Lessons Learned from a 24 unit deal
Recently we closed a 24 unit deal in Southern Oregon! As with every deal, there were learnings. It’s always good to document the list of learnings for the future and for the benefit of others.
Rule 504 in Regulation D is a bad idea
Many Syndicators are not even aware that Regulation D has as rule 504. The main advantage of Rule 504 is that you don’t need to make a PPM. Thus the paperwork gets reduced considerably. You only need a Subscription Agreement. But the major disadvantage is that you need to comply with blue-sky laws for every state your security (share for your LLC holding the real estate) is sold in. In our case, because of 504, an investor in New York could not invest in our syndication. The state’s laws required us to file something to a department in the state and take their permission before proceeding!. Thus if you are planning to have investors from multiple states, Rule 506(b) is much preferred as the federal laws supersede and you don’t need to comply with state blue sky laws. A good comparison between all the different rules in Regulation D are listed here. Our lawyer is the one who steered us towards 504 because it’s easier and cheaper to do so. Thus the biggest lesson here is that sometimes lawyers can give you bad advice and it’s worth sticking to the conventional wisdom!
COVID Issues are getting resolved automatically
We had economic vacancy on the property. There were at least 4 tenants who were behind or not paying their rents in February. One of the tenants had trashed their unit. When we went there for inspection, our inspector said this was the worst unit he has seen in all his recent inspections! But as time passed, the situation started getting better. Some tenants started paying rents and the worst tenant cleaned up their unit after a threat to evict from the seller. In our case we decided to hook him up with the Oregon rental assistance program as well through our property manager. Thus, as the economy got better, our economic vacancy came down and collections went up.
Credit unions require 51% owners as guarantors
When you get a multifamily loan from a credit union, the credit unions require 51% of the LLC owners to guarantee the loan. This means if you are raising $500K, people who have contributed $255K must sign the loan as a guarantor. There is no requirement that they need to be General Partners in the deal. Thus they can be limited partners as well. To be fair, they are just a guarantor and not the primary signers of the deal. I wasn’t aware of this going in. I am not yet fully sure whether this is a rule our credit union had or all the credit unions require this.
Unexpected Inspection Issues
As part of inspection, we found un-anticipated problems. While most of the problems were minor, roof was a major issue. The roof had deteriorated and would only last for a year or so. This is a 4 building property and replacing the roof would have cost us more than $100K. The negotiations with the seller didn’t go that smoothly. We were expecting credit for this unexpected issue, but the seller finally only gave us $50K. Fortunately we were able to make the underwritten model work by raising $50K more. The returns didn’t suffer much.
Other than that, the deal went smoothly. We closed it after using the one month extension in the PSA. Having extension provisions in PSA is definitely a good idea!