In my last blog post Real Estate Syndication: What is it and How it Works, I mentioned a case study of a recent project. Well, here it is. This one turned out to be a phenomenal success, so pardon while I gloat a little. Kidding aside, the performance of this project can be attributed to three things: 1) Entering a sub-market at the right time, 2) optimizing management and rents, and 3) exiting at peak performance.
The property was a complete gut rehab triplex in an up and coming neighborhood in Philadelphia. We had a great working relationship with a local developer who gave us priority access to some projects. Negotiating and being true to the deal for a win/win can’t be understated in real estate. While still under construction, we agreed to a sale price of $420k with no contingencies. Don’t do this unless you have a tried and true relationship with the developer!
Quality Finishes and Function
The underwriting process is the most critical aspect of the deal. Underwriting the deal is all about knowing the numbers that make up income and expenses over time and then seeing if or how those fit into an investment model. We knew that if we hit our conservative projected rent rates, we would be buying at 7-7.5% cap rate with lots of potential for that to increase over time. Lots of numbers and fancy analysis tools go into our process. Reach out if you want to dig in deeper here, but be sure to love math and formulas!
When calculating the total raise amount, we estimated additional expenses – closing costs, lender fees and points, legal fees, and a variable amount – to ensure we could close. The amount was then converted into a share price equated to a percentage equity. For this project we needed to raise $130k, which meant $13k for a 10% equity share. This calculation also considered a sweat equity share for the sponsor. The rest of the money came from the bank. Leverage is the operative word here, which I will cover in a future blog post.
Going Beyond the Basics
Raising funds is pretty straightforward. We create an offering in the form of a detailed analysis of the project, pro-forma and expected returns. From there it’s a matter of reaching out to our existing network of prospective investors for interest. We quickly received responses from 2 investors interested in funding the whole deal. Done!
As I mentioned, the performance of the property is where you make the deal work. It’s about getting the rent and expense projections as accurate as possible, while balancing expectation for some unforeseen expenses.
In this case we projected just over $45k a year in gross rents, including a 3% vacancy rate. We don’t cut corners in our marketing and advertising, which translates into fast lease-up and quality residents. We also start marketing as soon as we find out a resident is leaving, so we didn’t have more than a couple of days vacancy at any time during ownership. This isn’t easy!
The actual gross revenue, which included laundry income, was actually over $48k year one. Unit rents were $1350, $1290 and $1350. We raised rents mostly on turnover or after the two year anniversary for existing residents. Rent increases weren’t large, but that’s because we got the rent right from the start. From there you’ll see in the chart below that the cash flow was well in the black each year. The fluctuations between years is primarily due to acquisition date (Year 1), the timing of last quarter owner draws (Year 2), and apartment turnover costs (Year 3). We also were recognizing rent payments when made instead of on the due date, which we have since changed.