Deal Structure For First Deals

Stoo's picture
Stoo - Certified Professional
Rank: Orangutan | banana points 326

Hey everyone,

I was curious to know how you structured your first deals that you did on your own or how you would structure deals you do on your own in the future? (This is assuming you have investors and it wasn't all your own money)

Some additional questions for those of you that have done a few deals outside of your 9-5:

  • What product type?
  • What was the equity amount of your first few deals? How did you raise the funds?
  • How did you finance the deal?
  • What was/is the hold time on your deals?
  • Did you charge fees? If so, what fees and how much?

Would love for this to be a discussion so please add anything else relevant to the topic.

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Comments (33)

Mar 6, 2019

Interested as well

Mar 6, 2019

I focus on multifamily in areas with mostly affordable housing. My first deal was a 3 flat with a rather vanilla investment mortgage. Funds were my life savings at the time. I refinanced that to buy another building once the first one was stabilized.

First deal with partners was when I was still new to real estate and found a 6 flat for $100k total investment. It needed significantly more work than I was used to and I was working in consulting with little time. The deal was structured very simply with me taking 50% interest and two investors taking 25% each. Both myself and the investors divided up the workload (construction management, property management, legal, bookkeeping, etc.).

Financing - none, due to condition of the property it had to be cash.

Hold time: Probably at least 10 years, the building provides a nice income stream.

Mar 7, 2019

Did you structure the deal as an LLC? Doesn't seem like the case (nor worth the cost), but curious anyhow.

Mar 6, 2019

Yes, we have an LLC for each building and a separate one for our property management group. While it is a bit more expensive, they act as an insurance policy that prevents anyone going after personal assets or the rest of the portfolio.

Most Helpful
Mar 6, 2019

Going through this process right now at a new shop trying to establish a track record with basically no balance sheet. Tied up the deal (ground up multi, 225 units) with a purchase deposit using personal assets...located an LP willing to fund pre-dev costs during the pre-closing period AND flash their balance sheet/liquidity for non-recourse construction financing in exchange for a fee. Total equity check of approx. $17M. Long term hold with crystallized promote post-stabilization.

Having looked at a few of these (albeit in a short time) it already feels pretty typical to a) give up a fee in exchange for balance sheet strength, b) give up a significant amount of promote (up to 50%) to get a guarantee on the note and/or satisfy bank liquidity requirements.

Our position so far has been to be as aggressive as possible on development fees. This keeps the lights on, but more importantly serves as the future balance sheet that will allow us to tie up more deals in the future (deposit $) so that we don't get overextended.

    • 9
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Mar 6, 2019

Interesting. Can you clarify your promote fee and how much equity you put into these deals? Is it the typically 90/10 with a preferred return?

When you say you give up a fee, what is this exactly?

Thanks.

Mar 6, 2019

Most of these term sheets are like a 9-10 pref with three promote hurdles up to around a 30-35% above a ballpark 17% IRR. We are putting in 2.5% of the equity check.

In terms of giving up a fee, we are getting charged 1-2 bps on the total equity to the LP in exchange for having them sign on the completion guarantee and use their balance sheet strength to satisfy lender liquidity and asset value requirements. We are also giving up a percentage of all our promote proceeds, really for the same issues.

    • 2
Mar 7, 2019

What do you mean by "crystallized promote"

    • 1
Mar 6, 2019

On a long term hold deal that is 10+ years our IRR gets smushed, so there really is no way to hit your promotes in that time period. Crystallization as a concept lets you do an appraisal or valuation of the property at stabilization to do a moment-in-time IRR calc for purposes of determining the promote payouts consistent with the timing of a more typical merchant deal where you would flip out at stabilization.

    • 4
Mar 12, 2019

What are you charging in development fees?

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Mar 7, 2019

Convertible note

3 yr

7% accruing interest

20% discount

$5m valuation cap

Problem with this structure is having to explain it in layman's terms to non-finance folks and closing deals in a risk-averse environment. Sucky.

    • 1
Mar 8, 2019

Do you work within Equity Linked products?

Mar 7, 2019

Negative. This was an early stage raise for my first business.

@m_1 what was yo first deal?

Mar 9, 2019

Great topic, OP.

I'm a passive investor in a 100-unit value add multi family property. Property had about 30 units that were not operating when we purchased it, plus a bunch of low quality tenants that have since been replaced. Purchased about 20 months ago and just about have it to 90% occupied with all units up and running. Knowing what I know now, I probably wouldn't have agreed to the terms of this deal. But I was eager to get in the game and get some first-hand experience. Anyways, the Sponsor takes 20% of the cash flow off the top, and the remaining cash flow is split pari passu. Original projected IRR was 33% on 10 yr hold. I know we are already getting much higher rents than projected, but we've also spent more on capex than projected. No distributions have been made in the first 24 months which was expected. The sponsor on this deal essentially lives at the property when he's not working his 9-5, and I believe he's done an excellent job dealing with tenants, upgrading units, etc. On the other hand, he's spending so much time on the operations side, it's inhibiting his ability to produce clear/timely/transparent financials. I don't if I am to the point I don't trust him yet, but he hasn't inspired confidence in his ability to aggregate the data and make appropriate distributions, etc. Definitely been a good learning experience, but I will definitely have to reconsider investing in the next deal.

Love to hear others's experiences, what's caused you trouble, mistakes you've learned from, what's worked well.

    • 1
Mar 12, 2019

PM me if you are interested in outside capital. I want to know how on earth you got to a 33% IRR on a ten year hold in the multifamily space... If you can get to a 20% project IRR during that time frame that is still incredible.

Mar 13, 2019

Lmao this is ass backwards.

Mar 9, 2019

Not to completely hijack the thread (since the deal structure is more important to understand)- but, out of sheer curiosity, around what age did everyone start investing in real estate?

    • 1
Mar 9, 2019
SponsorPromote:

Not to completely hijack the thread (since the deal structure is more important to understand)- but, out of sheer curiosity, around what age did everyone start investing in real estate?

I second this. As a young person I would like to hear what ages you guys decided to start taking part in the risk.

Mar 12, 2019

For long-term holds, I think a less complicated way (and not currently used often to my knowledge) to structure deals is through a CF split incentive off of Cash-on-Cash hurdles.

Equity funds pari passu, pari passu capital return, then a pari passu CF split up to x% CoC (distributed quarterly or semiannually), 75/25% CF split above to a y% CoC, then 60/40% thereafter.

I would try to avoid getting eaten by pref at all costs on my first deal...

Mar 13, 2019

I agree. IRR hurdles make no sense for buy and hold plays.

Mar 15, 2019

Thoughts about this.

If these CoC thresholds ratchet from 8% to 12% to 15%, for example, doesn't that encourage the operator to let a property sit without any improvements as as the returns outweigh invested equity? For a long term buy and hold, an operator may not want to invest in capex if it reduces his promote away from a 15% CoC back to a 8%, for instance.

How do you incentivize the operator being throughout to make sure the property remains in good shape?

Also, if a share were to incur, would you structure in something like the minimum of a 10% IRR or 2.0x EmX at a capital event (for example), then returns are disproportionate to the operator. Thinking it would be smart as an operator to try to get an outsized return if you do happen to sell.

Mar 12, 2019

These are great ideas. Also, maybe one could mandate a sizable CapEx reserve and have an annual inspection which would result in utilization or distribution of withheld cash.

For long term holders of real-estate (10+ years) I would imagine the best metric would be CoC seeking a yield spread over NCREIF.

Mar 13, 2019

Kinell - lot of real estate posts cropping up.

Was looking forward to some stories of hybrid mezz + warrants/unitranche/other exotic financing mechanisms..

Mar 12, 2019

In a unitranche structure, does one special purpose entity hold the lien which contains a syndication of lenders? Is there a simple cashflow waterfall that would result if the property were liquidated in order of seniority/subordination spelled out by some sort of workout document?

Mar 13, 2019

This is the real estate forum.... what did you expect?

Mar 13, 2019

Crap! didnt realise! Taking myself out...

Mar 7, 2019

Another question I would like to ask the group, is how much money did everyone start out with (from your own pocket)?