Last week (see first article), we showed a project that we were looking at in the very early stages and came to a surprising conclusion:

Even With $180K Of Equity On The Table, This Was A Marginal Deal

Why you might ask?  Simply because of the way that this project was structured.   What we are going to discuss this week is how to restructure this opportunity into something that many people would consider very attractive.

As a reminder, here is how the deal ended up last week:

The major problems that we see are:

1. Between down payments and negative cash flow, there is a need to put in a total of $136,000. 

2. For such a large cash outlay, a net gain of $54,800 is not that attractive.

3. Not clear what the risks are if the project does not resell in 2 years.

Reworking The Deal

Now the real question….. with this much equity in play and a real desire from the developer, is there a way to produce an excellent opportunity for the individual investor?

This particular developer is facing a common situation these days called an equity squeeze.  The lender for both their land development and construction loans is not happy with the sales rate and they have the right to require the developer to put in more equity on their total project….. On this project, this could mean the developer may have to put multiple millions dollars of additional equity into the project.   I don’t care how strong you are as a developer, this is not pleasant.

So, as a consequence, they are working hard with us to try and make a deal very attractive for our buyers.  THIS IS NOT A DONE DEAL YET and some numbers may change, but let’s see how this now looks for educational purposes.

At this point, the restructured deal looks as follows:

1. Price changed from $540K to $555K.

2. Down Payment at 5% rather than 10%

3. Lender ok with cash out refinance at the 12 month mark.

4. Developer providing 10% of purchase price back at close

5. Developer agreeing to sell our units as developer units starting about 10 months after close, including selling the units from the model center.

6. Insurance and taxes have been increased from previous article to reflect closer estimates of actual.

7. Net rents have been increased from previous article to reflect closer estimates of actual.

Cash Flow Considerations

Bottom line as an individual investor…..

“How much money will come out of my pocket and

how much does it appear that can be made.”

If the expected amount of future profits is large, and the expected money out of pocket is small, then a lot of people start to pay attention.  Let’s see how to do that in this project.

The figure below now shows the cash flow considerations for this project based on our current structure… Please be advised, these numbers may still fluctuate as we do more and more due diligence.

So what is happening in this chart? 

Quarter 0:  Closing – Because of cash back and 5% down and assumed closing costs of 3.5%, then the investor is net positive at this point.  (Quarter 0 Not Shown On Chart (+$11,500)

Quarters 1-4:  First Year – Net negative cash flow is occurring.  The investor can think of this period as paying their down payment over a period of 4 quarters.

Quarter 5:  Cash Back Refinance – Because of considerable equity, after 12 months seasoning, then purchaser refinances for $620,000 in this example.  Note that now purchaser has considerable cash in pocket.

Quarter 6-8: Waiting To Sell – During Quarter 4 if desired by the purchaser, the developer has offered to sell the unit as developer inventory via their model center.  Negative cash flow is financed via money left over from refinance.

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Discussed so far is the first 2 year period which was what was discussed in the first article.  Looking at the chart, then we see that the expected cash out of pocket is about $40K as compared to $136,000 before.   That is a huge change.

We will address quarters 9-12 in the Oops, What If It Does Not Work Out Section

Re Sell Considerations

While this particular property is probably great to hold onto if the purchaser can make long term, personal use for themselves, let’s now look at the resell picture.

In the Boca Grande area, which is truly world class, there is no danger of real estate staying slow forever….. the question, like in many areas, is how long does it take to really rebound.

What we wanted to know is what happens if sales stay at the same pace as today.   Working with one of the largest and oldest brokerages in the area, the best estimate is that even at today’s slow sales rates, sales of 1 per month is not unreasonable.  Between developer units and our groups units if we do this project, then there is a total of 19, or approximately a 19 month supply.

As a consequence, the developer wants 9-10 months to sell their inventory (10 units) and then will offer to take the purchaser’s inventory (9 units) on and resell as developer inventory…. The important thing here is that developer units get shown to drive up traffic.

After all the expenses are paid including a 6% commission for resell, then the figure above shows net profits.   If you are one of the lucky ones selling during the 4^th quarter, then this figure shows resale profits in excess of $110,000!

Now let’s see how we compared to article 1.

Remember though that this is assuming a sale at the 2 year mark which is hopefully pessimistic.

Oops, What If This Doesn’t Work Out

Of course, we cannot only look at the potential positive side of this project.  What if this does not work out? 

In this type of project, which I would refer to as bottom fishing on higher end units, you always have the difficulty of considerable negative cash flow eating into a large chunk of equity.  Some purchasers are very comfortable playing this type of purchase in very good areas (like Boca Grande) and for some it takes them out of their comfort zone.

For those people who can afford such projects, let’s look at the real down side on this project.  Referring back to the cash flow chart, let’s assume that:

·        The unit did not sell in 2 years;

·        You chose not to discount it to sell it more rapidly; and

·        You then required until Summer of 2010 to sell (boy I hope not)

Assuming no changes in cash flow (rent increases compensating any changes in taxes/insurance), then we see that by the time we get to quarter 12, the purchaser will now have about $60K into the project (ignoring any depreciation benefits that the purchaser has gained).  In addition, there is still ample equity in the project so a purchaser could chose to refinance again if desired.

As we see from the net profit chart, the purchaser is still making money on the total project unless they have to actually wait for the 12 quarter.  Again, this becomes a personal choice but we know that many people would view this as a relatively low risk, high gain type of opportunity.

Status

Right now, we are in the process of ordering appraisals and tightening some additional details.  As mentioned previously, this project may still change substantially so until finalized, the examples and numbers presented above are purely informational only.

If this type of project appeals to you and you would like to be considered after our due diligence is complete, then place your contact info below and when all details are available, then we will be happy to make available to you.