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Anyone who has ever worked on a renovation project knows that everything doesn’t always go according to plan. So, how do you handle the draws when you have a large value-add CapEx program and a loan with a bank or lender with construction draw money?
How do you prove to your bank that your draws are accurate, you’ve done everything right, but your actual plan doesn’t exactly align with your original one?
We purchased Forest Ridge Apartments in Parma, Ohio, for $11.65 million about a year ago. Our original loan was for $1.1 million in draws and $1.1 million in construction. From the start, the numbers lined up perfectly, but it got much more complicated when we firmed things up. When we submitted our final draw request, our banker needed an explanation as to why things were going the way they were.
In this episode, I want to use what happened with our project to show you a real example of pro forma versus reality. When you’re ready for the next draw with your banker, I want you to have the insight to be able to explain yourself when things get complicated, get the budget you need, and have the power to add value to your deals when it’s within reach.
Key Takeaways with Josh Cantwell
- Why we needed to invest additional funds into the commons at Forest Ridge apartments, and how this changed our budget.
- What happened when we submitted our final draw request, and how I explained what was happening with our lender.
- How we were able to beef up our budget from $1.1 to $1.41 million.
- How our improvements left us with a building worth more than it was when we originally underwrote it.
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Josh Cantwell: So, hey, there, it’s Josh. Welcome back to Accelerated Investor. And I just got off an interesting call with one of our bankers and I wanted to kind of tell you about it discussing some draws and some construction programs and exactly what to do to handle the draw process with your lender, especially when your actual plan doesn’t exactly match up with your pro forma plan that you put together a year or two ago. So, we’re going to talk about that today on Accelerated Investor.
Josh Cantwell: So, hey, guys, welcome back. So, listen, I thought we’d talk today a little bit about construction process, draws, and exactly, when you have a large value-add CapEx program and you’ve got a loan with a lender, a bank, or a bridge lender that’s got some construction draw money, how do you handle the draws? How do you prove to the bank that the draws are right and accurate, that you’re doing a good job, especially when the actual plan doesn’t exactly match up with the original plan?
So, let me tell you a little bit about what’s going on. I have a property that we’ve owned for about a year. It’s called Forest Ridge Apartments. You can look it up, Forest Ridge Apartments in Parma, Ohio. We bought the building for $11.65 million. And when we originally applied for the loan, the original loan amount that we applied for was $1.1 million in draws, $1.1 million in construction. Simple math, 220 units times $5,000 a unit, $1.1 million, pretty straightforward. That’s the easy part, but the tough part is actually putting together the real budget. It might look like $1.1 million divided by 220 units is five grand, but the actual money and where it was spent was totally different than that.
And so, when we look at the $1.1 million budget and we got into the due diligence of the property, we’re walking the units, we’re getting ready for closing, we looked at that, we firmed up that budget. And when we firmed up that budget, we’re like, okay, we’re not just going to spend $1.1 million. We’re actually going to spend $1.41 million. So, it’s an extra $310,000 that we’re going to spend on the building. High-level numbers. We bought the building for $11.65 million with the goal of putting about $1 million, $1.4 million into. We’ll be all in for about $13, $13.5 million with the soft cost and acquisition fee and stuff like that. so call it $13.5 million. And the stabilized value based on the future rents, the renovated units, the increase in rents stabilizes out to be of worth about $18.5 to $19 million. The plan was to then refi it, pay off the $13.5 million that we’re all in, and then keep the building forever.
So, going pretty smooth, we jumped into the building, which we did about $17,000 to $18,000, buying new security doors for some of the common spaces that was in the budget. We spent about $35,000 sealing and striping all the driveways that was in the budget, about $20,000 on roofs and landscaping that was done, that was in the budget. We ended up turning over 100 units in the last 11 months, and some of those units we did as full turns that were $9,000 with everything from landscape, 5.5-inch trim, all new kitchen, all new baths’ cabinets, black-matted hardware, black appliances, all new bathroom low-flow toilet, vanity sinks, either glazing the tub and the tub tile or glazing the tub and then doing a tub surround. You add it all up with the materials and labor, it’s about $9,000 a unit.
And so, the thing we did not plan for was the fact that once we started turning these units, the units looked great, but then the commons looked really dated. So, the entryway, the foyer, the flooring, the tread on the stairwells, the carpets on each of the landings, the handrails, the paint, and the lighting were all in what we call classic condition. And so, we thought we weren’t really going to have to do the commons. But then what we found was that people were coming to the building, they were walking into the building, the common, the main office, the leasing office, they were looking at the model unit, they’re like, “Great, wow, this looks really fantastic.” We had people tell us, “Hey, this building, actually, it’s nice to see that the actual pictures match the actual unit when you come to see the actual unit.” It matches the pictures that are marketed online, which had one prospective resident tell us, “This is the first time I’ve been to a building where the building’s actual condition matches the photos.” Because normally, they showed the best unit, the best photos, and then the unit looks like crap compared to what they’re actually trying to lease out.
And so, we’re like, “Okay, this is great. We’re getting great feedback on the units. We’re getting great feedback on the exteriors, the landscaping, the parking lot.” However, believe it or not, now, they don’t want to walk in the commons because the commons look outdated. Oh, man, we’re like, “Okay, that wasn’t in the budget.” So, we ended up going and spending about $7,000 per common. There are 20 buildings there. So, it was about 150 grand on the commons. So, it was about $3,000 to paint all the commons, including all the doors and all the trim. It was about another $3,000 to $3,500 to do all the flooring, the treads, the carpets, and some tile on the lowest-level garden-style apartments, the tile on the lowest level because it’s actually below grade. So, that’s where you have any kind of issues. If you had issues, you’d have issues with water on that lowest level, which is down by the laundries.
And then you also have the LED lighting. LED lighting is $40 for each light, that’s the cost of the material, $25 per light for installation, and there’s about six lights per common. So, 65 times 6, and you’re basically right at about $400 for lights, for labor and materials. So, add it all up at seven grand, multiply that times 21 one commons, and you’ve got $150,000 that you did not really plan for when you submit it. When we submit the original budget to our banker, it was $1.1 million. When we reviewed all of this during due diligence and we were getting closer and closer to closing, we actually beefed up the budget to $1.41 million to include these commons. So, we go apply for our first draw, no problem. We slam out half a million dollars worth of work. The draw gets approved. Then we slam out another $300,000 worth of work, including a bunch of the commons. That gets approved. So, now, out of the $1.1 million that we got approved for the loan, we’ve got $800,000 that’s been released to us.
Then we go submit the final draw request, which is $300,000, and the banker is like, “Whoa, wait a minute. Slow down.” Because normally, if you’re the banker and you have to report to your committee, you have to report back to the leadership team at the bank, you have to demonstrate that the work has been fully completed. So, with the $1.1 million, we were able to turn over 100 units, we were able to turn all the commons, but we’ve exhausted the $1.1 million. And now, we’ve still got about $300,000 to $350,000 worth of work left and we’ve also got $300,000 to $350,000 worth of cash left. But remember, when we applied with the bank, they heard $1.1 million, that’s the loan they approved. We did not go back right before closing. Right before we were about to close the deal, we did not go back to the bank and say, “Hey, oh, by the way, we beefed up the budget to $1.41 million.” We didn’t want to do that, we didn’t want to upset the applecart, we didn’t want to change things around right before closing. So, we just rolled with it and closed.
And so, I was on the phone with our banker just about an hour or two ago. He’s a great guy. We have a great relationship, and he’s just asking, “Okay, Josh, tell me what happened and versus where we’re going.” And I just helped him understand, look, we’ve got the money that we spent in the commons was not really part of the initial budget. That $1.1 million, about $5,000 a unit is what we were going to spend and we were going to turn 220 units. That was the original budget that we submitted to you. As we got closer to closing, what we realized is that we really needed to spend about $150,000 to $200,000 on the exteriors, the landscaping, the parking lots, and then improving the commons, so that’s $200,000. So, that was new. And we beefed up the budget to $1.41 million.
So, let’s do the math together. You take $1.41 million, subtract $200,000 for the commons, the exteriors, the landscaping, the roofs, the sealing and striping, the security doors, then that leaves us $1.21 million to turn the units. Remember that number, $1.21 million. Then, again, when we bought the building, there were about 30 units that were in really good shape that had kind of been turned by the previous owner that were pretty much when we got those units, when they became vacant, we knew they would be make-readies. So, we weren’t going to have to do a hard turn on any of those, primarily make-readies. So, we’ve got $1.21 million to work with and we got roughly 190 units to turn. So, what I explain to our banker was, look, that’s the new plan, 190 units divided by the $1.21 million, that blends out to about $6,400 a unit. That’s a pretty good amount of money to spend on every unit.
Now, the last thing that I had to explain to him was, listen, in the beginning out of these first 100, 110 units that we turned, we were spending more like $9,000 a unit for hard turns because we wanted to recruit a whole new type of resident, we wanted to go for more of a C-Class resident to a B, B-Plus Class resident, so we did all the commons and we hard turned these first 100 units. Meaning again, all new LVP flooring, 5.5-inch trim, new white shaker cabinets, new sink, new granite countertops or butcher block countertops, new black appliances, new bathroom, new low-flow, new, even granite in the bathroom. So, this is about $9,000 a unit. And we did those first 100 units.
So, now, the last piece that I had to explain was, listen, on the next 100 units to get us to the 190, remember, there were 30 that were already done by the previous owner, the remaining 80 to 90 units that we had to do, we’re going to do more of what we call a quarter turn, where those budgets are more like 2500 bucks, you multiply that times roughly 100 units, that’s $250,000 to finish off the building and improve the entire building. So, what does that mean? Well, now on these remaining 100 units, if you paint the unit, that’s about 700 bucks. If you glaze the tile and the tub, that’s about 700 bucks, that’s $1,400. If you put in a new low-flow toilet in, that’s 150 bucks, that’s $1,550. If you also do the carpet, and it’s done $1, $1.15, $1.20 a foot installed, that’s $1,000.
So, now, on a quarter turn, about $2,500 budget, we can paint the unit, we can glaze the tub in the tile, we can put in a new low-flow toilet to save on the water expense, and we can put new carpet in, but not new LVP. That brings us to about 2500 bucks. We’re going to keep the cabinets, we’re going to keep the countertop, we’re going to keep the appliances, we’re going to keep the fixtures. Maybe we swap out a couple of fixtures, a few hundred bucks, but nothing substantial. And now, those units are essentially quarter turns, just a little bit more than a make-ready. Make-ready is basically shampoo the carpet paint, and you’re done. These are more quarter turns, where we’re painting the entire unit, even painting the cabinets, new carpet, and we’re basically glazing the tub and the tile, that’s about 2500 bucks to three grand. That’s about $250,000 to $300,000 that we put in. And now, we can go back to our banker and tell them we’ve polished off the entire building. Every unit’s been touched, roughly half of the units are hard turns, the other half of the units are quarter turns, and all the commons have been done. The landscaping has been done, the roofs are in good shape, the security doors are installed, the sealing and striping has been all finished, and the building is truly 100% completed.
So, now, all of our ducks are lining up in a row. It makes all sense in the world. To me, to our team, to our banker, it all matches. Now, the final question is, is tell me about the rents? Here’s the best part. The pro forma rents on the two-bedroom were $865 for a two-bedroom improved. The pro forma on a one-bedroom, one-bath improved with $770. And those hard turns that I mentioned earlier, the ones that we put nine grand in, we’re currently getting $950 to $1,000 for the two beds, so over $100 over pro forma, and two years early. And then on the one-beds, which was $770, we’re getting between $825 to $850, so we’re $50 to $75 over pro forma, and again, two years early.
On those quarter turns that we’re doing that I mentioned, like half the building is full turn, half the building is quarter turn. On the quarter turns, guess what we’re getting? We’re getting pro forma. We’re getting $850 on the two-beds and we’re getting about $750 on the one-beds today, two years early, which is great because over the next two years, as we stabilize the building out and we just keep renting out units, guess what’s going to happen? We’re going to be at pro forma on the quarter turns, we’re going to be above pro forma on the full turns, and the building’s going to end up being more than it was actually worth when we underwrote it. So, that is a real case study of a real deal and a real conversation that I just had with my team, with my CFO, with my partners, Glenn and Tyler, and with our banker. I’m trying to help everybody understand.
When you put together an underwrite, and you put together a business plan, you want to execute as close to that as possible, but let’s be realistic. Nobody has a crystal ball for what’s going to happen two, three years from now. Nobody has a crystal ball for exactly what the rents are going to get. The market is going to tell us what the market’s willing to bear, the market is going to tell us what the market’s willing to pay, and then, the pro forma becomes reality. And now, you have to operate in reality, what’s actually going on? And that’s what we just did, and that’s what I had to just explain to our banker.
And so, I just hope that this case study, this real example of pro forma versus reality, underwriting versus reality, and talking to bankers about rehab draws versus reality, I hope this allows you to give you some ammo, give you some insight when you have your next draw with your banker or you have a deal that you’re working on. What this actually looks like in the real world when you’re dealing with a $20 million asset and millions and millions of dollars of cash flow and CapEx, this is what actually happens.
I hope you enjoyed this episode of Accelerated Investor. I hope you enjoy these stories, guys, of me telling you about my real deals because I think this is what really happens in the real world. It’s nice to have guests on and talk high level about business plans, but this is when the rubber meets the freaking road, this is how it really goes. Alright. If you enjoy this kind of case studies, guys, please jump into Spotify, iTunes, YouTube, Stitcher, wherever you get your podcasts, iHeartRadio, wherever you’re hearing this, and leave us a five-star rating and review, let me know how we did, and we’ll talk to you next time on Accelerated Investor.
Josh Cantwell: Well, hey, listen, if you enjoyed that case study, guys, and you want to build more passive income or active income as a multifamily syndicator, go visit us online at JoshCantwellCoaching.com. There, you can apply to be part of our mastermind group, our partnering program, and our coaching program. We have over 70 members right now. We’re looking to get to 100 before our next event. Our next event is coming up in July of 2022. And so, if you’d like to be part of that, meet up with the other members, build your network, do more deals, raise more capital, find more properties, go visit us online at JoshCantwellCoaching.com and submit your application. Then we’ll jump one on one on the phone and we’ll take it from there. We’ll talk to you next time.