When you’re putting together large deals with multiple people involved both passively and as general partners, you’ll need to focus a lot of organizing everything. Theo will be covering what kind of accounts you need and how to keep it all organized. If you enjoyed today’s episode remember to subscribe in iTunes and leave us a review!
Best Ever Tweet:
“Contingency is to cover things that you may have miscalculated”
Evicting a tenant can be painful, costing as much as $10,000 in court costs and legal fees, and take as long as four weeks to complete.
TransUnion SmartMove’s online tenant screening solution can help you quickly understand if you’re getting a reliable tenant, which can help you avoid potential problems such as non-payment and evictions. For a limited time, listeners of this podcast are invited to try SmartMove tenant screening for 25% off.
Go to tenantscreening.com and enter code FAIRLESS for 25% off your next screening.
TRANSCRIPTION
Joe Fairless: There needed to be a resource on apartment syndication that not only talked about each aspect of the syndication process, but how to actually do each of the things, and go into it in detail… And we thought “Hey, why not make it free, too?” That’s why we launched Syndication School.
Theo Hicks will go through a particular aspect of apartment syndication on today’s episode, and get into the details of how to do that particular thing. Enjoy this episode, and for more on apartment syndication and how to do things, go to apartmentsyndication.com, or to learn more about the Apartment Syndication School, go to syndicationschool.com, so you can listen to all the previous episodes.
Theo Hicks: Hi, Best Ever listeners. Welcome to another episode of the Syndication School series, a free resource focused on the how-to’s of apartment syndication. As always, I am your host, Theo Hicks.
Each week we air two podcast episodes, every Wednesday and Thursday, and the Best Real Estate Investing Advice Ever Show on iTunes. We also turn these into YouTube videos as well, posted a little bit later in the week. Each of these episodes is focused on a specific aspect of the apartment syndication investment strategy, and for the majority of these series we offer a free resource, whether it’s a PDF how-to guide, an Excel template calculator or a PowerPoint presentation template… Regardless of the type of resource, we’re always giving away free stuff on SyndicationSchool.com, in addition to the actual free episodes. All of the previous free resources and free Syndication School podcast episodes can be found at SyndicationSchool.com.
This episode is gonna be a quick one, but it’s still important information to give out. We’re gonna talk about the different accounts you will have when you are asset-managing a deal. These are the different types of bank accounts you’re going to have, and we’re going to talk about what they are and what they are used for.
There are really two main accounts, and the second one is kind of a part one, part two, or a and b; it kind of depends on the type of loan that you get. But the first account – the main account – is going to be your operating account.
The operating account is the account that all of the revenues you collect go into. All of the rents you collect, all the security deposits you collect, all of the other fees you charge, whether it be moneys from renting out a carport, or other types of parking, valet trash, pet fees, application fees, things like that. Basically, any money that you are collecting from tenants are going to go into this operating account. And since money is coming in, money is also going to be going out, so whenever you are paying your expenses, those will come out of this operating account. Ongoing expenses such as maintenance and repairs, paying your property management company, paying your taxes, paying insurance, any types of reserves that you plan on saving – those will come out of this operating account. This is the main account you’re gonna use for the everyday incomes and everyday expenses.
Additionally, since this is the account that has all the money in it, this is the account you’ll also want to use to pay out your investors. We’ve talked about this before, but typically you pay your investors distributions on a monthly basis, quarterly basis, or you can do bi-annually or annually. We do monthly. The most common one is quarterly; sometimes you’ll see twice a year or annually. So whenever it’s time to pay your investors, this is where that money comes from.
Now, since it’s gonna be a bank account, you can either pay them in the form of check, so you send checks in the mail, so you’ve gotta get checks for this account, or have your property management company set up direct deposit… Just making sure you have all that set up before closing, so that your investors can get their first distribution smoothly.
Now, one of the common questions we get from our clients, as well as those other people who are interested in doing apartment syndications – a very specific question when it comes to underwriting, and that is “What is this operating account fund cost assumption?” So whenever you’re underwriting a deal, obviously you’ve got to raise money for your down payment, for closing costs, for fees you’re charging as a GP, whether it’s acquisition fees, guarantee fees, things like that… And then depending on the type of loan you get, you might have to raise additional money for your cap ex costs… And then there’s this other item, which is the operating account fund.
So now that we’re explaining what the operating account is and how it’s used, the upfront operating account fund should make a little bit more sense. This operating account fund is essentially to pay for any unexpected issues that arise, or shortfalls that arise, before you’re able to accumulate enough money in that operating account.
So after 12 months of owning the deal you should have collected enough rent, enough other incomes to have a large enough purse to pay for any sort of unexpected maintenance issue. A large boiler goes down and you need to spend $20,000 to repair it.
After 12 months, you should be able to cover that no problem. But what happens if you buy the property and then the first month something happens to the boiler, and you go to your operating account and you have to decide whether you’re gonna distribute money to your investors for the month, or if you’re going to pay and fix this boiler. Obviously, to pay and fix the boiler, which means you have to delay your distributions to your investors, which might be an issue for them. That’s why the operating account fund upfront is so important.
So you’re going to want to raise additional capital upfront, and put it into your operating account, so that, following this example, if that boiler were to break down and you need to replace it, you already have money allocated towards issues like that… Whereas if you didn’t raise this money, you would have to make some hard decisions.
So the upfront operating account fund amount depends on the business plan, depends on the type of deal. A good rule of thumb – and this is kind of a large range – would be anywhere between 1% to 5% of the purchase price, raise additional capital for that. So that would be raising a few extra acquisition fees, because the acquisition fees are usually 2% of the purchase price, so… Again, it varies. Some people do a flat rate of, say, 100k. It kind of depends on the deal itself. So make sure that when you are underwriting your deal, like all things in your underwriting, you run it by your property management company first, and you ask them “What would be a good amount of money to put in this operating account fund?” Ideally, you’re working with an experienced property management company who knows what that is and has a good idea of what might potentially come up.
Now, this is different than contingency. When you’re underwriting your deal and you’re creating your interior and exterior cap ex assumptions, you’re gonna go in there and renovate the units, and maybe you’re gonna upgrade the clubhouse, and install some carports, and do some other touch-ups to the property, you’re gonna wanna have a contingency fund that’s equal to 10% to 15% of the overall interior and exterior cap ex budget for unexpected issues that arise while you’re doing the renovations. So let’s say you projected $5,000 per unit, but it ends up being $6,000 per unit, or $5,500, because the bid was a lot higher than you expected – that’s what the contingency covers.
The operating account fund is different. That’s gonna cover things that come up that have nothing to do with your initial cap ex. These are like deferred maintenance items that you missed. Or maybe to pay insurance or taxes upfront, or sooner than possible. Things like that. They’re kind of similar, but they’re actually two distinct things.
Contingency is to cover things that you either miscalculated or that come up while you’re doing the exterior and interior renovations, and then the operating account fund is to cover unexpected issues that come up that are unrelated to your actual cap ex.
So hopefully that clears up what that operating account fund is when you’re underwriting your deal and making sure you’re raising the right amount of money to cover that upfront, as well as also having the separate contingency budget for your exterior and interior renovations. So that’s the first account, that’s the main account. You’re gonna have that account really no matter what type of loan you get.
The second and third account, I guess we’re gonna call them 2A and 2B. Those are going to depend on the type of loan that you get. So 2A we’re gonna call the capital account. The capital account is if you are securing an agency loan, so a Freddie Mac or a Fannie Mae loan, and you are not including any renovations in your loan. There are agency loans that do allow you to have moneys allocated towards renovations, but for the capital account, this is when you’re getting a loan – whether it’s an agency loan or some other type of loan – and you know the cap ex interior or exterior are going to be included in that loan, and instead you need to raise money from your investors to cover that. That’s where the capital account comes in.
So whenever you perform a renovation, your contractor finishes up and they’re ready to get paid, this is the account they get paid out of. They’re not paid out of the operating account, they’re paid out of the capital account, because this is where you put your investors’ money. So when you raise the money from your investors, obviously a portion of it goes to the down payment, another goes to the closing costs, fees to you, some of it goes to the operating account fund – the rest of it, the chunk that goes to your cap ex, is gonna go into a separate account; it’s gonna go into the capital account, and that is how you pay your contractors.
A contractor finishes up a unit, or finishes up half the units, whatever your agreement is, and they come to get paid – you pay them out of your capital account, not your operating account.
And then as I mentioned, since this is going to be how your contractors get paid, this is where you’re gonna wanna put your investor’s money. So when they are wiring their funds to you, you’re gonna put it in this capital account and then pay for the loan, pay yourself, pay the closing costs, transfer money into your operating account for that operating account upfront fund, and then the rest will stay in that capital account and be paid out to the contractors. So that’s 2A.
2B would be if you got a loan program like a bridge loan or some other loan program that does include renovations, then your lender may require you to create what’s called a DACA account. What this is is that the lender may require you to rather than depositing any of the rents straight into your operating account, the lender may require you to deposit the rent into this DACA account first, and then funnel that money into your operating account fund, maybe even that exact same day.
The purpose of this DACA account is to technically stop income coming to you, the borrower, if you fall into what’s called cash management from not passing the debt service coverage ratio test. Typically, when you are getting money from a lender for renovations, they’re gonna have some debt service coverage ratio requirements, maybe some occupancy requirements, maybe some timeline requirements where you need to have the renovations completed within a certain amount of time, and then they’re gonna come to the property and do some inspections to make sure that everything is going according to plan.
If things aren’t going according to plan, if you’re not hitting their debt service coverage ratio requirements, then you go into what’s called cash management, and they will in a sense take money from this account to pay themselves for whatever issue that arose. So this is something that’s different from the capital account. If you’re not paying for renovations you’re self, you’re not gonna have a capital account, because they’re coming from the lender, through the draws, but you might have to have a separate DACA account, so that if for some reason you’re not following the lender’s requirements, you fall into cash management, they can stop the money from coming to you. So they’re not gonna take the money, they just put a halt on it and you can’t collect that money until you hit those requirements.
So those are the three different types of accounts you’re gonna come across when you are asset-managing your deals. It’s important to know, because you wanna make sure that you’re not paying your investors out of the capital account, that you actually have an operating account, that you have enough money in your operating account to pay your investors, to pay your property management company, making sure you have enough money in your capital account to pay your contractors, and making sure you have that DACA account if required, so that you’re meeting the lender’s requirements.
And again, the capital account will be if you are paying for renovations yourself, or your investors are paying for the renovations. DACA account is something that you might have to do if the lender is the one who’s covering the renovations, and you pay for those in your down payment.
That concludes this episode. As I said, it’s gonna be a quick one, but this information is important to know, especially since typically a lot of the focus in the real estate apartment syndications are on the front-end activities, like how to find deals, how to build your team, how to raise money, how to underwrite deals, and not focused as much on the asset management side. So we’re definitely gonna be talking a lot more about asset management in some future Syndication School episodes, even though we focused probably an eight-part series on it earlier on, so you’ll definitely wanna check that out on SyndicationSchool.com.
Until tomorrow, make sure you check out some of our other Syndication School series, make sure you check out and download all of the free documents we have available to you. Both of those can be found at SyndicationSchool.com.
Thank you for listening, and I will talk to you tomorrow.
