How
First, say the family decides they want to build a $6 million apartment building in town, but they only want to invest $1 million of their own plus receive a management fee. The new holding company is the perfect way to achieve this. They create a new company, Oak Lane Apartments LLC, and contribute $1 million in cash and write the operating agreement so that other investors can buy $2 million in ownership (2/3), and the bank can provide $3 million in debt financing through a secured non-recourse mortgage. The operating agreement requires that 5% of rents be paid to a business called Arlington Property Management LLC, which is another new subsidiary the holding company formed.
In effect, the family is using only 10% of its assets, or $1 million, to control a $6 million apartment building. They are receiving 33.33% ownership in the building, plus 5% of rents, giving them a form of “synthetic equity”. But if they wrote it correctly, they would only have $1 million at risk. They have achieved 6-1 leverage with a relatively small amount of debt; it is the structure that did it for them.
