Terrance Doyle, Founder The VareCo

This post with Terrance Doyle and Ben Davis of The VareCo covers how The VareCo sourced a 25 unit portfolio, got it under contract, underwrote, raised capital and their plan for repositioning the properties. The property portfolio includes six all-brick structures. Five buildings are fourplexes, and one is a five-unit building in Wheat Ridge, CO. Each of the 25 units consists of 2 beds and 1 bath, with a total of 780 square feet per unit. 

A note to readers: Terrance and I are planning on doing one syndication deal analysis per month; this is the first one. Please let us know what questions you have and how we can improve on future analysis. I highly recommend listening to this episode of the podcast because it’s packed full of great information.

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

Sourcing the Deal

This was an off-market deal The VareCo sourced from a multi-family broker who reached out directly. Terrance and his team have worked on establishing positive relationships with commercial brokers in the Denver multifamily space and brokers now know The VareCo has the knowledge, experience, and interest to close this type of deal.

Within a day, the property was put under contract at $3.85 million, with a 21-day inspection contingency and 30-day close. Their due diligence process was meticulous, as Terrance has built a business around protecting investor capital and only acquiring properties that they themselves will invest in. 

• Inspection – Full inspection by a licensed inspector that specializes in multi-family properties. 
• Phase I Environmental Study – This includes title examination, soil studies, improvements and permits pulled, as well as hiring an attorney to read through.
• Rent Study – Understanding not only rent rates at comparable properties but researching what components within the market achieve certain rent levels. Understanding the value of washers/dryers, parking, amenities, etc help The VareCo team underwrite accurate rents. 
• Construction Bids – Obtaining bids from licensed vendors for any areas of concern identified in the inspection report.
• Ultimately, everything indicated a potential deal. The team was able to negotiate a $60,000 price concession due to the roof condition, which resulted in a final sales price of $3.79M.

Underwriting: Paint An Accurate Financial Picture

In addition to solid due diligence, accurate and conservative underwriting is critical when raising investor capital; particularly during a pandemic when collections have increased potential to be volatile. The VareCo underwrites (UW) its deals with less than ideal circumstances, accounting for lower revenue and higher expense metrics than what is experienced in today’s market; doing so has created the ability to under-promise and over-deliver on quality and returns alike. 

For this property, numerous comparables were available to paint an accurate picture and project rents for 2-Bed/2-Bath units in the area. However, Terrance can attest to the fact that until a lease is signed and a rent check is written, UW rents are strictly that, underwritten rents. For that reason, the team decided to discount UW rents to a rate received at a comparable property previously owned by The VareCo. While this rate is likely 15% under what’s achievable, the goal of underwriting is to confirm whether or not the project is a worthy pursuit. More simply, The VareCo wants to know if this deal can survive in a worst-case scenario. 

For vacancy, The VareCo again takes a conservative approach. While the actual occupancy rate achieved by the seller was 98% over the past 5 years (attributed to rents being significantly under market value, at $944 per month), vacancy rates throughout Denver are more consistent with a 5-8% figure. The VareCo ultimately underwrote the deal at 8% during renovation and then 6% thereafter—again using numbers that should allow them to execute and over-deliver.

With respect to the budget, The VareCo develops a renovation plan with projected construction costs of $150,000 that includes a new roof, updating electrical panels, soffits and fascia, tuck point and paint on exterior brick, new gutters, and hot water heaters for each unit. Renovations will be completed in phases over the next two years, with a total budget of $400,000.

Financing

Funding a syndication typically requires capital from two sources, investors and bank financing. For this deal, The VareCo sought bank financing for 65% and an equity raise for the remaining 35%. When The VareCo looks at loan terms they’re focused on the following items highlighted on the term sheet: 

• Loan to Value
• Interest Rate
• Amortization Period
• Prepayment Penalty
• Personal Guarantee Requirements
• Loan Fee

Relationships and prior performance are highly valued in this space, the team invests heavily in the bank relationships it maintains and does everything within their power to maintain a positive track-record with existing loans. 

Keep in mind. The bank is focused not only on you as the borrower, but they’re also highly interested in the prior performance of the property. If your seller has poor records or no records and/or extended periods of poor performance, this should be negotiated as it is likely to be reflected on the term sheet you receive. 

Regardless of COVID-19, banks have their own underwriting teams considering both past performances as well as your projections. No matter how successful The VareCo’s prior projects have been or their projected returns for this deal, a bank is going to want to see the seller’s records and how the property historically performed. This will ultimately impact terms. This should be negotiated with the seller in the same way a leaky roof or broken concrete might be.

Execution

The VareCo is founded on execution and derived its name from providing “value-add” real estate; the deal can underwrite as a home run and you can get the best loan terms in the city, and you still have to execute. The team creates a monthly cash-flow projection worksheet that breaks down each and every month of the 7-year project and analyzes numerous metrics from bank account levels to the vacancy caused by remodeling, to tax increases. With that information, the team applies its renovation plan to the model and creates a transparent concise execution plan for each month of operation. On this project, the renovation plan is to do two units per month, taking 12-15 months to turn all units. This allows for the distribution of cash every quarter to investors. As each unit is renovated, the rents and thus the net operating income will increase by as much as 30-40%, thus the “value-add” is executed, both for the tenants, as well as for their investors.

The VareCo will then take the deal to the existing lender or alternative lenders, showing the improved NOI, reduced risk, and refinance closer to 80% LTV and use the proceeds to return significant capital to investors. Additionally, at this point, they will negotiate into an interest-only payment for 2-3 years in an attempt to distribute cash flow back to the investor vice principal paydown. With the investor’s capital in large-part returned, the investor is enjoying significant cash-flow at little to zero risk level.

Finally, The VareCo’s projects a sale of the property somewhere around the seven year mark. To estimate expenses and income at that point they chose an accelerator of 3% increase per year. This is a critical data point to understand as it is the key predictor of future NOI which is the major variable in calculating the properties’ future value using the income method (cap-rate). In reality, no one can predict the exact accelerator rate, and margins between income and expenses will either increase or decrease over time and have a tremendous impact on profits.  

Deal Structure

For this project The VareCo offered

• 70/30 GP/LP Split
• 8% Preferred Return
• Fees paid on Acquisition, Development, Asset Management, and Disposition.

In the hypothetical Sale of a property for $1M, the company would then,

• Satisfy all Current Bank Debt, Obligations, Closing Cost
• Return Investor Principal
• Satisfy Investor Preferred Return 
• Then divide remaining dollars 70% to Investors and 30% to the projects managers or General  Partners

The Short of It

1. Purchase with 65% LTV Bank Debt.
2. Raise the remaining 35% capital from investors.
3. Conduct renovation of all units and deliver units back to the market with increased rents.
4. Convert to agency debt at 80% LTV and interest-only financing.
5. Distribute cash-flow to investors.
6. Dispose of property in year 7. 

To Recap

Relationships and reputation matter in multi-family, this deal was sourced and financed through existing relationships. Given the current uncertainty, finding a bank to fund a multi-family deal without a track record or existing relationship will be very tough. 

Underwrite conservatively. Use conservative numbers that will make it easier for you to execute your business plan and over-deliver to investor LPs. Never get emotional about closing a deal or proceed when the numbers don’t pencil out. “Having a feeling this is a good deal” should never be your reason for closing.

Note to readers: 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.

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YouTube Video: Deal Analysis of Denver 25 Unit Syndication

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