By: Justin Laub
What is better than getting your money back on a successful real estate deal? Well, getting a profit on your money is a start. How about doubling your money on that investment? That’s definitely a good day by most standards. What’s even better than doubling your money? That’s right, not paying taxes on those profits. Pretty good, right? However, can it get better? The answer is “yes”! How is that? Well, what if you got your money back, made a 2x profit on your money, didn’t get taxed on your profits and – the kicker – you still get to keep your ownership of the property? No, it’s not a unicorn. It’s entirely possible!
One of my recent deal closings highlights how this is possible. The story starts back in 2015 when I was tasked by my client with sourcing an acquisition bridge loan for a Class C- apartment property in a tough neighborhood. It was an extremely difficult assignment. First, it was a tired, dilapidated, flat-roof complex with a central chiller-boiler system in a high-crime area. Second, the Seller – who ran the place for 40 years like a slumlord – had mostly hand-written rent rolls and operating statements. The operating statements did not correspond with reality, having wildly inflated property expenses in order to minimize the seller’s income tax burden. Though this bit of funny business was obvious to me, it was a tough sell with the potential lenders. Third, my client was buying the property at effectively a 4% cap rate, which by market standards is very low. I could list reasons 4 through 10 as well, but suffice it to say, it was a difficult deal to finance. I took the loan to sixty (yes, 60) lenders, and found all of one (yes, 1) lender that would actually finance the acquisition.
Fast forward two years to 2017 and my client has done a good job upgrading the profile of the property, while also benefitting from a modest amount of improvement in the surrounding neighborhood. The cash flows at the property have increased significantly. The revenues increased by over 50% and the property was now generating a significant, positive Net Operating Income, as opposed to the negative annual cash flow that the seller’s operating statements showed at acquisition. With the acquisition bridge loan coming due, my client asked me to refinance the property and to get him as much loan proceeds as possible.
Lest you think this was an easy assignment, let me explain to you why it was not. First, my client wanted to max out the new loan proceeds. He didn’t just want his original investment back (aka a “cash-out”); he wanted additional money (“profit”) put back in his pocket from the new loans proceeds. Second, he hadn’t quite owned the property for two years, which is a minimum threshold for many lenders to even consider doing a cash-out, let alone put profits back in the borrower’s pocket. Third, there was still a crime element to the neighborhood. Just a few months prior, a dead body was found on the property that was the result of a homicide from a drug deal gone wrong elsewhere in the neighborhood. Fourth, the existing bridge lender had a thorny provision in its loan documents that gave the lender the first right of refusal to match the terms of any refinance loan, with lots of time to get back to the borrower as to whether they did, in fact, want to match any terms. That provision kills the appetite of other lenders and significantly hampers the loan marketing process. So, while I am tasked with maximizing the loan proceeds for my borrower, the bridge lender has a provision in its loan documents that severely dampens the market for a new, refinance loan. Do I need to list reasons 6 through 10? Thanks, I didn’t think so.
Despite all of the above, I was able to get my client a 12-year loan, non-recourse, fixed at 4.39% with a 30-year amortization schedule. The loan paid off the bridge loan returned my client’s original investment in the property and put an additional profit back in his pocket equal to the amount of his original investment. So, he doubled his money, realized this profit on a tax-free basis and still owns the property. I think he’s pretty happy.
The author, Justin Laub, is a Senior Director in the Dallas office of Metropolitan Capital Advisors.