You want to go from buying one rental to buying whole apartment buildings, right? The key isn’t just saving more money it’s raising money. But the moment you start talking about raising capital, you’ll hear a term that can stop aspiring investors in their tracks: flotation costs.
As you progress on your real estate journey, your goals get bigger. The single-family rental that once felt like a huge achievement now serves as a stepping stone to a 10-unit apartment building, and then a 50-unit complex. This evolution from solo operator to dealmaker requires a new set of skills and a new vocabulary.
You’ll quickly learn that scaling is less about your own savings and more about your ability to structure deals and raise capital from partners. But bringing in Other People’s Money (OPM) isn’t just a handshake agreement. It’s a formal process with its own set of rules and costs. The most important and often overlooked—of these is a concept known as flotation.
Table of Contents
What is Flotation?
Flotation costs are the total expenses incurred when raising outside capital from partners or investors for a real estate project. In simple terms, it’s the money you have to spend to get money. Understanding this concept is what separates solo investors from sophisticated dealmakers.
Key Attributes
- Capital Raise: Flotation costs only apply when you are raising equity from external partners. They are not associated with getting a standard bank loan for a property you buy yourself.
- Upfront Costs: These expenses are typically incurred before the deal closes and the property starts generating income. They are a fundamental part of the project’s initial budget.
- Deal-Specific: These costs are tied directly to the investment offering and the legal structure required to bring in partners, not the physical property transaction itself.
When Does Flotation Matter in Real Estate?
For your first solo rental bought with a standard mortgage, you won’t encounter flotation costs. Your primary expenses are the down payment and closing costs.
However, this isn’t a post about your first deal it’s about your next deal. It’s about your ambition.
The moment you want to team up with a friend, bring in family money, or syndicate a deal by pooling funds from multiple investors, flotation costs become one of the most important line items in your budget. Understanding them now is like learning the rules for the next level of the game before you play. It’s what prepares you to act confidently when the right partnership opportunity comes along.
The Anatomy of Flotation: What’s Actually on the Bill?
Flotation costs are not a single fee but a collection of professional services required to structure a deal correctly and legally.
- Legal Fees: This is often the largest component. It pays attorneys to draft crucial documents like the Private Placement Memorandum (PPM), subscription agreements, and the operating agreement for the new LLC. Why it’s non-negotiable. These documents legally protect YOU, your investors, and ensure you’re compliant with SEC regulations. This is not a place to cut corners.
- Accounting & Filing Fees: The costs to professionally set up the new legal entity (usually an LLC) that will own the property and file the necessary paperwork with the state.
- Syndication & Marketing Fees: Costs to create a professional “investor deck” (the slide presentation that outlines the deal), fees for using a crowdfunding platform, or a commission paid to a third party for helping raise the capital.
- Administrative Costs: Minor costs for printing documents, courier services, and bank wiring fees associated with the capital raise.
It’s critical to know these are not the same as closing costs. Closing costs (like title insurance, appraisal, loan fees) are tied to the property transaction. Flotation costs are tied only to the act of raising capital from partners.
Calculation Example: The “Maple Street Apartments” Deal
Let’s walk through a step-by-step example to see how flotation costs work in a real-world scenario.
The Scenario: You find a great 10-unit apartment building for $1.5 million. You have the skills to manage it but need to raise the down payment from a group of investors.
- Gather Your Data:
- Capital You Need to Raise (for down payment & reserves): $500,000
- Calculate Your Flotation Costs:
- Legal Fees (PPM, Operating Agreement): $15,000
- Accounting & LLC Filing Fees: $2,000
- Investor Deck & Marketing Materials: $1,000
- Total Flotation Costs: $18,000
- Determine Your Net Capital:
- $500,000 (Total Capital Raised) – $18,000 (Total Costs) = $482,000
This means that after raising half a million dollars, you are only left with $482,000 to put towards the actual deal. That $18,000 gap is the flotation cost. A smart investor plans for this from day one; an unprepared investor gets a nasty surprise that could jeopardize the entire project.
How Flotation Impacts Your Deal Structure and Returns
Flotation costs are almost always paid from the capital raised from investors. They are treated as a legitimate “deal expense,” just like the purchase price or renovation budget.
The logic is simple: the deal would be impossible without the investors’ capital, so the cost of raising that capital is a fundamental project expense. This is why the underlying deal must be strong enough to absorb these costs and still deliver excellent projected returns (like Cash-on-Cash Return and IRR) that get investors excited. When you build your financial model for a deal, “flotation costs” should be its own line item in your sources and uses table.
Common Pitfalls and Limitations
While essential, understanding flotation costs means knowing the risks involved.
- Underestimating Costs: A common mistake is guessing at legal or accounting fees. Always get quotes from qualified professionals early in your due diligence process to ensure your budget is accurate.
- Cutting Legal Corners: The biggest danger is trying to avoid legal fees by using generic online templates or handshake agreements. This exposes both you and your investors to massive financial and legal risk.
- Ignoring the Impact on Returns: Failing to account for flotation costs will skew your projected returns. A deal that looks great on paper might become mediocre once these real-world costs are factored in.
FAQs: Flotation Costs
What does flotation mean in real estate?
Flotation is the process of “launching” an investment offering to raise capital. Flotation costs are the expenses associated with that process.
Do I have flotation costs if I use a hard money loan?
Generally, no. A hard money loan is debt, not equity. The fees associated with it (like origination points) are considered loan costs or closing costs, not flotation costs. Flotation is specifically for raising money from equity partners.
Is there a standard percentage for flotation costs?
No, it varies significantly based on the complexity of the deal and the amount of capital being raised. However, they often fall in the range of 2% to 5% of the total equity raised. A larger, more complex raise will have higher absolute costs but may be a smaller percentage of the total
Conclusion
Flotation isn’t a barrier it’s a milestone. Understanding it means you’re no longer just thinking about buying a property you’re thinking about building a portfolio. You can now analyze more complex opportunities, ask smarter questions, and confidently step into conversations about partnerships. By planning for these costs, you position yourself as a credible and sophisticated investor ready to take on bigger and more profitable deals.
