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“Syndicating is a B*tch”?
I hear people ask all the time, how do I get the downpayment for my first deal. I can tell by the way they pose the question that they think that’s all that’s needed for their first purchase. Not even close!
In this article I’m going to cover the four main buckets of money needed for that first purchase along with some general rules of thumb on numbers and percentages.
First off, what exactly goes into the total needed to purchase a multifamily property?
A little more detail:
The Down Payment
This will be the largest chunk of cash needed for your deal. In today’s market (2021) you should expect 20-30% on average for B and C class properties but can be much higher as you get into the A asset space. For a first time buyer with little to no experience you will probably be looking at a C or maybe B which will likely run about 30%.
These are the costs incurred while working through the close process. For larger deals this will usually be 1-3% of purchase price for me but deals below 100 units could 3-5% or more.
(Examples: Loan application fee, loan origination fee, lender’s attorneys, your real estate attorney, your syndication attorney (if buying as a syndication), appraisal, title insurance, survey, environmental study,due diligence inspections, utility deposits, one years prepaid insurance, etc…)
Think deferred maintenance, improved curb appeal, unit upgrades, etc…
(Really light could be 1k – 3k per door all the way up to deep value-add possibly 10k-15k per door or more, this is the largest variable item in your cash raise. I would always overfund this as there will always be something unexpected or undetected during your inspections and bid during the close process.)
This is the money used for the daily operations of the business
I use 1-1.5x the total of a month’s expenses including Principal and Interest, even if you have interest only at the beginning of the loan, remember the goal should be to stay conservative and safe.
If you go into the deal with just the money needed for the down payment, rehab and closing costs you could get yourself into a real jamb without the operating capital cushion to cover bills that come up before you start receiving income. Even after the income starts to come in I would always leave the operating capital in the account to guard against any unforeseen surprises.
You are now running a business and all businesses need reserves, remember COVID-19??
So, as you can see, this is roughly 35% of the purchase price for your deal. Remember also that these are rough guidelines and that it could be a bit above or a bit below this depending on the property itself, yourself strength as a borrower as well as how much you bid for the property
A few additional thoughts
All this is without considering the earnest money you will need to get the deal under contract. That will often be 1% of the purchase price. A $1,000,000 property will require roughly a $10,000 earnest money deposit.
One additional thought; if you are going to be charging an Acquisition Fee then you need to add this to your total to be raised.
Withholding Initial Distributions
To achieve the over funding or contingency amount of the rehab you could withhold the first quarter or two’s distributions on a cash flowing, stabilized asset. This could be added to your rehab or reserve accounts. This approach will lower the amount needed to be raised on the front end.
Whatever you do, do not use the tenant security deposits as your reserves or to bolster your rehab or operating capital. This is NOT YOUR MONEY, it is held by you in the tenant’s name and should be returned to them on move-out if they fulfilled the lease contract and caused no damage to the unit. If, once they move out, you need to confiscate it due to damages or breaking of the lease you then will claim it as income but not before.
While this all may seem like overkill to some of you, you should always operate a deal conservatively which includes ample reserves and contingencies. Not doing so can cause you to lose the property and if you are raising money from others in a syndication structure you may now need to go back to the investors for more money, that will never be welcomed and may harm your ability to another deal as your investors could start to lose confidence in you.