This is the third VareCo syndication deal featured on the Denver Real Estate Investing Podcast. Check out the podcast episode as Ben Davis, our CFO, and I join Chris Lopez to discuss the details of this deal. Feel free to reach out with any questions and ways to improve this analysis.

Listen to the podcast or watch the video for the full discussion. 

Persistence, Rapport, and Trust Drive Value

Denver’s market has been red hot for a number of years now, and the Highlands neighborhood is at the epicenter of this historical boom. How did The VareCo get this deal, in this highly competitive and highly sought after neighborhood, for hundreds of thousands less than the competition? The short answer is persistence and rapport.

The seller of the 23 unit Wyandot Street (Wyandot) property, which also included a neighboring lot and duplex, had a personal connection to the property. He and his father built the building, owned it for dozens of years, and held it free and clear as a cash flowing asset for many of those years. However, the seller took out a $3M line-of-credit on the property to fund another construction project he had taken on in a mountain town. The seller’s liquidity crunch drove the slow deterioration of the property which led to a lower income tenant class, less revenue, and ultimately an underperforming asset.

At the beginning of 2018, the seller decided to list the property, as the line-of-credit had a balloon payment due at the end of the calendar year. Initially listed at $4.75M, the property fell in and out of contract multiple times in the summer of  2018.  The property went under contract and fell out of contract multiple times until the listing agent’s contract expired. 

Contributing Factors to Acquiring the Deal:

Persistence: I first called the seller in June 2018. That call was brief and he communicated a sale was expected to close next week and then hung up. I called again the following week, the deal had not closed, but the conversation again didn’t go much further. I called him again in July and set up a meeting to walk the property. We kept in touch from that point, talking or meeting about every two weeks, and in September he suggested that I make an offer.

Trust: The VareCo initially offered $3.5M and the seller’s response was that the number was too low. A month later he called back and asked if I would do the deal for $3.8M. After another round or two of discussions, we ultimately landed on $3.7M ($1M under asking, and at least $300K- $500K less than other offers!). The driver of the deal was the seller’s trust. During multiple meetings and conversations, I developed a level of rapport with the seller.  He trusted that unlike the previous buyers with whom he had been under contract, The VareCo would close. The final sales price, after concessions and agreement to pay the listing agent, was $3.75M.

Rapport with Listing Agent: Due to working with this agent in the past, knowing The VareCo’s reputation, and believing we could handle this project, this agent reached out to me, suggesting I directly contact the seller to negotiate a deal.  

Interesting Deal Term – The Jumpstart

Closing in December 2018, just before the due date on the seller’s balloon payment we negotiated unique management terms, giving The VareCo the right to provide our own management 30 days before closing date. This jumpstart allowed us to prepare for construction by issuing tenant notices and helping the existing tenants transition to new living arrangements. This clause saved The VareCo at least $15K in holding costs and put us ahead of schedule.

Acquisition Financing

The VareCo used both private and institutional money to fund this acquisition. The duplex and the vacant lot with commercial mixed use zoning, were funded with private investors, separate and apart from the 23 unit building. The VareCo flipped the vacant lot to another developer for $425K seven days after closing with a cost basis of $325K. The VareCo also renovated the adjacent duplex and quickly began renting it for $4.2K gross a month. Separating these elements from the 23 unit building, and then flipping that lot shortly after closing leaving us in a better cash position for the acquisition on the 23 unit building renovation.

Profit from sale of vacant lot = $100K

Cash Flow From Duplex  = Expense Coverage During Construction

We funded the 23 unit building using a construction loan at 70% of total cost (approximately 70% of $4M) at an interest rate of 5.25%. Private investors provided the majority of the 30% down payment needed to close.

The Bumpy Road of Construction

At the time, this was one of the larger projects we had taken on and the first subject to the commercial permitting process. Based on prior walk-throughs of the building, we knew most of the units and all of the mechanicals needed a complete renovation. Mold and active leaks were present in several of the units and we wanted to start demo on those units as soon as possible.

Hiring a general contractor (GC) to oversee the day-to-day construction and pull the permits, but the plan was to use our own crew(s) for the actual work. We worked with the GC on prior jobs and thought he was capable of handling a project of this scope. The GC pulled a roof permit and advised The VareCo that the City would be ok with our crew starting demo, even without an official notice. Shortly thereafter, an inspector working on other jobs in the Highland neighborhood (one of the most active in all of Denver) walked by and noticed the work being done. The inspector instituted a “stop work order,” bringing all construction activities to a halt. 

It turned out that our chosen GC never contacted the City about our planned project and the building permit process was, for all intents and purposes, at square one. As a result of the premature start of work and the GC’s failure to get the building permit process started, The we had to :

• Look at this project as though it were a new build.
• Incur the additional expense and time of preparing architectural drawings for each of the 23 units.
• Incur the additional expense and time of preparing mechanical engineering studies and drawings for all mechanicals (HVAC, boiler, electrical and plumbing). 

This detour left the project at the starting gates throughout all of 2019, and construction was not ready to proceed until January 2020.

Investor Buyout

With virtually no construction work completed as of May 2019, The VareCo’s investors became agitated with the lack of progress and wanted to exit the project. Understanding their frustration and wanting to avoid a dispute and still provide a reasonable return, The VareCo offered to buy out the investors by returning their principal plus an additional 10% return. While this was not required contractually, The VareCo places a premium on relationships and ensures that those involved in their deals walk away satisfied even when things don’t turn out as planned.

Putting Together the Right Team and Bringing the Project Home

Once The VareCo learned of the initial GC’s shortcomings, we targeted a GC with significant multifamily experience, as well as a superintendent to be on-site every day to protect our interests and ensure the trades were performing as intended. In January 2020, the VareCo began construction in earnest, working with the city to ensure everything was done in accordance with all permitting requirements. In September 2020, we completed construction and passed our Certificate of Occupancy inspection.

Despite significant construction delays, The VareCo’s timing was favorable in that market conditions drove up rents by approximately $200/month and significantly reduced lending interest rates. In light of these market adjustments and The VareCo’s buyout of its private investors, we decided to spend additional funds, adding a mural and higher finishes such as granite, butcher block, and enhanced backsplashes. The one-bedroom units are currently available for lease at $1,595 per month and studio units are listed for $1,350 per month. The property, inclusive of the duplex property, is expected to generate $470K in annual gross rents, RUBS, and parking. A conservative appraisal should result in a valuation of approximately $6M and The VareCo’s all-in number totaling approximately $4.2M.

What Now?

We are in the process of refinancing the property to recover its capital investment and set up the property for future long-term cash flow. Due to the COVID-19 pandemic, most of the Fannie Mae and Freddie Mac loan products continue to have 12-month reserve requirements in order to qualify. The VareCo is negotiating primarily with local banks offering between 70-80% LTV, with lower reserve requirements. One strategy The VareCo is taking with these lenders is offering to pay for an appraisal in hopes that the lenders will utilize the current appraisal value and avoid 6-12 month seasoning requirements. Once the VareCo has leased approximately 20 units, we will have the property appraised and finalize the loan. The VareCo is anticipating a 5-year fixed loan of 75% LTV, with 30-year amortization, at 3.25% interest rate, and that the lender will require a personal guarantee. The VareCo’s underwriting shows an expected Debt Service Coverage Ratio of approximately 1.6 at conservative occupancy levels, which in addition to its location in the Highland neighborhood, makes this an attractive property for local banks to finance. 

The VareCo is also considering selling the property for $6.5M. If we continue to hold the property, we will likely look for an opportunity to do a second refinance in 3-5 years at 60% LTV in the form of a non-recourse loan. Although this project encountered some bumps in the road, The VareCo was able to complete the project at an all-in number below 75% of the ARV. In doing so, The VareCo was able to add a tremendous property to its portfolio, in one of the best locations in Denver, and will achieve an infinite cash-on-cash return—as it recoups its investment through the initial refinance and enjoys annual net operating income (inclusive of financing costs) of approximately $142K.

Disclaimer: Investing in Real Estate involves a high level of risk. The above figures and return data metrics are strictly for the purpose of education and do not represent actual data or return values. Investing in Real Estate involves a high degree of risk and is appropriate only for investors who can afford to sustain a loss of their entire investment.

YouTube Video: 23 Unit Wyandot Street Value-Add Property

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