This is my story about how I bought a 12-unit apartment building with money raised from private individuals.
This deal closed against all odds and then nearly bankrupted me.
Don’t make the same mistakes I did and learn how to raise money to buy your first apartment building.
Finding the Property
One day in March 2011 an email came in from real estate investor friend (we’ll call him “Frank”) who learned of a 12-unit apartment building in NE Washington DC. Even though I get the vast majority of deals through my brokers, every once in a while there’s an exception
My investor friend positioned the deal as a rehab flip (i.e. buying it, fixing it up, and selling it for a profit), which is what I also do occasionally.
Another investor he knew (“Richard”) had it under contract. The seller was asking $500,000. Frank had a marketing agreement in place with Richard that if he referred a buyer, he would be paid a marketing fee (nice, huh?).
I ran the sample rent roll he sent me through my Deal Analyzer Software and quickly realized that there might be an opportunity. The deal itself worked OK, but my gut was telling me that $500 for a 1-bedroom, even in NE Washington DC, seemed low. I confirmed this with some quick rent comps on rentometer.com. I then asked Frank for an introduction to Richard, was looking to assign the contract to an ultimate buyer (maybe me?) for a fee.
After speaking with Richard, I still liked the deal, but there were issues with the building (there always are, aren’t there). It had been listed at $650,000 and had been on the market for over a year. Even though buildings like this are selling for around $900,000, the rents are so under market that buyers couldn’t justify a higher price.
The seller was a widow who was slowly selling her deceased husband’s assets, including this building. She was motivated, but not super-motivated. My sense was that the purchase price would be at fair market value based on the financials on the building, but that this might be a value-play opportunity. I felt that if the rents could be increased from $500 per unit to $750, we could add significant value over time.
I decided to proceed.
The next step was to sign an agreement with Richard to assign his purchase contract to me. Here it is:
This agreement of sale is made April 11, 2011 between You (“Consultant”) and Me, LLC (“Buyer”).
Whereas, Consultant performs marketing services for Buyer with the intent of purchasing real property;
Whereas, Consultant referred to Buyer the sale of the property located at 123 Main Street (“Property”) for which Buyer shall pay to Consultant a marketing fee of $xxxx at closing;
The parties hereby agree to the following:
Fee: For services rendered, Buyer agrees to pay to Consultant a marketing fee of $xxxx (“Marketing Fee”), payable at closing.
He then sent me a copy of his purchase contract. Instead of assigning it, we decided to shred it and sign a new one (this seemed more straightforward to the seller. You should always make it easy to do business with you. If it doesn’t hurt you, be accommodating).
The contract we used is a standard state Multi-Unit Sales Contract that is accessible by any residential or commercial real estate broker.
The contract terms to buy this apartment building were:
- Purchase price $450,000 (plus the marketing fee payable to Richard and Frank)
- $4,000 deposit
- 20 day contingency for feasibility study
- Seller has 7 days to submit documents, and I have 7 days to review
- We have a 45-day appraisal & financing contingency.
There were a few clauses that were missing in this standard contract, and I addressed this with a one-page addendum that added these conditions:
Once I receive all of the requested information, I have 20 days to complete due diligence and to terminate this contract if the Property is unsatisfactory to the Buyer in any respect. That way, if the seller drags her feet with getting documents to me, she is not eating into my due diligence time.
I have final approval of any new or changes to rental agreements, service contracts, or leases between Ratification Date until closing. I don’t want the seller to add any poorly qualified tenants that I then need to evict!
I have the right to assign the contract. My intent was not to sell the contract (like Richard) but I did want to title the property in a new LLC that I was going to create for this purpose.
I had her confirm that to her knowledge, no part of the property is in violation of any existing code, health or safety regulations, and is not involved in any governmental or judicial proceedings; and
I have the right to extend the closing date by 30 days in return for paying 0.25% of the purchase price of an additional deposit, and I can do this more than once.
The seller signed the purchase contract and addendum – we were ratified. My heart was pounding! I was going to buy my first apartment building!
The Long Road to Closing
My exhilaration was quickly tempered after the closing attorney asked me a few questions like, “Have the tenants waived their TOPA rights, or have they expired?” and “Can you provide me with current rent registration form?” Say what?
I knew the building was under rent control, but I wasn’t aware of the details. Every year, the owner has to register the current rents with the city. The last time the current owner did this was in 2005, so there was a compliance issue that needed to be resolved.
In addition, selling a building in DC is more challenging than many other parts of the country because of its Tenant Opportunity to Purchase Act (TOPA). This gives the building’s tenants the right to organize and to purchase the building. This rarely happens, but it complicates and oftentimes delays or even prevents a sale.
It turns out the tenants had decided to exercise their rights to purchase the building, and the seller was working with them on this process, which can take 6-9 months to play out.
I realized that these two issues would take longer than the 20 day contingency period we had put in the original contract. So I fixed this by having the seller sign another addendum with these additional terms:
This Contract is contingent upon:
Approval by the Buyer’s title attorney that all TOPA requirements have been satisfied and are satisfactory for Buyer to obtain title insurance. If TOPA requirements were not met in the opinion of Buyer’s attorney, Seller agrees to take measures to comply.
Seller shall provide verification from the DHCD (this is the organization that handles rent control registrations) that current rents are in compliance with rent control statutes.
Section 10 of the Purchase Contract shall be restated as follows: “This Contract is contingent upon a period of 20 days from the Date contingencies (a) and (b) referenced in this Addendum are removed, for the Buyer, at Buyer’s expense, to determine the feasibility of the Property for Buyer’s purposes”. This means that I’m not wasting time reviewing due diligence documents until these two conditions are met, and then I have 20 days from that point.
And, the closing shall occur on or before 45 days from removal of all contingencies.
At this point, I was in a holding pattern. I checked with the listing agent once per week to get an update. It took seven weeks to satisfy those two contingencies. The seller hired a consultant (who was a former administrative judge) to fix these issues.
I was a bit surprised that the TOPA matter was addressed so quickly. I learned later that she agreed to pay the tenants an agreeable amount at closing if they would waive their rights to purchase their building vs. letting the rights expire. Wow.
Now that these two issues were taken care of, I had to spring to action and start my due diligence. I only had 20 days to move forward or cancel the contract.
I wrote the owner a letter requesting all kinds of documents. She took a long while to respond, and then the documents I got were incomplete. Not a problem! My 20 days wouldn’t start until I got all documents from her.
Eventually I got the documents I felt I needed, including her bank statements. I wanted to verify that she’s actually depositing the rents she claimed she was getting. It turns out she was only collecting half of the rents!
This was completely unacceptable! The value of the property is based on the income of the building, and her income suddenly was only half of what was advertised.
I told the listing agent that we could not proceed with the contract as it was, and I gave him three options:
- We terminate the contract;
- We add a contingency to give the seller time to collect 100% of the rents for three consecutive months; or
- She could guarantee the rents for a year.
The seller insisted that the tenants would all pay. As far as I was concerned, this deal was dead. Too bad because I had spent countless hours on this deal already.
Three weeks later, the agent called me back and said the seller was going to guarantee the rents. Really? OK, that would work.
We revived the deal with yet another addendum that spelled out the terms of this rent guarantee: whenever I don’t collect rent from one of her tenants, I could collect the difference from the escrow account. I also got her to agree to a repair credit (from our building inspection), and we changed the name of the buyer to the new LLC I had created.
All contingencies were satisfied (except for the financing contingency), and we agreed to close within 45 days.
This deal came back from the dead, and now we were moving forward again!
My lender’s appraisal and their property inspections were fine and we were scheduled to close in 14 days, pending final underwriting review. This is normally a formality, but in this case, the bank’s loan committee inexplicably decided they didn’t want to do the loan. The lame explanation was that the loan committee changed their mind about the location and were no longer comfortable with proceeding.
Really? 14 days before closing?
This is where my previous networking with loan brokers came in handy. I called up another broker I had spoken to about this deal. Initially, the term sheet from the lender he was representing was not quite as attractive. However, they jumped at the deal and said they would close within five weeks.
I explained the situation to the listing agent and exercised my option to extend for an extra 30 days by paying an additional deposit (see how nifty that was?).
The new lender took care of business and we closed four weeks later.
Five months after we were under contract.
How I used Private Money to Finance the Purchase
From the very start, I wanted to use money from private individuals to purchase this apartment building. I want to give you some background on how this was possible.
For several years, I have been renovating houses, fixing them up and reselling them for a profit. I raised the money with a $25,000 minimum from friends and family and paid them 12% to 15% simple interest, guaranteed by the house. The title companies took care of the promissory note and recording the deed, and it was simple to do.
People like and trust real estate, the returns were good and the perceived risk was low. It was surprisingly easy to get friends and family to invest for these reasons.
As I was eyeing commercial real estate, I polled my existing investors to see which ones were interested in buying commercial real estate and if they could refer me to anyone who they thought might be interested.
I quickly assembled a small group of individuals who were interested in investing in apartment buildings. Since I didn’t have a deal at the time, I created an investor package of a fictitious building. Everything about the building was accurate (photos, location, financials, etc), except the purchase price – I made that work to achieve the returns I wanted for my investors. In other words, I approached potential investors with a deal package that looked like the real thing.
I said, “I don’t have a deal right now, but when I do, it’ll look substantially like this” and then I’d show them the package.
By the time I got this property under contract, I had already primed my investors. When I sent out the deal overview for this property, my investors responded quickly.
I needed $250,000 in cash for the 25% down payment, closing costs, and repairs.
I try to structure the deal so that the investors achieve a 10% – 15% average annual return over the life of the investment. To achieve this return based on my financial projections for cash flow, loan amortization and resale, I could do a 50/50 split with the investors to achieve a 15% average annual return.
I then paid myself an acquisition fee of several thousand dollars at closing. Based on the number of hours this deal took, none of my investors had an objection.
All of this was disclosed in a Private Placement Memorandum and LLC Operating Agreement that was drafted by an SEC attorney. This is expensive, but it’s worth it. It not only protects you but also spells out to the investors the terms of the deal, how profits are split, how decisions are made, and what the potential risks are.
I felt mighty proud of myself for closing this deal, even against all odds. But the fun was only just beginning.
The First Year – A Nightmare
This is the story of “Paul”, one of our tenants, and how he nearly bankrupted us.
Paul is a good guy, I suppose his heart was in the right place. He wanted to make sure everybody, including me and the District of Columbia was doing their job.
He repeatedly sued me for alleged housing code violations. I was in court every six weeks. This was his way of communicating with us, and we responded by addressing every issue we reasonably could.
In the first six months of this, my property manager and attorney were handling all of these cases. I thought this was the way you do things.
Until I got his $3,500 bill after three months of activity!
I realized that if this went on for a year or longer, the legal fees alone would exhaust our capital reserves.
I had an urgent meeting with the attorney and asked him about the sustainability of this plan. He then admitted that for most of these hearings, I did not need legal representation but could represent the LLC myself.
Really? Now you tell me? Well … I guess I never asked either.
I quickly replaced this attorney with one who billed promptly and provided fixed-cost pricing for most eviction-related issues.
I also started going to court myself.
Not a very pleasant experience, but I started getting used to it. We were systematically working through the issues.
In addition to making the court system work, Paul also contacted other governmental compliance agencies, such as the DCRA, which issues construction permits and enforces violations. He would call them daily, reporting construction activities. An inspector would promptly inspect the property and find something awry that needed to be written up.
Because of the high visibility of this building within the agency, the DCRA was enforcing the letter of the law, which in D.C. requires you to have a permit for EVERYTHING you touch with a hammer or screw driver. These permits are expensive, and they can only be pulled by licensed contractors (in other words, I could not do it myself). Due partly to my own ignorance related to “how to do things right” in the city and the heightened level of enforcement, I had to pay thousands of dollars in permits and fines.
Paul called the EPA regarding alleged lead paint violations, and of course, an inspector promptly arrived, asking for a lead paint inspection from a licensed professional. Two thousand dollars later, we knew we were lead free in all of the units. But there was lead paint on the railings in the hallways.
You can either be “lead safe” or “lead-free”. To be lead safe, each time a tenant moves in, you have to certify that the unit is lead safe and you have to disclose any lead paint that is known to be in the building. This costs about $250 per unit.
We decided instead to become “lead-free”. That required that we cover the railings with drywall. Our 3rd party lead paint inspector then came back and certified the building as lead free. Another several thousand dollars later, I now have a lead-free building.
A Life Lesson in the Middle of the Storm
As these events unfolded, I grew more and more anxious. My primary concern was running out of money. If we ran out of money, I would have to go back to the investors, tell them that their capital reserve money that was slated for renovations was exhausted, and that they need to put in more money. Failing that, I would lose the building in bankruptcy and never raise money again.
Not the best start to my commercial real estate investing career.
With each certified letter containing violations or a summons to appear in court, my despair grew. I had trouble sleeping, I was tense. A paralyzing fear was starting to overwhelm me.
In situations like these, my wife is a rock. She can always put things in perspective and offer support that can lift me up. She has tremendous faith. She reminded me that God loves me no matter what happens, that God is good, and that He only wants good things for me. Maybe, she suggested, I’m going through this for a reason. Maybe I am supposed to learn something.
I thought about this for several days and asked myself the question, “what am I supposed to learn?” After much reflection, I felt that my lesson was to be at peace no matter the circumstance.
My prayer shifted from “God, please make my problems go away” to “Please let me be at peace, regardless of what happens”.
But how could I be at peace in the face of imminent bankruptcy?
This is where prayer and faith come in. Because I prayed for peace and believed that it would be granted to me. My prayer wasn’t answered immediately, it took about a week. The sense of peace I felt was inexplicable yet tangible. My body relaxed, and I was able to sleep again – despite the fact that I was scheduled next week for yet another hearing at the Superior Court in Washington DC.
Sudden Change of Heart
At this hearing an odd thing happened.
Because we had been in court so often, the judge wanted to meet in a less formal setting to work through the issues. In attendance were myself, my property manager, the judge, and Paul.
As I sat there silently while the other three discussed the outstanding violations, Paul suddenly turned to me and said, “I’d like to talk to Mr. Blank a bit” and then he leaned over the table to extend his hand. As I took his hand, I stammered something like, “OK, that would be great”. The judge and my property manager excused themselves, and then I was alone with Paul.
A long time ago, I made several attempts to communicate with Paul. Once through a 3rd party, and the other time myself. Both attempts were not received well and went no where.
I was shocked at what was happening.
I don’t exactly remember what we talked about in those 5 minutes. I just remember that we agreed to grab a cup of coffee after this.
We called the judge back in, and she asked him how he’d like to proceed. He said he would like to dismiss all charges. My property manager looked at me in utter disbelief.
As if in a daze, I found myself sitting with Paul, sipping on a coffee in the court house café downstairs and engrossed in a conversation as if we were long lost friends.
He was sharing about his life, and so was I – more, probably, than our common sense should have allowed given our adversarial history.
At one point he turned to me and said, “you don’t have to worry about me any more.” We exchanged contact information and agreed to stay in touch.
He withdrew all outstanding complaints and stopped calling the agencies.
I am open to the possibility of miracles. The miracle of child birth, the mystery of human consciousness, or a series of coincidences. Miracles happen all around us, if we’re open to seeing them.
This development with Paul was so inexplicable that I had to classify it as some kind of miracle. I also concluded that God allowed the circumstance to change because I had learned the lesson I was supposed to have learned. If you master a lesson, will a situation always improve? No, probably not. But I think I was rewarded in this case with a sudden change of heart that I could not take any credit for.
The Long Road to Stability
A year had gone by since buying the apartment building, and it had been a roller coaster ride – but not one of those fun ones, one of those terrifying ones you want to get out but can’t.
I had spent thousands of dollars more than expected. My business plan was out the window – I had missed my annual projections by a mile. I felt my credibility with my investors was shot. However, they have been very patient with me, for which I am grateful.
I have learned a valuable life lesson, which is to be at peace regardless of the circumstance. It is a lesson that I am still working on.
And I have the most compliant building in the District of Columbia.
Two years after closing, we are 100% occupied and collecting 100% of the rent. We have been able to raise the rents in several of the units. We have the cash flow to quickly respond to repairs and make some cosmetic improvements. And we have a good relationship with our tenants.
Update March 2017: I have the building under contract for sale for nearly twice what we bought it. It shows that despite setbacks, challenges and mistakes, can be overcome with a mix of ambition, guts, persistence, discipline, and faith. This multi-unit property required a strong dose of all of these. Despite all of the challenges, I am convinced that investing in apartment buildings is still the best way to replace your income and build long-term wealth.
Thanks for reading, and to your success!