It is very possible for any individual to purchase an income property without using their own cash. You may have heard this from other people before, but they may not have described this secret I’m about to share with you. It’s not about pulling equity from your home as some people don’t have one. And it’s not about using vendor take backs or seller financing methods. Let me explain.
Let’s say you would like to purchase an income property for retirement. The property you have your eye on is a sixteen unit apartment building for $3m and nets $300k a year before debt service. However, you do not have a downpayment of $900k (30% of $3m) required to purchase it.
99% of the people will STOP here.
But you keep moving forward and start to think creatively similar to this group of investors. Today, you were approved a $90k unsecured line of credit at the bank. Congratulations. (Obtaining this amount is possible as I have done it before.) This represents 10% of the $900k downpayment, now you have some skin in the game. You start reading about real estate syndication, and private equity deal structures and realized that you need equity partners in your deal to make this purchase a reality.
You want to structure the deal so it’s very appealing for an investor. A possible structure can be a 70/30 split where your investors receive 70% of the profits. This is your first property of this size and the $90k amount you have invested shows the investor you are committed. Your investor is putting up around $1m. The income generated from this property may be split 70/30 as well. You will be the active partner (aka the operator) and your partner will be passive (they just put up the money). Your exit plan is to buy and hold for seven years then sell. So let’s see the numbers:
Purchase Price: $3m
Downpayment: $900k
Mortgage: $2.1m
Closing Costs 5%: $150kAnnual Net Income: $300k
Commercial Annual Mortgage Cost: $192k
Net Income After Debt Service: $108k
If the split is 70/30 of the net income after debt service, then you will receive $32,400 and your investor will receive $75,600 per year.
Let’s say the property went up at approximately 8% per year for seven years. Then the value of the property will be $5.1m. Your mortgage at year seven will be around $1.7m. After paying your real estate agent and legal costs, the net profit will be $3.1m. You will have a cut of $930,000 and your investor will have a cut of $2.1m . This should be a no brainer for an investor to invest with you. You can now rinse and repeat until you are satisfied with your retirement fund.
Where you can find this partner that will have about $1m to invest with you? The answer may be right under your nose. If you’re starting out, you need to look for them. You may need several partners to fund the $1m needed to close this deal. Then the profits will be typically split proportionately to their initial investment. I’ve found nearly $1m by consistently using social media to explain about my deals and current projects. Interested people connected with me over the years. I will start by asking people you know such as friends and family first. Then later you may want to join real estate groups in your community and network from there. Today I’m still working on the networking piece of the industry.
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What I have just explained is an over simplified example of how many large projects are put together. Search for “real estate syndication” or “private equity structures” for more information.
Operators typically form a company, hire lawyers to draft up their legal documents, put together a team to raise capital, people pool their funds together, and the operators will execute the project with the help of property managers they hire. On exit, the profits are distributed accordingly. Real estate projects like these typically take a handful of years to complete.
Operators can charge fees as well. But note, the higher your fees, the less appealing to the investor. An example can be the “acquisition fee”. If you do a search, the range is typically between 1%- 3%. Thus, on a $3m deal, the operator will get paid $30k to $90k on closing for the work required to put this entire project together on the behalf of the investors.
So the next time you’re involved in a pre-construction, or rent a unit from a large building, it is very likely that the model I described above was used. But instead of being the operator of your own project, you are the one that is part of their deal.
This industry is very competitive, there are a lot of opportunities out there. If you are going to participate in any investments, please seek a professional for advice. All information presented on this article are for educational purposes only.