Monday, June 4, 2012

Walking Away From A Few Million Dollars... Part 2: Long Work Days & Financing.

I had originally thought that this would be a 3 part post... While writing it, I have realized that hope is an impossibility for readability and enjoyment's sake. I'll admit have no idea as to how many parts this will end up being, but I think that breaking up the posts more than I had originally intended will not only help me be more clear in the story, but will also make it more entertaining- as I doubt anyone wants to read super lengthy posts on the matter.

Moving along, to the beginning of the rest of the story...


For the duration of the purchasing process, I was generally commuting ~45 minutes from my home in Lexington, KY to the apartment complex in Frankfort, KY on close to a daily basis. For the first time in my life, I was getting up at 6:30 or 7AM by choice, often not needing an alarm to get up whereas I generally sleep til 10 or later... despite this, I was still going to bed between 2 and 3AM as usual. As you could imagine, it was pretty typical for me to work for 15+ hours a day for the slightly more than 20 days we were working on this. I even significantly cut back the number of nights I went out to shows and drank- which for those of you that know me, really says something about how I felt about the project... just seeing a single live band, maybe 2 per week was a real turn of events at that point in time.

It isn't like I hadn't worked like this before, it had just been a while. At the time, my personal rental homes required very little in the way of upkeep.  When I rehab a house for a flip, I often contract out a lot of the work to get it done a bit quicker (especially things like painting, which can be economically outsourced)- besides, all of my project houses were completed and listed with my realtor. In regard to stocks, while I almost always read a lot, I could count all my allocations on fewer than 2 hands. It would take next to no effort for me to stay informed informed on them. Add in the fact that I was pretty much fully deployed at the time and not keen on moving things around, other than to buy up more of Sitestar and I was A-OK with not being on the prowl for allocations given the potential that this project had. This life of relative ease was drastically different to when I first started buying properties just a few years ago: I was a full time college student, would often work around 35 hours a week at a jewelry pawn shop- during Christmas and Valentine's seasons, occasionally getting in excess of 60 hours a week, served on the board of directors of a 209 unit home owners association (for free, mind you), was revamping a project house (doing most all of the work), was reading as much as I could, and still managed to have a decent social life... Being that busy was something that I kind of missed.

It can take a while to talk to a contractor or government inspector and walk them through a complex that is greater than 70,000 square feet. Interestingly, a lot of time was spent talking to the inspectors, who didn't want to look at too much, whereas contractors didn't want to talk, but rather, look at everything. Needless to say, a lot of my time was spent on site. The same could be said for Bill. The interesting part of this, was that at the time, he had the most free time that he had ever had in recent memory. His phone was ringing off the hook for rental units even though he was completely full, which remained the case for nearly 3 months. We figured this to be an obvious bullish sign for rentals, and by extension, a great sign for the complex that we were buying.

On my commutes, I was making various calls on the drive to the complex, pricing items that we would need, or even doing research the legal requirements to be an elderly housing complex so that we could act in total accordance with the law. Things that would normally seem simple could be quite complicated- something as simple as getting a quote for the insurance was a daunting task, as few brokers seemed to really understand the type of project we were taking on. Even when contacting companies that were owned by Berkshire Hathaway (as a value investor that practically worships at the altar of Buffett, I figured they would be the easiest to talk to) I still had trouble getting quotes that covered us in the way we needed, to feel comfortable. As an example, it is really hard to explain to a person how a building has fire walls, but that they don't go through the roof. Even though we would be extending them through the roof line, things of this nature made for some complicated quotes. Having a sprinkler system was surprisingly frowned upon, even though it makes a fire claim much less disastrous. The policy we would choose came through Zurich and was a hybrid sort of construction product on the individual buildings and common areas. We would eventually be able take off of completed buildings to a more standard apartment complex policy, building by building, despite having to pay for 6 months of coverage, with no refunding for an early cancellation in the event that we were ahead of schedule.

With lengthy work days and commuting, there were a lot of nights I would stay at my uncle's house so we could get a head start in the morning and work later at night- saving about 20 minutes of commute time. My Aunt Anna's delicious home cooked dinners would often occur with me eating at a desk, or bringing my MacBook and notepad to the dinner table (much to her chagrin). Conversations naturally always went towards the complex. Our best ideas were often hatched and solidified as a team, over the delicious cooking that can only be learned by a person who came from an agrarian society in impoverished Appalachia. Numerous nights, I couldn't sleep due to my excitement and would try to calm down by playing pool, streaming investing talks, or reading a book on the formative years of Ashland Oil... often, failing at my objective. I once overheard Bill saying to a few of his friends at a landlord meeting that "I have trouble keeping up. Jeff just doesn't stop... He doesn't eat, sleep, shit, or even sit down. He just keeps going..." I still don't know what to think about this, but, I keep telling myself to take it as a complement. ;)


The first point of contention was for us to get some sort of financing, as we had no real idea how to pay for the place- we knew that we would be able to make something work, but we didn't have the cash on hand to fix it up and it is such an odd project that financing could get sticky... Key for me, was to get in with very little of my own money. I really liked the idea of finishing the place, renting it out, and getting a nicely sized loan and after 9 months or so, especially as we would have enough cash flow and equity to where the debt load wouldn't be of much concern. I even floated the idea of selling off 25% of our LLC's equity in exchange for the purchase price of the property to single or various limited partners and then getting a construction loan to fix the place up with- the nice thing is that it would have been an overly collateralized loan and a situation that given a bunch of people a nice return on capital.

After a few long days of meeting with various people at the complex, we had solidified some pretty good budget numbers and walked into my favorite bank with a nice packet. For example: we were able to track down the people that had previously worked on the sprinkler and elevator systems... The sprinkler contractor said, "Oh yeah! I remember that place. It should take 1, maybe 2 days... at the max to bring it on line. Shouldn't cost more than a grand or 2 and 2 days of work." We budgeted $10K. The elevator repairman said virtually the same thing, and that it shouldn't be more than $2K. We budgeted $20K, on the chance that our hunch that there were problems with the hydraulics system turned out to be true.

What we had originally thought on our back of the envelope projections from day one, our honed Excel spread sheets proved: this was a Hell of a deal... potentially the deal of our lifetimes. On the cover page, we broke down how little we were paying for each apartment in the complex: $3,080 dollars. We then noted that every day the complex wasn't online, we were essentially losing $2K in rent. When you put that on the cover page and your banker, who has a good bit of real estate experience and is a really smart guy says, "Man! I really like those numbers... That's GREAT!" you really feel like you have stumbled onto a gem. The 3 of us had a 10 minute conversation and our lender said that while he would have to take the package to committee, he didn't see an issue with anything we proposed.

Previously, I had told my banker when we were setting up a meeting time, that we would need around $600K for everything and that we were going to pay for additional improvements out of cash flow. However, upon realizing how bad of an idea that was (losing $2K a day and realizing that you would be renting units out of a construction project is a good motivator), we decided to try to get more efficiencies by buying labor and supplies in bulk. Plus, we wouldn't have tenants complaining about noise or contractor vehicles and the like. Thus, we were needing a bit more money- closer to a million dollars. He came back to us with a construction loan to accomodate that amount, where the bank would take a first lein on 3 or 4 of Bill's owned rent houses, with no interest or amortization. The liens would be released once the complex would be at 50% occupancy- just above the number where we would be profitable. Our rate was at a reasonable LIBOR +1% (with a minimal floor), to be adjusted yearly by a maximum of 1%, with an 8.5% cap. At our discretion, they would put it on an amortization of 15 or 20 years (our pick). All we had to do was pay for the appraisals and closing costs. When you are scared to death of rising interest rates and had made some contingencies for healthy double digit interest rates in your private numbers, this was all a BIG plus. Additionally, there weren't any covenants that made the loan callable... due to my experience as an observer and shareholder of Steak 'n Shake, Syms, and a few other companies that ran into debt issues, these were very important for us to have in the package. I have never been one to like the potential for being in a situation where onerous covenants that encourage short term thinking in operations, but also don't seem to care about the worth of the company, could potentially force a loan to need repayment, despite not actually being a bad loan risk or never missing a payment.

Effectively, my banker and I had just set up a deal where we going to get into this thing for a few thousand dollars out of pocket, which was much better than the deals we were offered from Bill's lenders. Even if we ran into any issues with state regulators, we would be lent the additional capital that we wanted, but didn't necessarily need. Bear in mind, this was despite our being overly conservative with our numbers AND throwing in a huge contingency allowance- well into the double digits, into the package. While the total came in at just under a million dollars, this was for a place that we were pretty sure would be worth well north of $2 million once up and running.

This highly levered package was justified to us and by the bank on the rents that we thought we could get- conservatively, $400-$600 a month per unit. We even threw in a huge allowance for all the utilities we were going to have to pay for the tenants, as the units weren't on separate meters. For figuring purposes, we assumed that energy prices would double from present prices on the day that we closed, that we wouldn't be insulating the building any more than it already was (even though we had plans to), that tenants would want extreme room temperatures in the winter and summer, and that energy rates would have a steady climb over the coming years (even after doubling on day 1). After all of that, hiring a manager, paying for on site security, budgeting a healthy repair allowance that was significantly more than either of us use on our personal rental units, and allowing a vacancy rate 10%, we would end up cash flowing just shy $15K a month... for each of us. This was a rate that would involve very little day to day work on our part once up and running. Even if the complex was just 50% occupied, we would still be above water.


On day one, Bill had facetiously said that if he didn't jump at the project, it was likely that he would wither away and die, but if he went to my Aunt Anna and told her what we were getting ready to do, she would kill him... he was in a bit of a bind. An hour after that and saying that exact thing to her, she was on board and ready to go- arguably, just as excited as Bill. She even volunteered to be there 3 days a week to take rents, do books, dispatch workers, and the like. I mirrored their feelings in that I was thrilled to be doing something I considered to be really constructive (no pun intended), which is something that I hadn't felt in over 2 years, when I took on a project where I replaced a bunch of floor joists in a termite infested house... At that point, it was looking like I was going to make a ton of money AND do something that was going to take a piece of shit boarded up building, which had been destroyed by crack heads in their never ending thirst for copper, and turn it into something that would be productive for society. It was a win-win situation for both the capitalist and humanitarian that reside inside of me.

Still, raring to go and looking to close... ASAP.

1 comment:

K Prasad said...

Thanks, looking forward to the rest!