March 31, 2023
Read Time: 5 minutes
Deals can fall apart by any means. But nothing kills a deal like bad financing.
And when I say financing, I’m talking about both sides… debt and equity.
Here are 3 ways that finances will kill your deal.
The first financial failure we see comes from not qualifying to take on the debt from a bank.
Now, with commercial multifamily, it’s a little bit easier to qualify. I’m sure you’ve heard us talk about this quite a bit at this point.
You don’t have to bend over backwards as much to prove your income, like you would with a traditional mortgage for your primary residence.
With anything over 5 units, banks are more interested in the profitability of the asset. Basically… will this asset’s cash flow be sufficient in paying off the debt.
While this might make things easier… banks still have some other qualifications on who they lend to. Yes, they’re lending based on the income of the property… but there are 2 other areas of interest.
Your net worth and your post-close liquidity.
This is where we see most people trip up.
If you’re a new investor you might not have enough net worth strength to throw around. Or if it’s a bigger deal, you might not have enough liquidity. So, what do you do?
You can bring in a Key Principle, somebody who has a strong balance sheet that meets the qualifications that you’re not able to.
But, here’s what you don’t want to do… pad the numbers.
If you haven’t listened to Dan & Anthony’s episode on Matt Onofrio, go check it out. Essentially, Matt was allegedly committing fraud by having someone send money to an account, and after the banks saw that he was liquid enough for the deal, he would then send that money back.
You want to be open and transparent with your lender. If you’re not, it’s going to come back to bite you, one way or another.
And don’t commit fraud… hopefully that’s obvious.
The Money Will Follow
We see this with new operators far too often. Seasoned investors and operators know this is not the case when you’re first starting out, but we still hear it all the time…
If you have a deal, the money will follow.
Green investors will come across a banger deal, and believe that the opportunity is so great that surely they’ll find someone along the way to finance it.
They dive right in because they can’t pass on this amazing deal, and they just know that they’ll find others who can’t pass on it either.
However, somewhere down the line, an investor falls through, or someone backs out, and suddenly they’re close to the end and they can’t close the deal.
This phrase… “Get the deal, and the money will follow”… is spouted out by so many big players in the game. And they’re not wrong… for them.
Sure, once you’re 10 years into the industry, and you’ve got an impressive track record under your belt… finding the capital for a deal can be very easy.
But new investors and operators don’t have that luxury of experience and connections, and they fall prey to this advice all the time.
So make sure your deal is well capitalized before you get too far into it.
This one is tricky, because seller financing can seem very enticing, yet it’s difficult to pull off.
A lot of people will have their underwriting completely dependent on seller financing and then when they go to the bank and present the deal… they’re turned away.
Seller financing sounds so great, we’ve actually tried it ourselves quite a few times… but at the end of the day, it’s a lot of leverage.
I’m going to try to keep us out of the weeds here…
Most people will go to the bank, and they’ll get 70-75% in the form of a senior note. And then they’ll go to the seller for a loan of anywhere from 5-20%… it all depends on how you structure the deal.
So you might only be in this deal for 5%, and the cash-on-cash returns start to look pretty juicy at this point. But there’s a problem.
That’s a lot of debt.
The bank, in the senior position, is underwriting this thing not just based on the risk profile for the debt that they put on it… but the total amount of debt.
You’re just not going to find a bank that’s cool with this. They’re not going to give you 95% LTV, so why would they be cool with you putting 95% on elsewhere.
All of this isn’t to say that seller financing doesn’t work, or that you shouldn’t try. Only that it’s difficult, and dependent on a multitude of factors.
Check out Bill Ham’s book, Creative Cash, if you want to hear some success stories.
You Need To Communicate
The key lesson here, and the solution to each of these 3 problems, is to simply communicate with your lender.
You have to be upfront and transparent about your situation to truly find a good option with your bank.
They’ll work with you if there’s wiggle room to make the deal work, they’ll give you your options.
But if the deal won’t work… it’s best you find out now, rather than at closing.
And again… don’t commit fraud.
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