How Big Can You Go? Ask Your SponsorPosted on October 20, 2015 by
“What size property is right for me to start with?” This is a question I get asked all the time. My answer is usually the same. “Depends on how much of a loan you can qualify for”.
Unless you already have all the cash you need to buy your next apartment deal (and I am assuming you don’t) then you are going to need to get a loan. Understanding what it takes to qualify for a loan is one of the best ways to decide on a property size when you are starting out. If you try and go too big you are limiting the chances that you will complete the project. 80% of your efforts in finding deals should be spent looking at deals that have the highest chance of closing. What has the best chance of closing? Ask your sponsor.
In almost all loans commercial lenders want to see that you have the net worth equal to or greater than the loan amount. For example if you want to borrow $1,000,000 then you need to have a total net worth of at least $1,000,000 or more. Now, the nice thing about this situation is it doesn’t have to be just your net worth, it can include the net worth of your sponsor. A sponsor is a high net worth partner that you get to join you in the deal who brings the balance sheet you need to satisfy your lender. That is the great part of the multifamily business. We can get partners that will help us build our business and there is enough cash flow and equity for us all.
Now back to my first point of what property size is right for you to start with when you are building your business. First step is to calculate your own personal net worth and the net worth of anyone you can get to join you in the business (usually family or close friends to start with). Now that you have the total net worth of you and your sponsor, translate that into units in your market. For example if you and your partners are worth $1,000,000 then you should reasonably be able to qualify for a loan in that amount. Now how many units does one million dollars buy in your market? That answer will be different in each market as the values change from market to market.
This is how I help most people answer the question of “what size property should I be looking at?” Now you see that you should spend most of your time looking at deals that are likely to close. The deals that are most likely to close are the ones you can qualify for a loan on. If you and your partners are worth a million bucks and you are looking at a property selling for ten million then you are likely not going to get the loan and waste a lot of time. It’s better to start smaller and get started than it is to try and go too big and close nothing. When you are ready to do bigger deals… find bigger partners.
There is no set rule as to what you should offer a sponsor to join you in your deal. The only answer is whatever it takes to get the deal done. You will need to negotiate with your sponsor as to how much equity you give them. A general rule of thumb is about 10% of the deal. That will get most sponsors on board with your business plan. They can invest money too but as a sponsor you will be giving them equity in the deal just for helping you guarantee the loan.
When meeting new and potential sponsors, you should keep in mind that not all things of value are considered “net worth” by lenders. Tangible assets hold the most value to a lender when considering net worth. Real estate, cash, gold, equity in other properties, etc. Business and intangible assets will be discounted by the lender. For example if your sponsor is a lawyer and most of their net worth is in the law practice they will not be able to sponsor much. A lender won’t put much value on a business that would be relatively worthless if the lawyer wasn’t there.
Sponsors are the backbone of a new real estate business. You can never have too many. Your job is to be networking all the time to find and meet these people. It takes time to build a relationship with these high net worth individuals so get started now and when you are ready to go bigger with your deals…find bigger sponsors.