5 Ways Multifamily Syndications can Stay on Budget when Adding Value
Keys to Managing Contractors & Renovations
Multifamily syndication is a great way for investors to gain exposure to a high-demand asset class, while benefitting from cash flow, appreciation, and numerous tax benefits. But running a multifamily syndication deal as a General Partner is not an easy thing to do!
Multifamily syndication deals often have a renovation or value add component. After acquisition, the syndication team will hire contractors to perform renovations, to update & upgrade units. The goal is to fix up your property so future tenants will be willing to pay more rent, thereby raising the value of your property.
The key value add equation
Let’s say you have a 150 unit property. You see that you can raise rents by $100/month by investing $10,000 per unit to upgrade. That’s 150*$10,000, or $1,500,000 to upgrade your property.
What’s the upside?
You’re raising rents by $100 per month per unit net, so each unit brings in $1,200 more per year. Multiplied by 150 units, that’s $180,000 more per year in income.
Here’s the key: that income is capitalized, or added to the value of your property. In a 5 % cap rate market, those renovations increase your property’s value by $3,600,000!
So your property’s value has increased by more than double the investment in renovations, plus it’s producing more cash flow every year! This is a fairly baseline example, too. $100 per month rent upside is fairly low, many of our deals are $250-300 per month under market when we buy them.
Managing our contractors
Now that we understand the upside, you can see why it’s so critical to control our construction costs. The example above had a renovation cost of $1,500,000. If we do not properly manage our contractors, if we go over budget, or if we didn’t properly determine costs before acquisition, that’ll eat into our profits!
Here are 5 key steps to properly setting expectations, sticking to budget, and managing contractors both before and after you buy a property.
1) Provide the Materials - Don't have the contractor provide them
Real estate renovations have two main cost drivers: Materials and labor. Contractors’ main job is to provide the labor, but most of the time they will attempt to provide materials as well. That is okay for small jobs, but not for large renovation projects with numerous units.
3 Reasons Real Estate Syndicators Should Source Materials:
- You’ll get the best pricing by buying in bulk
- Contractors will not care as much about quality
- When you own the materials it’s easier to fire & replace your contractor
2) Don't pay for Incomplete Work
Renovations happen in stages, work isn’t completed overnight or even in one week. Since you’re going to provide the materials, your contractor’s main expense is going to be his payroll, paying out everyone on his crew every week. It can get very expensive to carry that cost, and many small to midsize General Contractors do not have the finances to carry those costs until jobs are complete.
That means they’ll ask to get paid for incomplete work. Unfortunately, when you pay them for incomplete work, you make it very easy to walk away from a renovation without getting it done!
The solution is fairly straightforward – set payment milestones, stick to them, and don’t pay for incomplete work.
Paying for incomplete work on Friday could mean that nobody shows up to get the job done on Monday.
3) Get Multiple Quotes
This one may seem obvious, but you’d be surprised how many syndication teams get one bid from a single contractor, then use that bid for their syndication pro forma.
Big mistake! Particularly if the real estate syndicator’s team doesn’t have the skills or knowledge to get multiple bids & evaluate their validity.
Don’t just get one quote and base your whole business plan around that.
4) Sanity Check their Numbers
This step will help us dig deeper into a contractor’s bid to see if it’s really a feasible number, or if they’re underbidding just to win a job.
What if I told you that I’m going to drive from New York City to Los Angeles, driving 30 Miles Per Hour 8 hours a day, and I’ll get there in 3 days?
Sounds silly, right? You know there’s no way I can do that, the numbers just don’t check out.
Maybe you don’t know exactly how long it would take me to make the trip, but you just know that the numbers don’t add up. This is the same idea, just applied to contractors’ budgeting. Typically a contractor will spend $1,000-$1,500 per day in labor.
Let’s say you received a bid that’ll take 120 business days, bid at $40,000. That means the contractor’s charging $333 per day on average. You’re providing the materials, so his only cost is labor.
If the typical cost for a renovation project is $1,000-$1,500 per day, does the bid at $333 per day sound reasonable? No! It’s tempting to try to pay less, but don’t fall into the trap of trying to get too good of a deal. When push comes to shove, it’ll be your problem if the job doesn’t get done on time or on budget.
5) Have Trades-Knowledgeable Team Members on the Syndication Team
In-house expertise is an irreplaceable asset. When you have people on your team who know exactly how renovation projects need to work, what can go wrong, typical costs, and more, you’re in a much better position to deliver on time.
These takeaways came from my recent interview with Stas Grinberg of Vision & Beyond Capital Investments, a multifamily syndication firm. As of the time of this writing they have $250 million in assets under management with more along the way.
What is Real Estate Syndication?
Real Estate Syndications are generally private deals, not registered with the SEC as public offerings. Otherwise called a type of “Private Placement.”
Most real estate syndications are offered under the SEC’s Regulation D, Rule 506(b) or Rule 506(c). Regulation A (or Reg A) is also occasionally used by sponsors to raise capital.
The specifics are covered on the SEC’s website. If you’re looking to do a real estate syndication deal you’ll need a securities attorney to help you get the documents set up and to help keep you in compliance with the law.
Accredited investors have the most passive investing options, because they have access to both 506(b) and 506(c) syndications. The number of accredited investors who can participate in 506(b) and 506(c) deals is not capped. Unfortunately for non-accredited investors, they are limited to 506(b) deals only, and only up to 35 non-accredited investors can participate in any given 506(b) deal.
