The most common method apartment syndicators use to fund their projects is raising money from a group of individual sophisticated and/or accredited investors.
However, once the apartment syndicator has taken a few deals full cycle (i.e., acquisitions to disposition), the door to another money raising option begins to open – private equity real estate.
According to Investopedia, private equity real estate is “an asset class composed of pooled private and public investments in the property markets.” In other words, private accredited investors, institutions such as pension funds and nonprofit funds, and third parties such as asset managers investing on behalf of institutions invest in a private equity real estate fund that is used to invest in real estate.
Experienced apartment syndicators can raise money from these private equity real estate funds to fund their apartment deals.
My company, however, does not pursue private equity real estate funds for the following three reasons:
The main reason why my company doesn’t work with private equity real estate institutions is because they only review deals that are already under contract.
Once an apartment syndicator has signed the purchase sale agreement (PSA) with a seller, the private equity real estate institution will perform their due diligence to determine whether they will provide funding.
This poses a problem for my company.
For us to get a property under contract, we typically have to offer a non-refundable earnest deposit.
If we sign a PSA with a seller that includes a nonrefundable down payment, the private equity real estate institution performs their due diligence, and decide to not fund that deal, we lose the nonrefundable down payment if we need to back out of the contract.
Of course, it is possible that we could lose the nonrefundable down payment by raising capital from a group of individual accredited investors. However, it is less probable because we are raising capital from multiple individuals as opposed to relying on one institution to fund the entire deal. In other words, we don’t need every single person on our investor list to invest to close whereas we would need the institution to invest.
Not only do private equity institutions review deals once they are placed on contract, but they won’t approve or deny funding until at least 30 days after the deal is placed under contract.
Once an apartment syndicator has signed the PSA with the seller, they won’t know if the private equity institution will provide funding for at least a month.
This also poses a problem for my company.
Generally, the number of days from PSA to close is approximately 60 days. We will begin the formal funding period a few weeks after placing a deal under contract and our goal is to secure 100% of the funding approximately 30 days prior to closing. That way, if one or more investor needs to back out of the investment, we have a 30-day cushion to find a replacement.
Let’s say we decided to raise money from institutions instead. Even if they decided to deny the deal at the minimum of 30 days, we’d only have approximately 30 days to raise capital from individual accredited investors. Rather than having the majority or all of the funding required to close 30 days prior to closing, we’d have $0.
As a result, we’d have a compressed timeline to attempt to raise capital from individual accredited investors. It is possible, but much less probable that we’d be able to secure all of the funding required. So, we’d have to back out of the deal and lose our nonrefundable earnest deposit.
One objection you may have is “well, what if I’m not putting down a nonrefundable earnest deposit? If the institution doesn’t approve, I can back out of the contract without losing any money, right?”
Unfortunately, that is not the case.
When we are 30 days or more into the due diligence period, we have more skin in the game than just the earnest deposit.
First, there are the upfront due diligence costs. Typically, the main due diligence items are completed early in the contract so that we can review the reports and make adjustments to our business plan or renegotiate the contract terms. These due diligence items such as inspections, appraisals, surveys, etc. aren’t free. If we close on the deal, we are reimbursed for these items at sale. However, if we fail to close, that money is lost.
In addition to money, our reputation is also at stake. If we pull out of a deal because we couldn’t raise enough money, our reputation takes a hit with the seller. If the seller owns multiple apartments in the area, we reduce our chances of being award their deal once they decide to sell other assets in their portfolio. If the seller is well known in the local area, our reputation may also take a hit in the eyes of other apartment owners and apartment professionals that they know. “Don’t work with Joe. He wasted 30 days of my time because he couldn’t secure funding.”
Our reputation would also take a hit with the listing broker for similar reasons. Then, we are less likely to get awarded a deal that is listed by that same broker. And since everyone typically knows everyone else in the broker world, we may also reduce our chances of being awarded a deal from any broker.
So it is a double whammy. Not only will we lose our earnest deposit (if it was nonrefundable) and due diligence expenses, but our reputation will also take a hit with the seller and listing broker, at minimum.
Overall, the three main reasons we don’t work with institutions are (1) they don’t review deals until after they are under contract, (2) they don’t approve funding until at least 30 days after the deal is under contract, and (3) we lose money and our reputation takes a hit if they don’t provide funding.
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