Debt Service Is Like CO2
It will kill your deal slowly
I’m at the tail end of renovating my 1885 Historic St. Louis 4-family flat.
And so far I’ve poured over $15,000 dollars completely down the drain.
(with at least another $3,500 to follow)
Interest-only bridge debt loan payments are literally killing the deal slowly.
I bought the property for $175K.
I used a hard money loan that covered 90% of the purchase price and 100% of the renovation (send me a private message if you’d like my financing contacts).
The interest rate is 11%.
Every month I’m bleeding $1,809 on top of my capex spend.
(Total CapEx spend is sitting around $50,000)
Although venting helps cope with the pain of suffering a gut punch to the bottom line every month—that’s not what you came here for.
You’ve got the gist of how lethal debt service can be when renovations drag on and refinances are delayed.
But you’re more concerned with the different ways in which you can prevent high interest rate loans from eating into the profits your next deal.
(Understandably so. Those insights are slightly more useful than my real estate war stories and battle wound tales.)
Bring More Money to the Table
The most straightforward and direct approach to lowering the debt burden on a project is to bring more equity to the closing table.
In other words: increase the size of your downpayment.
The more capital you invest up front, the less debt you’ll have pay on the back-end.
Low and no-money down loans - such as the product I utilized for my recent acquisition - are often leaned on as the default purchase vehicle of choice.
But in actuality, they should be used sparingly.
Naturally, growth-hungry investors are attracted to the prospect of putting up a nominal amount of their own capital, while leveraging the bank or lender’s funds for the bulk of the buy.
But ultimately, steep borrowing costs gradually chip away at the profit margins of the deal until there’s hardly any left by the time you refinance or sale.
In some cases investors even end up in the red due to mismanagement of their capital stack.
Unless you’re juggling multiple projects - or you have an alternative investment that can passively yield you the 10% APR that it’ll cost you to keep your money in your pocket - it’s often wise to maximize your equity position and minimize your LTV (Loan To Value).
Break the Project Up Into Pieces
I’m preaching to the choir for most commercial investors and those that go after larger acquisitions, but I’ll say it anyway: attack your projects in phases.
You don’t eat a watermelon whole—you slice it up into bite sized pieces.
The same goes for most renovations.
If you have ten units to turn over, tackle one or two units at a time.
Rent out each completed unit to get some cash-flow coming in before moving onto the rest of the building.
This makes the scale of the project more approachable.
But more importantly: it softens the blow of your debt service payments, enables draw requests, and allows you to partially fund the repositioning of the asset with any net positive rent revenues.
This approach isn’t appropriate for single-family flips and rentals.
But it’s undoubtedly the wisest way to take down anything over two units.
Especially if you’re carrying a loan on the property.
Start Stashing Materials
Material lead times and order delays will bring your project to a screeching halt.
And when you’re carrying a loan on a building, time is money—a lot of money.
By the time I accumulated my first ten units, I formulated a solid grasp of the finishes, appliances, and fixtures that are needed for pretty much every renovation.
With this in mind, I began buying in bulk and purchasing materials in advance so that I could have everything my team will need on standby.
In doing so, I’m able to expedite the timeline of the project, and ultimately, reduce carrying costs (aka debt service).
Debt service is the silent-sneaky-killer of profits.
A ton of focus is placed toward purchase price and cash-to-close.
But investors rarely put an equal amount of thought toward financing terms.
Failure to structure a winning capital capital stack that’s equipped with the appropriate amount of leverage, coupled with an unorganized repositioning plan that lacks strategy and systems, is a recipe for poor returns.
It won’t seem this way initially—but the deal won’t end well.
To avoid death by a thousand paper cuts, you have to major in the minor details.
Underwrite the acquisition as many times as it takes to determine the optimal downpayment.
Map out a concise renovation timeline that expedites the lease-up process and minimizes vacancy.
Pre-order supplies to reduce lead time on materials and speed up certain phases of the project.
These are all small pieces of the larger puzzle; but when combined, they have a huge impact on the overall outcome of the deal.
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