Hey everybody, long time lurker, first time poster here. Thanks for everything you all do; this community has been my go-to for years now and I'm excited to finally start a discussion of my own here.
Let me set the scene. My family has invested in single-family rental real estate for ~15 years now, and we have very consistent returns at small scale (current portfolio is less than 10 units). These units are in a small community (~500 units), with a Home Owners Association, a community pool, ~50/50 renter/owner split, the whole deal. We use a Home Equity Line of Credit on our primary residency to fund the acquisitions, at an ~5.0% interest rate. Cap rates for the units are ~7.5%, so illustratively:
100% Equity:
NOI: 7,500
Equity: 100,000
CoC: 7.5%
80% Debt @ 5%, 20% Equity
NOI (less interest expense): 3,500
Equity: 20,000
CoC: 17.5%.
We've decided to get serious and use the cash flow strictly to fund acquisitions, along with injecting some capital from other income sources. Issue is, this HELOC will only go so far to maintain a reasonably high debt/equity ratio, which juices the returns so much. The lowest I see lenders offering for investment properties is ~8-9%, which reduces the CoC return given that rate is higher than the cap rate.
Some units can get beyond that 7.5% cap rate through upgrades, but not by much. The cost of debt is so high, it essentially makes this a non-factor. For that reason, I don't see how this scales. Anybody have any ideas on how to fund this to get to mid-double digit returns? The dream is to figure the cap structure out, contribute a small % of the equity and syndicate the rest to LP's at ~12-14% IRRs in this community, and then repeat in Tier 3 communities across the country. Any comments on the broader idea are welcome as well.
TLDR; $25MM worth of single-family homes with impeccable rental histories available for sale at 7.5% cap rates. How would you build a realistic capital structure to get at least a 15% CoC return (assuming there is only 1 level of equity holders)? If not enough info, ask away!
Shameless bump
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Appreciate all of the details and context here, makes it much easier to weigh in.
I'm assuming this is the case but wanted to confirm, I'm assuming that home equity line of credit you've been implementing is limited to the asset level? What is the constraint and maximum proceeds you can pull at any given time?
From the outside looking in and given the nature of your product/experience (while also admittedly knowing nothing about your personal balance sheet and ability to borrow), it feels like that as long as your portfolio and future acquisitions are in the same regional area you should be able to get more efficient financing vehicles.
Although the banks are (still) conservative with new construction, if you have a big umbrella entity that owns shares of the separate LLCs you should be able to form a programmatic relationship with a lender for a bigger line of credit which would open this up for you more and help your returns.
That's coming from the developer perspective however so I'll let the mortgage brokers for this asset class weigh in as they have better intel than me.
You raise outside equity capital and take a general partner non-cash investment equity position for an infinite return + some sort of performance bonus (endless potential structures). You set up your own management company and as the GP you hire your own management company and pay it the management fee.
Broaden out the scope to small multifamily, seek $10-50 million in outside capital. Use 50% leverage to boost your ROE but to also keep your risk low. Wait out a recession and then pounce.
Thanks for the response. I think I have a solid grasp on how to juice my own IRRs using a GP/LP structure like you described. The issue is, I can't provide double digit IRR's to the LPs unless I sufficiently lever the properties. I can't do that without finding a debt capital source that scales, and I'm having trouble finding that solution for the reasons described in my above response (tldr; DSCR is too low). No scalable debt = no double digit IRRs = no LPs = no infinite returns to me as the GP!
Edit: didn't see the ending of your post there. Assuming there is only interest payments and no principal payment (roll any equity created into purchasing new properties simplifying assumption), then using 50% leverage @ 5% gives an ~10.3% ROE. From my understanding, returns should be 12-14% before you get LP interest, especially in a hyper concentrated investment like this (literally one neighborhood). Interested in understanding why you think small multifamily improves this deal? Are lenders or LP more attractive to that? Operational efficiencies available there that aren't in SFRs? Also speaking of a pending recession, what are your thoughts on a "buy and hold forever, rolling any returns into new acquisitions" strategy.
It scales by you bringing in legitimate outside investment capital, buying a significantly sized portfolio, pooling the properties into a single credit facility and acquiring relatively inexpensive financing (5-6% P) from a traditional regional bank. Keep your LTV low (30-50%) to potentially avoid personal guaranties, to juice returns, and to potentially obtain interest-only financing.
If your cap rate is 7% and you're able to leverage I/Odebt at 6%, you're in the rare situation of positive leverage. If you can get it to 7.5% cap rate and 5.5% I/O debt and 45% LTV that pushes you to over 9% cash on cash. And so on.
Also, when you sell to investors, you don't sell them the straight cash on cash return. Because of depreciation, there is a nice tax benefit. You sell to them the taxable equivalent ROE.
For debt, check out CoreVest. They have a variety of products for experienced SFR owners
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