I am in the process of putting together investment binders. I gave myself lots of time on the financing deadline. I am using a reputable commercial broker that has found a very good rate. The bank is financing 85% and the vendor 5%. They are OK with this as the DCR is still 1.32. This isn`t a major center but still has a population of $75,000. Fundamentals are good and a vacancy rate of 1%.

I am not in any way counting on this as a condo conversion for my calculations. This unit is in a very good location close to all amenities. The conversion would be a bonus.

I still have the option of giving my investors a flat 50% share. I am confident that this would give them a much higher return than 25% per year after a five year hold. I am looking at this as a way to secure my investors return and pull out an extra few hundred thousand myself if things work the way I think they will. I really only need an equity increase of $250,000 after 5 years on a building worth 1.65M. Anything more than that is a bonus to me. I think I can get away with giving them a fixed 20% (or double their money in 5 years). Since this is such a highly leveraged purchase, I am not needing to pay a return on a very large initial investment ($200,000).

Would you give the 50% equity or a fixed rate of return of 20% for 5 years?
I think I will do very well either way.... But I do like the idea of having 100% of the building in 5 years.

Thanks
Mark

 

[Thomas Beyer]

QUOTE (MarkTorgerson @ Oct 24 2008, 10:07 AM) Hi Thomas

The price per door is $75,000 each or 1.65M. Places have been selling in this area from $80,000 to $85,000 per door in the market.

This is indeed CMHC and they have seen the deal. As per the numbers, they will committ but need to look at our net worth and credit rating. I am in the process of putting together investment binders. I gave myself lots of time on the financing deadline. I am using a reputable commercial broker that has found a very good rate. The bank is financing 85% and the vendor 5%. They are OK with this as the DCR is still 1.32. This isn`t a major center but still has a population of $75,000. Fundamentals are good and a vacancy rate of 1%.

I am not in any way counting on this as a condo conversion for my calculations. This unit is in a very good location close to all amenities. The conversion would be a bonus.

I still have the option of giving my investors a flat 50% share. I am confident that this would give them a much higher return than 25% per year after a five year hold. I am looking at this as a way to secure my investors return and pull out an extra few hundred thousand myself if things work the way I think they will. I really only need an equity increase of $250,000 after 5 years on a building worth 1.65M. Anything more than that is a bonus to me. I think I can get away with giving them a fixed 20% (or double their money in 5 years). Since this is such a highly leveraged purchase, I am not needing to pay a return on a very large initial investment ($200,000).

Would you give the 50% equity or a fixed rate of return of 20% for 5 years?
I think I will do very well either way.... But I do like the idea of having 100% of the building in 5 years.

Thanks
Mark
sounds great .. usually CMHC does not like VTBs behind 85% .. so this would surprise me if they do this deal with 90% leverage ! do not count on it .. get it in writing !

a DCR of 1.3 with 90% leverage and 6.5% CAP does not compute .. possibly your expenses are off .. but hey, if they give you 85% and allow a 5% 2nd behind it .. TAKE IT !!!

Your partner may be asked to sign a personal guarantee also .. depending on your networth !!

Yes, get a buyout OPTION for you @ 20%/year at any time .. or 50% minimum up to 2 years ... say when you re-finance in 2 or 5 years .. I have done 50/50 deals where the investors did 300%+ .. so yes, if you can buy them out @ 20%/year this may be a great deal for you !

 

[RedlineBrett]

Fixed rates can be a bit dangerous, especially on a big amount like this. Also not wise in my opinion to do so and count on appreciation of a MF\C property to make it happen. We only do it if we can pay the interest out of cash flow. If your building is at 1.3-1.6 at 90% finance you may be able to do this but are you going to be able to cash out your partner in five years?

Grab some sales data for the hat and see if they have achieved a 5% average sale $/door on apartment complexes in the past 20 years. I agree with Thomas that 8% is rich... even for residential but definitely for multi-family.

If your ultimate goal is 100% ownership I would consider some other options.

For example, if the vendor is willing to carry 5%, will they do 10, or even 15%? They are going to be paid out over 75% when the deal closes so they are getting lots of cash... I would work with these guys to minimize the gap you have to fill with a partner.

Perhaps you can negotiate an agreement-for-sale with the vendor and stretch out the sale over a five year period?

If you can still get financed and only need 100k or so from a partner than you could offer them a fixed rate of 10/15/20% with a refi later on to back out their initial investment.

Have you found out specifically what CMHC/your lender needs as far as net worth is concerned? What happens if you have a bigger VTB, what do they need to see then?

Also, your partner doesn`t have people bringing large cashflow multi-family investments to them every day. Considering the current market environnment for stocks/bonds it`s not like they have a tonne of better options... so don`t let them talk you out of the farm!

Good on ya for pursuing the deal!



QUOTE (MarkTorgerson @ Oct 24 2008, 10:07 AM) Hi Thomas

The price per door is $75,000 each or 1.65M. Places have been selling in this area from $80,000 to $85,000 per door in the market.

This is indeed CMHC and they have seen the deal. As per the numbers, they will committ but need to look at our net worth and credit rating. I am in the process of putting together investment binders. I gave myself lots of time on the financing deadline. I am using a reputable commercial broker that has found a very good rate. The bank is financing 85% and the vendor 5%. They are OK with this as the DCR is still 1.32. This isn`t a major center but still has a population of $75,000. Fundamentals are good and a vacancy rate of 1%.

I am not in any way counting on this as a condo conversion for my calculations. This unit is in a very good location close to all amenities. The conversion would be a bonus.

I still have the option of giving my investors a flat 50% share. I am confident that this would give them a much higher return than 25% per year after a five year hold. I am looking at this as a way to secure my investors return and pull out an extra few hundred thousand myself if things work the way I think they will. I really only need an equity increase of $250,000 after 5 years on a building worth 1.65M. Anything more than that is a bonus to me. I think I can get away with giving them a fixed 20% (or double their money in 5 years). Since this is such a highly leveraged purchase, I am not needing to pay a return on a very large initial investment ($200,000).

Would you give the 50% equity or a fixed rate of return of 20% for 5 years?
I think I will do very well either way.... But I do like the idea of having 100% of the building in 5 years.

Thanks
Mark

 

[MarkTorgerson]

QUOTE (thomasbeyer2000 @ Oct 24 2008, 10:18 AM) sounds great .. usually CMHC does not like VTBs behind 85% .. so this would surprise me if they do this deal with 90% leverage ! do not count on it .. get it in writing !

a DCR of 1.3 with 90% leverage and 6.5% CAP does not compute .. possibly your expenses are off .. but hey, if they give you 85% and allow a 5% 2nd behind it .. TAKE IT !!!

Your partner may be asked to sign a personal guarantee also .. depending on your networth !!

Yes, get a buyout OPTION for you @ 20%/year at any time .. or 50% minimum up to 2 years ... say when you re-finance in 2 or 5 years .. I have done 50/50 deals where the investors did 300%+ .. so yes, if you can buy them out @ 20%/year this may be a great deal for you !

The DCR of 1.32 at 90% leverage is definitely correct. I have the CMHC template and I have also had 2 lenders work out the numbers. We all came to the 1.32 DCR. I have been mainly using this as a tool to see if deals work as CMHC is now 1.30 DCR and this is the tool they use to analyze deals.
I have also had 50/50 deals where the investor has made 200% (after just a couple of years). This is why I am taking another approach.

My partners are willing to sign personal gaurantees. We are going to incorprate as a group with a % of share structure. Then I wanted to add the buyout clause. By incorporating as a group (instead of just me), I can use their strong credit and net worth to qualify.

 

[MarkTorgerson]

QUOTE (RedlineBrett @ Oct 24 2008, 10:34 AM) Fixed rates can be a bit dangerous, especially on a big amount like this. Also not wise in my opinion to do so and count on appreciation of a MF\C property to make it happen. We only do it if we can pay the interest out of cash flow. If your building is at 1.3-1.6 at 90% finance you may be able to do this but are you going to be able to cash out your partner in five years?

Grab some sales data for the hat and see if they have achieved a 5% average sale $/door on apartment complexes in the past 20 years. I agree with Thomas that 8% is rich... even for residential but definitely for multi-family.

If your ultimate goal is 100% ownership I would consider some other options.

For example, if the vendor is willing to carry 5%, will they do 10, or even 15%? They are going to be paid out over 75% when the deal closes so they are getting lots of cash... I would work with these guys to minimize the gap you have to fill with a partner.

Perhaps you can negotiate an agreement-for-sale with the vendor and stretch out the sale over a five year period?

If you can still get financed and only need 100k or so from a partner than you could offer them a fixed rate of 10/15/20% with a refi later on to back out their initial investment.

Have you found out specifically what CMHC/your lender needs as far as net worth is concerned? What happens if you have a bigger VTB, what do they need to see then?

Also, your partner doesn`t have people bringing large cashflow multi-family investments to them every day. Considering the current market environnment for stocks/bonds it`s not like they have a tonne of better options... so don`t let them talk you out of the farm!

Good on ya for pursuing the deal!

Unfortunately this is already an accepted offer. I had tried to change a couple of financing terms (dates) but they won`t move. If anything, they want the deal to fall through as I believe there is a couple of backup offers that are stronger than mine. I will always have an out if needed but I beleive in this purchase. I follow the market very closely in this city and this is the best deal for DCR that I have seen in months. So many of the other sales have a huge separation between their asking price and what they charge in rents. This one works well.

I am not worrried about my partners talking me out of the farm. In fact it is just the opposite. They are happy holding 50% at this point. I am looking at it from another angle as to where I can pay them a very strong rate of interest and benefit myself at the same time. Even if this building only appreciates by 5% per year, I would have $460,000 in gained equity in 5 years to pay back their gained return of $200,000. This isn`t even taking into consideration accumulated cash flow or principle paydown.