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The Legacy of a Failed Raise

After closing on a my first deal flying solo, the broker brought another property to my attention. The property was a six-unit building with four retail spaces and two apartments. Three of the four retail spaces were rented, all with delinquent tenants, and the two apartments were vacant. Before getting into the guts of the deal, its important to note that just having closed a single deal in the market was enough to generate more leads on potential deals. Below is the exact setup that the broker sent to me:

On its face, the deal looked spectacular, but digging into the broker's numbers, there was quite a bit missing. The broker estimated closing costs at just over $3,000, while in reality that figure would be closer to $10,000. Also missing were any repairs required to make the vacant units serviceable, a cost which I estimated at $5,000. However, the most glaring omission was the fact that with the current vacancy, the property was only generation about $2,500 in cash flow, and that no bank would even take a look at the property. Furthermore, without a deep track record, bridge money was not a real option.


Not yet knowing that the deal would be impossible to finance, after signing a contract on the property, I made my own pro forma and began showing the deal to potential investors. Using conservative estimates, my pro forma yielded a 10.2% cap rate and a 14.7% cash on cash return. Not half bad. Below is an actual screenshot of the offering memorandum which I sent out to potential investors.


Presenting as a freshly minted investor, the offering memorandum was not as polished as it should have been, and I was not prepared with support to answer basic questions from interested parties. I had no rent comps for the vacant spaces, no plan on dealing with the delinquent tenants, no estimates for the work required, and no term sheets from any lenders. I didn't receive even a single expression of interest in the deal, even after considering taking no promote or management fee.


With no investors in hand, despite that fact that I had what I thought was a phenomenal deal, I looked towards bridge lenders, and was able secure a 70% LTV loan at 10%.I funded the balance of the equity through a 401k loan and closed on the property. Within a week of closing, the delinquent tenants had agreed to leave and I was left with a vacant building. I commenced the renovations, which in the end costed me almost triple what I had budget, or $13,254 to be exact. But on the upside, I was able to rent the units for significantly more that what I had projected in the pro forma. Additionally, I was successful in a tax appeal and reduced the taxes from $8,150 to $7,055. Within a year I was ready to refinance, and below is the setup which I sent to my prospective lenders. The property was performing at a 25% cap on cost. Better than what anyone could have imagined.

But going back to lenders was not an easy process. Nobody wanted to lend on a property that had undergone a complete transformation with no seasoning. I had one bank that agreed to refinance at the two year mark, so I waited. And the wait paid off. The property appraised at $575,000, and the bank lent me $390,000. I paid off the bridge loan and was left $234,000 on an equity investment of around $67,000. Beyond that, I still retained $185,000 of equity in the property, and was left with a cash flow of over $33,000.


In hindsight, my failure at raising equity for this deal was a major setback, and almost left me walking away from the property. In hindsight, completing the deal was the right move, and the benefits far outweighed the pain. I have approached some of the investors who had turned me down on this deal after the refinance, and showed them the execution and returns. They story has come full circle, and these investors are now established LPs. Don't let rejection at the outset kill your best deals.

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