One of the things I love most about doing multifamily financing is hearing how people got started, how they built their wealth and how they continue to maintain or grow their portfolio. I get to learn about their mistakes, how they pivoted and how they would have done it differently. I get to see their financials and see how their properties are performing, discuss their strategies and understand their investing philosophy. It’s helped me come with my own strategies and plan for investing in apartments and after years of learning from others and investing on my own I now get to advise my clients on how they can grow their portfolio.
When I would talk to these large apartment owners, I always wondered, how did they do it? Nowadays, if you want to buy an apartment building you need 25 to 35 percent down. At least if you’re in Southern California and that equates to hundreds of thousands of dollars. For most, it’s not realistic to make enough money for a down payment on a property on a regular basis. Most of us spend years trying to save enough money to do our first deal. Once you figure that out, you’re officially ‘in the game’ and the next hurdle is figuring out how to do your next deal. And the deal after that…and so on.
Since the days of buying properties with zero down or putting your down payment on credit cards is off the table (yes, that’s exactly how some of our clients bought their first deal!), there’s got to be another way. Right?
Now that I’ve figured out how to get off the sidelines and ‘get in the game’, I can tell you how we’ve used leverage to grow our portfolio. It’s also how many of our clients have done it. This isn’t the only way to grow a portfolio but it is certainly a way to grow faster. So if you don’t have endless amounts of cash but you want to generate cash flow and grow a healthy multifamily portfolio, leverage is going to be your best friend. Now I’m going to go through the scenarios in which you may be able to utilize leverage.
The ways I’m going to share are not only how we’ve done it but how I’ve observed our clients do it over the 17 years I’ve been financing multifamily properties. It is also how we’ve helped clients grow their portfolio through not only financing but also as a former owner of a property management company that managed over 1,400 units in San Diego. I have handled nearly every aspect of the owning and operating apartments from finding the deal, representing the buyer, inspecting the properties when buyers aren’t available, financing, renovating, day-to-day management and even selling the property.
There are a few different scenarios in which you may be able to tap into your equity AKA pull cash out of your property so you can continue to grow your multifamily portfolio. Before we dive in, I want to stress how important it is to take calculated risk. I am not suggesting that you should over leverage yourself or even take the maximum amount. It’s up to you to decide what is best for your situation. That is different for everyone. It really depends on how aggressive you are comfortable being, where you’re at in your life and what kind of market we are in. The bottom line is, you have to do what is right for you.
You’ve owned a building for several years
If you have apartment buildings you’ve owned for several years chances are you have an amortized loan you’ve been paying on for a while or may even own the building free and clear. In this case, you’ve likely also benefited from the last several years of being in a strong real estate market and have quite a bit of equity in the property.
If you fit in this category, you likely also have room to increase rents a bit or may be able to make some cosmetic improvements then raise rents to increase your cash flow. The key to getting the maximum loan amount is to increase your income as much as possible so you can get the largest loan amount along with the best rates and terms available.
Don’t have the cash to do that? Well it’s not the end of the road. Of course having the cash available to make the improvements prior to refinancing is ideal, but not always necessary. If you can do the improvements before you refinance that will allow you to get a higher loan amount. If not, you may still be able to do a cash out refinance to get the funds you need to make the improvements and potentially even a little extra cash to invest in a new property.
You inherited an apartment building (or buildings)
If you inherited a property, there is likely room to increase rents and may even need a little TLC. The situation is essentially the same as if you’ve owned a building for several years. You can either make the improvements with your own cash or do a cash out refinance to fund the improvements and possibly even take out some additional cash to invest.
The key here is really to understand the opportunity that you have. You may not be in real estate or own any other investment properties so it is going to take a little time, research, education, and a good team to walk you through the process. We all start in the same position of not knowing anything but inheriting a property can be a blessing, a curse or a lost opportunity.
It’s a blessing because we would all love to inherit an apartment building (Congrats!). It’s a curse because you can easily lose everything if you don’t understand, aren’t careful and don’t have a good team to support you. It can also be a curse if you inherit the property with others and everyone isn’t on the same page. It’s a lost opportunity if you don’t understand what you have and don’t take the time to.
I see so many families torn apart because they can’t agree on how to continue with what they’ve inherited. In the same token, I talk to a lot of people who are passing their portfolio on to their children or family members who want nothing to do with the real estate and just want to sell everything. While that may be the right decision in some situations, I also think that a different choice might be made if they can understand the opportunity they have to generate cash flow. This cash flow can allow you to retire, pursue your passions or try new things. It creates generational wealth that can help your children or other family members. Enough about that, you get the point. And if you don’t, give me a call and I can go through it in more detail.
You are in contract to buy or recently bought an apartment building
If you are in escrow to purchase an apartment building or recently purchased a building you will want to look for opportunities to add value. Sometimes it’s as simple as increasing rents. Other times, you may need to invest some money in the building before increasing the income.
The good news is you typically more than recoup the cost of the improvements in the form of increased value. This is why I’m a big believer in maximizing your investment. I know it sounds obvious but so many long time apartment owners get behind on increasing rents, renovating units and improving their properties. This is lost opportunity, lost cash flow and lost value that a very lucky buyer down the road will capitalize on. Why not be that person?
If you’re currently in escrow and know you may want to access some of your equity in the next few years, you really need to consider the financing. Since prepayment penalties are common and standard for multifamily, you will want to consider not only getting the best rate but also the lowest prepay. There are times when we can negotiate a reduced prepay and some instances where we can not have a prepay at all. While the rate and the costs are important to consider, the key is to get the best overall terms based on your goals.
If you’re doing significant renovations, oftentimes you can refinance and recoup the cost of the improvements and even some of your down payment through refinancing. Bridge financing may also be available. Bridge financing is essentially a short-term loan used to cover costs until you are able to get long term financing. These loans are generally more expensive than conventional financing but less expensive than hard money. It’s a great option if you plan to reposition a property and refinance once it is stabilized.
Here are a few quick examples of how we have been able to help clients:
30 unit apartment purchase in National City, CA
This is a building we purchased. We owned 2 other buildings totalling 16 units that we renovated and increased rents on and did a 1031 exchange to purchase this 30 unit building for $5.7MM. We put down about $1,850,000 from our exchange and got a loan for $3,850,000 at 4.55% fixed for 5 years with 5 years of interest only.
Less than 2 years later and after renovating about 4 units using the cash flow from the building, we are in the process of refinancing the building with $400,000 cash out at 2.75% fixed for 5 years with 5 years interest only. Since we are refinancing in such a short period of time, we are paying a 1.75% prepayment penalty on the loan we are paying off. This made sense because we are recouping the cost in less than one year in addition to the cash out which will allow us to buy another building.
8 unit apartment purchase in San Diego
Our client purchased an 8 unit apartment for $1,500,000 using a combination of seller financing and private money totalling $900,000. The rents were extremely low and the property needed significant repairs. Our client invested $160,000 for renovations which we also managed and coordinated. He was able to increase the rent by $4,600 per month. Just 8 months after purchasing the building, the property appraised for $1,950,000. We completed a refinance for him at a loan amount of $1,100,000 equating to 83% Loan to Cost (purchase price plus renovation costs).
These are just 2 examples of many that demonstrate the power of leverage. When you can buy right and get strategic financing, you are able to grow much faster through utilizing leverage.
Feel free to contact us with any questions. Also, watch this video on how to utilize leverage to grow your multifamily portfolio.