Raising Equity For Your Build

Understanding Equity in Real Estate

Alright, Bright Builders.

Let’s talk about raising equity.

One way to think of equity is like the down payment when you buy a house. We previously talked about securing a construction loan and you know that the funds from that loan will typically cover 70 to 80 percent of the development cost, just like a mortgage does for a home purchase.

The rest comes from the down payment.

THIS is the equity you raise.

Now, to be clear, there are a TON of variations on equity raises but I’m going to talk generally about strategy so that your familiar with the process and as well as key ingredients.

First: Your capital stack must match your business plan.

What do I mean by that?

When it comes to equity, you don't want a bunch of investors looking for a short-term flip if you're going to build a multi-family apartment building and hold it longer term.

That will make them unhappy.

Conversely, if you're going to build a building and sell it, you don't want investors looking for long-term cash flow as part of your group.

It's hard to raise money in the beginning, and people often take money from anyone. BUT you have to ensure you're getting money from the right people who match your project's vision and business plan.

Two Main Ways to Raise Equity

There are two main ways to go about the equity raise. One is to raise money from a large private equity group or what we'd call institutional money. The other is the “friends and family” raise.

Institutional Money

Both come with their pros and cons. "Friends and family" is just a term. Not everyone you raise from on a particular deal might be your friends or family, but it's a common way to refer to raising money from your network. The major difference is this: When you raise from an institutional group, they're usually looking for a shorter-term strategy, typically a build-and-sell approach within three to five years. And you are only have one investor, as opposed to many with friends and family. Institutions typically focused on IRR (internal rate of return). They're not as interested in the design of the building or the community benefits. They care about how quickly they can double their money and move on to the next project. Institutional groups typically contribute 80 to 95 percent of the equity, requiring the developer to contribute 5 to 10 percent. The developer receives the developer fee, takes out the loan, and signs the loan guarantee, but the institutional group puts up most of the money.

Friends and Family Raise

When you do a "friends and family" raise, you can structure it any way you want. It's still important that the developers put skin in the game, whether it's 5 percent or 10 percent. We actually do as high as 25 percent. We typically roll our developer fee in as additional equity and also invest cash on top of that. This shows our commitment to the project and alignment with our investors.

In my friends and family deals, there's usually what's called a “preferred return.” For example, on our last few deals, we paid a 7 percent preferred return, meaning when the development is done, we aim to pay out a seven percent return yearly. We can't always pay it out, but that's the goal. Then there's usually a “promote” above that, where anything above the 7 percent preferred return is split, maybe 70 percent to the investors and 30 percent to the developers. A "promote" incentivizes developers to outperform. If a project goes really well and produces more cash flow than anticipated, the developer gets a bit more of the cash flow as a reward.

Variations in Institutional Equity Structures

With institutional equity groups, structures can vary widely. They'll usually take a preferred return first. Sometimes, there's a “catch-up” where they get all their money back first. There's often a “promote” for the developers. Developers often go in for the “promote” because they own very little of the deal, hoping for a nice backend sale.

These are high-level structures, but within those two types, there’s a lot of variety. There are no hard and fast rules. Everything's negotiable, and it's about knowing the market, what other developers are doing, and what's going on in your area.

How to Find the Equity + Hiring the Right Lawyer

So, how do you find the equity? Once you have your construction loan term sheet and know what your loan will be, you can calculate how much equity you’ll need. You create a professional offering memorandum.

The first step? Hire a lawyer who specializes in partnership agreements and raising capital. We use a different lawyer for deal structuring than we do for basic real estate. You have to use an attorney. In the friends and family mode, you're basically offering securities, and you cannot make a misstep. You have to follow the rules and be clearly aligned with your investors.

The first page of our offering memorandums, after a nice cool rendering on the cover, is a full page of disclaimers that your attorney should write. “You're investing in X, there are no guarantees of returns…” etc. The offering memorandum is usually between 10 and 30 pages.

Creating the Offering Memorandum

After the disclaimers, you'll have an executive summary, maps, nearby amenities, building plans, and renderings. You'll then get into the financials, show a project budget, and show the projected returns.

That's the package you put together. And then what do you do with that package? You ask, ask, ask.

And here's the key. You have to keep going because you're going to be told no a bunch, especially when you're starting. When I was raising money for my first deal, people kept saying, “We know you know what you're doing. We trust you. We like you, but you've never done this on your own. So, we're not comfortable investing in your first project.”

Consequently, the folks who do invest in your first project? They're the ones who bet on you in the beginning when you had ZERO track record. You need to take very good care of them for the rest of your investing career. They get the first take at new deals and other perks.

How to Approach Potential Investors

I don't ever directly ask someone if they're interested. I always say: “I'm working on raising money for this new development project in Minneapolis. Do you know anyone who might be interested in something like that?” Nine times out of ten, the person will say, “Well, what about me?! I'd be interested in that.” I knew they were interested, but I asked indirectly to let them off the hook if they weren't.

Once they've expressed interest, you'll send them the book. Some people will decide to invest right away. Some will review the book, call you back with questions, and then decide to invest. Sometimes, you'll talk through everything, and they'll decide not to invest. And some people will never get back to you because they're terrible at saying no and don't want to say no directly.

But that’s the human part of development, where bricks and math give way to individual quirks.

You just let that stuff go and keep moving. It's hard initially, but once you get your first project off the ground, it becomes exponentially easier. When I did my first equity raise, it took three months to raise a million and a half dollars. Now I can raise many millions in a matter of weeks.

Raising equity for a multifamily real estate development is a journey, and it's not always easy. But with the right approach, the right people, and a lot of persistence, you can make it happen. Remember, it's all about aligning your capital stack with your business plan and finding investors who believe in your vision. Whether you go the institutional route or the friends and family route, make sure your interests are aligned and that everyone is on the same page.

Keep asking, keep pushing, and don't get discouraged by the inevitable "no's" you'll hear along the way. Take care of those who bet on you early, and you'll build a network of supporters who will stick with you for the long haul.

Peace,