Real estate investing can be a great type of investment to add to your portfolio regardless of the level of risk you want to take on. Among the most effective forms of real estate investing is apartment syndication, which is commonly referred to as multifamily syndication. This investment occurs when numerous investors pool their money together to purchase larger apartment buildings that would be difficult to manage as an individual investment.
Through apartment syndication, each investor takes on a share of the risks and rewards associated with the investment. If you’re involved with asset-managing this type of investment, you’ll be tasked with controlling several different bank accounts, all of which you should understand before getting into multifamily syndication. The following provides a detailed guide on the three main apartment syndication accounts you’ll have.
The primary bank account that you’ll be dealing with in multifamily syndication is an operating account. All of the revenues that are collected when managing the property go into this account. The potential collected revenues include rents, security deposits, and any fees that tenants are required to pay. These fees can include carport rental fees, pet fees, valet fees, and application fees. All money that tenants pay will go into the operating account, which makes this account relatively easy to manage.
Keep in mind that money also comes out of this account for any expenses that are incurred while managing the property. Some of the expenses that must be paid when managing a rental property include ongoing maintenance and repair work, taxes, insurance, and property management company fees. Because the operating account contains all revenues, it should be the account that you use to pay investors, which could be done on a monthly, quarterly, or annual basis.
Since the operating account is a bank account, payments can be made via check or direct deposit. No matter which system you use, it’s important that payments are made smoothly and without issue to keep investors satisfied. Before opening this type of account, it’s highly recommended that you place an upfront fund into the operating account, which is designed to cover any unexpected expenses that occur in the first few months of owning and managing the property.
After one year of managing the property, you should have more than enough revenues collected in the operating account to cover unexpected costs while also paying investors right away. If a boiler in the apartment building happens to malfunction in the first month after the property has been purchased, the costs associated with repairing or replacing the boiler would need to come out of the operating account even if you don’t have enough funds in there. As such, investor payments would likely be delayed. You can avoid this issue altogether by raising extra capital upfront and placing it into the operating account. This fund should be anywhere from 1%–5% of the building’s total purchase price.
When you’re managing this type of investment, the other account you receive alongside the operating account depends on the type of loan you obtain, which means that there are essentially two accounts that you’ll hold when asset managing an apartment building. If you apply for an agency loan, you could receive a capital account. This account is available when securing a Fannie Mae or Freddie Mac loan. It’s also important that renovations aren’t included in what the loan covers.
If you need to perform renovations on the property, the costs associated with these investments will come out of your capital account. Once your contractor completes the job they’ve been hired for, they should be paid from this account. Keep in mind that your capital account should be funded by your investors when you need to make renovations and pay for other capital expenditures.
This account is necessary because investor money can’t be placed into an operating account. When investors wire funds to you, all of these funds should be placed into your capital account, after which you can pay yourself while also paying for the loan and any closing costs. All additional investments will remain in the capital account until they need to be used for renovations.
The third and final syndication account that you can have when managing this type of investment is a DACA (Deposit Account Control Agreements) account, which occurs when you obtain a bridge loan or similar loan program that provides coverage for renovations. In this situation, the lender you partner with may task you with creating a DACA account. When you open this type of account, all of the rents you collect each month should first be placed into the DACA account before you send it to your operating account. While this might seem like a hassle, many lenders allow funds to be transferred from the DACA account to the operating account on the same day.
This requirement is put in place because lenders may not want the money you collect from rents to go directly to you if there’s an issue with the renovations. When lenders provide you with money for renovations, they will have requirements for the debt-service coverage ratio alongside additional timeline requirements and occupancy requirements.
Let’s say that you’re required to complete renovations in a specific period. If so, your lender will have a professional inspector come to your property to make sure that the renovations are being completed according to plan. If you aren’t meeting the debt-service coverage ratio requirements or the timeline requirements, you will likely go into a “cash management” phase, which means that your lender will take money from your DACA account to cover the costs associated with the issues that arose.
If the money were to go directly into your operating account without first going into a DACA account, it would be more difficult for the lender to collect the money they’re owed. You will then need to meet the necessary requirements before you can get out of “cash management” and start receiving your money again.
These are the three types of syndication accounts that you could have when involved with asset managing a deal. With this information in hand, you should be able to avoid making the mistake of paying investors from your capital account or covering renovations with your operating account.
About the Author:
Joe Fairless is the co-founder of Ashcroft Capital, a fully integrated multifamily investment firm with more than $2.7 billion in assets under management and the founder of Best Ever CRE. His podcast, the Best Real Estate Investing Advice Ever Show, is the world's longest-running daily real estate podcast with more than 500,000 monthly downloads.
Disclaimer:
The views and opinions expressed in this blog post are provided for informational purposes only and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.