Passive Income Via Real Estate Investing

There are two kinds of real estate investing: passive and active. Here, we are going to focus on those who earn a passive income via real estate investing.

When you become a passive investor, you become a limited partner in a deal. You provide private capital to an experienced, knowledgeable syndicator—like myself—who will use those funds to acquire and manage an apartment community.  

Gaining passive income through real estate is popular, in large part, because it is a low-risk approach. When you make these investments, you join an investment system that already exists, has been successful, and is run by a dependable syndicator with a proven track record. Just ensure that you understand the projected limited partner returns before investing, meaning the results are more certain. And, as long as the syndicator follows my Three Immutable Laws of Real Estate Investing, the project should exceed projected returns.

Partner with Experienced Syndicators

Passive income real estate investing can be risky because it requires you to place a lot of faith in your general partner. That person, along with his or her team, will be the one constructing the business plan.

This is why it is important to work with the right people. Since breaking into this industry, I have established myself as an investor you can trust. As I’ve gained control of more than $900,000,000 in real estate, I’ve helped people across the country gain the financial independence they seek through passive investing opportunities.

In this section of my blog, you will learn more about how to earn a passive income through real estate investing and how I seek passive investors for nearly all of my apartment deals. If you’re an accredited passive investor, please consider completing this form to potentially work with me.

What Type of Investor Are You? – A Quick Self-Awareness Guide

Even though no two investors are exactly alike, there are patterns to investors, and generally speaking, they fall into two types:

  • The Passive investor
  • The Active investor 

Knowing which type resonates best with you can help align your investing to your personality and lifestyle preferences. Having this self-awareness is key when it comes to achieving your desired outcome. To help you figure out the best path and to understand the differences, let’s dive into these two investor profiles.

 

The Passive Investor

This is the most common type of investor, although, I’ve noticed over the past few years, there are not a lot of educational resources to help clarify the passive side of real estate investing. That is why the Best Ever Team and I have recently doubled down on creating free resources for passive investors. Learn more here

 

Common Traits of a Passive Investor Often Include:

 

  • Lacks the time to frequently monitor investments
  • Enjoys reading financial news
  • Likes to own a little bit of a lot (values diversification)
  • Seeks to match, not beat, the market

 

This type of investor is often unemotional about the investing process while being more “active” on the portfolio management side rather than on the investment itself. Passive investors have an understanding of multiple types of investments, as well as the overall associated risks. 

 

Portfolio Investments May Include:

 

  • Real estate syndications
  • Private placement offerings
  • Notes or hard-money loans
  • Tax liens 
  • REITs (Real Estate Investment Trusts) 
  • Stocks, ETFs and other publicly traded assets 

 

Generally speaking, this type of investor is proactive when selecting investments, and then tends to sit back and enjoy the ride. The philosophy? Primarily long-term buy and hold, hands-off investments. 

 

The Active Investor

In contrast to the passive investor, an active investor may also enjoy reading financial news; however, they often spend several hours each week or month actively monitoring and managing their investments.

 

This person may seek to have involvement in a number of areas in the investing process. An active real estate investor could be similarly compared to an active day trader who follows the stock market, even if they don’t execute dozens of trades each month.

 

This kind of investor usually prefers a more hands-on approach to their investing. An active investor is often more interested in the “business” of a particular investment or industry. 

Common Traits of an Active Investor Often Include:

 

  • Likes to create their own unique strategy or business plan
  • Doesn’t necessarily value diversification as a top priority
  • Seeks control over his or her investments
  • May have a unique skill or upper hand compared to competitors
  • Seeks to beat the market

 

Generally speaking, this type of investor is actively involved when selecting and underwriting investments. The philosophy? Short-term and long-term, “do-it-yourself” approach.  

 

More About Your Personality

Consider how you respond to financial transactions, emotionally. This can help you invest in a way that’s aligned with your comfort zone. For example, if you’re investing and you sometimes feel nervous about making a mistake, this is a sign to be aware of, especially if it causes you to buy or sell on a knee-jerk reaction. As another example, if you tend to develop an emotional attachment to a certain stock or piece of real estate, this may cause you to hold onto the investment longer than you should, in hopes that it will rebound; this can hurt your investment portfolio returns. 

 

If these two examples describe your personality type, you may decide that a passive investing approach is more suitable. No matter what investing decisions you make, there can be real value in having insight into your investing personality, which ultimately allows you to feel more comfortable with the investing process. The sooner you identify what suits you best, the better off you will be in the long-term. 

 

Emotions connected to money and finance can be traced back as far back as your childhood. For example, if your parents were anxious about how to invest; you may have picked up that habit yourself. It is helpful to be aware of these emotion-based patterns and break them as soon as possible, so they do not hinder your financial future. 

 

Understanding Your Risk Tolerance

 

How Do You Handle Risk? There Are Four Common Personalities When it Comes to Risk:

 

  • Cautious
  • Systematic
  • Spontaneous
  • Individualist

 

If you are cautious, you may be extra sensitive to losses in your portfolio, and you may feel more comfortable with safer or more conservative types of investments. Fear is usually playing the primary role with this personality type.

 

If you are systematic, you likely make investment decisions based on hard facts and data. Details and analysis matter and this personality type will often refer to research to make a decision. This personality type can also have a lower risk tolerance, but will rely on “the facts” to make a decision. 

 

A spontaneous investor often has a higher risk tolerance as does the individualist. If you’re spontaneous, you may quickly switch from one investment or strategy to another. Perhaps on advice or knowledge you’ve recently received, or because of a new developing trend. This personality type finds satisfaction from frequent change and new investing ideas. 

 

Individualists, typically seek unbiased research and due diligence to make decisions independently. They are often willing to take calculated risks because they are confident in their research. New trends and media hype often do not persuade an individualist.

 

Getting Started

No matter what personality type you have or what your risk tolerance is, self-awareness is a key ingredient to a successful investment strategy. Whether active or passive, investing is not a short-term endeavor, so it is beneficial to take a little time to reflect on your goals, your strengths, and the lifestyle you desire. 

 

Step one is to simply get started on your own self-awareness 

 

To Your Success

Travis Watts 

Follow Me:  
FacebooktwitterlinkedinrssyoutubeinstagramFacebooktwitterlinkedinrssyoutubeinstagram


Share this:  
FacebooktwitterpinterestlinkedinFacebooktwitterpinterestlinkedin

Don’t Quit Your Day Job – But Start Investing Passively

Through your investment activities, you understandably want to build wealth quickly. However, wealth building may not be your top goal. Are you dreaming about giving up your day job and living off of your investments? There are a few ways to accomplish this goal. For example, you could accumulate so much money in your retirement accounts that you can live off of the distributions. Another approach is to make investments that generate passive income. Numerous types of investments can generate passive streams of income, but some are more lucrative than others. Regardless of the type of passive investing activities that you participate in, understand that it likely will take a significant amount of time for you to fully develop these passive streams of income.

What It Takes to Live on Passive Streams of Income

If you intend to live off of passive income streams, there are a few important things that you need to be aware of. First, your sources should provide relatively stable income. As you research the these exciting investment opportunities more closely, you will notice that many income streams offer a varied range of risks. You should understand where the risks are for each type of investment before you begin allocating your funds to different types of assets.

Second, your sources of income should be relatively diversified. It can be stressful and risky to put your livelihood in the hands of one income stream. However, this does not mean that you need to invest in all of the different asset classes mentioned here. All of these asset classes hold many types of investment opportunities with varying returns and risks. You can choose to invest in only one or two asset classes and to diversify your holdings within these selected classes.

Top Passive Investing Opportunities

As a passive investor, your goal is to put your money to work for you so that you can work as little as possible. All passive investing opportunities will require some oversight and management, but the time commitment varies across the board. What are the passive opportunities available for wealth building and income generation?

Bonds and CDs

Bonds and CDs are generally the lowest-risk investment option on this list. A bond is essentially a loan that you give to a government entity or to a business. Bonds are slightly riskier than CDs because the entity could always fold. However, bonds and CDs may have a fixed rate of return, but the return is often lower than the return from other investment opportunities. Bonds and CDs generally require you to commit your funds to the investment for a period of time. Terms may range from a month to several years. Longer terms are associated with higher returns.

A common way to set up a passive stream of income from these investments is from a ladder. Essentially, you will purchase a series of these investments with varying term lengths. When one of these investments matures, you can use the return as income to live off of. Then, you can reinvest the lump sum of capital to continue your ladder. While some people have enough funds available to build a full ladder today, others will need to build their ladder slowly as funds are available.

Dividend Stocks

The dividend rate on stocks varies from a fraction of a percentage point to over 4 percent. Riskier stock investments may have an even higher rate of return. Most stocks pay quarterly dividends, and you have the choice to reinvest the dividends through a DRIP program or to pull the dividends out as income. While you are building your dividend income stream, you can take advantage of synergy through a DRIP program.

One of the great things about dividend stocks is that the stock value may increase over time while you enjoy a relatively stable stream of income from them. This means that your wealth is growing while you are living off of the return. However, companies can change their dividend payout at any time. If you choose to build this type of income stream, look at the company’s history of adjusting its dividends before you make a final investment decision.

Real Estate

When many investors think about making investments to generate passive income streams, they think about buying income-producing real estate. This is a smart investment option that has several benefits not available with other investments listed here. For example, your property purchases can be leveraged with a residential or commercial real estate loan. The property’s income will usually cover the mortgage payment in full. Because of this, you will eventually own the property outright despite paying for only a fraction of its value out of your pocket. At the same time, the property’s value is appreciating, and you are taking advantage of incredible tax benefits to maximize your return on investment.

Through these factors you can build a sizable amount of cash rather quickly. At the same time, the property may generate steady income for you. With income-producing properties, there is always a risk that the tenant will stop paying rent. Turnover and vacancies also can impact the steadiness of your income stream. However, when you make smart tenant selections and invest in a good market, your exposure to these risks drops dramatically. The fact that your income is fixed from a lease for a specific amount of time creates a relatively steady stream of income.

Crowdfunding Investments

Crowdfunding is one of the newer forms of investments that produce passive streams of income. There are various platforms that you can choose to find investments through. These may be personal loans to individuals, startup loans or business loans. You will be able to analyze the pre-determined creditworthiness of the applicant so that you can balance your exposure to risk with your desired return.

The primary risk associated with crowdfunding investments is the possibility that the borrower will default on the loan. One other factor to consider with crowdfunding investments is that your initial capital will not grow while you draw income from the loan. Therefore, if you intend to use the returns as income, you cannot consider this type of investment for wealth building.

Business Investments

As a business inventor, you can be an active investor with hands-on participation in the business, or you can be a passive investor. If you invest passively, you generally will have little or no say in business decisions. Essentially, you are lending the business money for a share of the profits indefinitely going forward. All business investments can be risky, but factors like the industry, the market and the experience of the active parties will impact your exposure to risk. It is possible to lose your full investment if the business folds.

On the other hand, you can build wealth while generating income through this type of investment. This is because your initial investment purchased an ownership stake in the company. As the business’s value grows, the value of your investment grows. You can potentially draw income from this investment for years, and you may see a sizable return when the company is sold or when your shares are bought out at a later date.

A Long-Term Approach Toward Building Your Net Worth

When some investors initially start generating passive streams of income, the inclination is to use these funds to support an improved lifestyle. However, if you want to eventually generate enough income passively to fully support your lifestyle, two things must happen. You must maintain your current lifestyle, and you must build up your streams of income. Essentially, you must continue living as you are while re-investing all returns from passive investments. This can have a powerful, synergistic effect. As you re-invest more of your returns in the development of passive streams of income, you will generate more income that you can later live on. You will also build a substantial amount of cash in the process.

Start Investing Passively Today

Unless you are already financially well-off and have an incredible nest egg to dip into, you will need to develop your streams of income slowly over time. Once you get started, you will be able to take advantage of re-investing your returns. Therefore, the best time to start investing is today. Regardless of how much money that you have available, start purchasing various types of investments that are affordable to you. Keep in mind that you can start by investing in a few stocks or CDs today. As your net worth grows, you can move up to property or business investments.

Living entirely off of passive streams of income can take time and hard work. However, this goal is within your reach. Start today, and you will reach your goal sooner.

Follow Me:  
FacebooktwitterlinkedinrssyoutubeinstagramFacebooktwitterlinkedinrssyoutubeinstagram


Share this:  
FacebooktwitterpinterestlinkedinFacebooktwitterpinterestlinkedin

The CashFlow Quadrant – How I Save Thousands on Taxes (Legally) 

One of the most life-changing discoveries came to me years ago when I realized I was earning income the wrong way. This was uncovered when I read the book, “Cashflow Quadrant” by Robert Kiyosaki. It’s a powerful book that helped guide me to become a full-time investor and to make financial freedom a top priority. Additionally, this book has single-handedly helped me save thousands in taxes over the years.  

Source: https://www.richdad.com/taxes-stealing-your-money

 

As you can see in the diagram above, each quadrant (E, S, B and I) represents a different way to generate income. Some people earn money in only one of the quadrants, while some earn money in multiple quadrants. There are advantages and disadvantages to each quadrant.

The two quadrants on the right side (B and I) are the primary paths to financial freedom. The majority of the Cashflow Quadrant book is about the unique skills and mindsets required to succeed on this path. If you haven’t checked out this book, it’s a worthwhile read. You can learn more here.  

Let’s Explore Each of The Four Quadrants:

E – Employee

An employee earns income via a job. This is the quadrant where most people earn their income. The job itself is owned by a business, which could be a single person or a large corporation. The employee exchanges his or her time, energy, and skills to an employer in exchange for a paycheck and often other benefits such as healthcare coverage and/or a retirement account match.

Employees can make a little or a lot of money, but when an employee stops working, or if the business goes under, the income stops.

The lack of control over income is a serious consideration of the E quadrant and something I became intimately aware of when I worked in the oil industry and layoffs began to occur around 2015. An employee’s financial freedom is dependent upon the success of the employer and the ability to show up to work and exchange time for money. 

Kiyosaki points out that the reason as to why most E quadrant workers pay around 40% of their income in taxes (as shown in the diagram above) is simply because most personal expenses aren’t deductible. You can’t, for example, deduct the expense of your personal car from your taxable income. Below is a simple illustration for educational purposes only. Please seek professional, licensed tax advice from a CPA for more information. 

 

Tax Example: 

Federal Tax: 27% 

State Income Tax: 5% 

Social Security Tax Rate: 6.2% (half paid by the employer) 

Medicare Tax Rate: 1.45% (half paid by the employer)

Total = 39.65% in Tax

 

S – Self-Employed

Many employees eventually get tired of the lack of control over their pay and schedule and choose to work for themselves instead. A self-employed individual still exchanges time for money, but they “own” their job. 

Common examples of the S quadrant workers include dentists, doctors, insurance agents, realtors, handymen, among many other skilled trades. It is possible as a self-employed individual to earn a large income, but like an employee in the E quadrant, when they stop working, so does their income.

Self-employed workers have more control compared to an employee, but more often than not, they also have more responsibility. As a result, success usually means working harder and working longer hours. Over time, this can lead to burn out and fatigue as I also experienced first-hand in 2015 when I was actively investing in real estate with fix and flips and vacation rentals. 

Kiyosaki points out that the reason why most S quadrant workers pay the highest taxes, around 60% of their income (as shown in the diagram above) is that Social Security and Medicare Taxes are paid 100% by the self-employed individual (they are not split by the employer as is the case with an employee). Additionally, an S quadrant individual often earns more income compared to an employee and therefore can be in a higher tax bracket. Below is a simple illustration for educational purposes only. Please seek professional, licensed tax advice from a CPA for more information.

 

Tax Example: 

Federal Tax: 37% 

State Income Tax: 5% 

Social Security Tax Rate: 12.4%

Medicare Tax Rate: 2.9% 

Total = 57.3% in Tax

 

B – Business Owner

Those in the B quadrant own a business system and they lead other people. In this quadrant, the business often has 500 or more employees. The systems and employees who work for the business can run successfully without the business owner’s daily involvement.

Unlike the S quadrant where a plumber, for example, might own and work in his own plumbing business, a B quadrant business owner might create a plumbing company and hire 500 or more plumbers, administrators, managers, and other staff to run the systems in the company.  

 

The wealthiest individuals in the world typically own B quadrant businesses. A few of these individuals include Bill Gates of Microsoft, Jeff Bezos of Amazon, and Mark Zuckerberg of Facebook.

Kiyosaki points out that the reason why most B quadrant business owners pay around 20% in taxes (as shown in the diagram above) is because businesses can deduct a wide variety of expenses from the income of the business, which can lower the businesses income taxes. Additionally, the recently passed Tax Cuts and Jobs Act in 2017 allows for a qualified business income tax deduction of an additional 20% for eligible businesses. You can learn more here. Below is a simple illustration for educational purposes only. Please seek professional, licensed tax advice from a CPA for more information.

Tax Example: 

C-Corporation Flat Rate Tax Rate = 21% 

Total = 21% in Tax

 

I – Investors

Now to my favorite quadrant. The I quadrant is comprised of investors who own assets that produce income. This is the quadrant for truly passive income.

Investors in this quadrant have usually accumulated capital that was earned in one or more of the other quadrants and now they place that capital into income-producing investments to produce even more income. This is the magic formula for financial freedom. 

For example, an investor might purchase shares of a company privately or publicly owned in the form of stock. This influx of capital from the investor helps to fuel the systems created by the business owner, and this fuel can lead to even more growth in the business and for everyone involved. Investing in real estate is a common example of an asset that can produce passive income from collected rents and other income-generating aspects on the property. Investing passively in private placements (apartment syndications) has been my preferred asset class in the I quadrant. 

Kiyosaki points out that the reason why most I quadrant investors often pay as little as 0% in taxes, legally (as shown in the diagram above) is that long-term capital gains tax rates (for assets like stocks or real estate held the long-term) are between 0% and 20% depending on the individual’s tax situation. You can learn more here. Below is a simple illustration for educational purposes only. Please seek professional, licensed tax advice from a CPA for more information.

 

Tax Example: 

2020 Long-Term Capital Gains Tax Rate (For Single Individuals) Earning $78,750 or Less = 0% 

Total = 0% in Tax

 

Conclusion:

There are many paths to financial independence, but most of them lead to the right side of the Cashflow Quadrant – B and I. If you want to achieve financial freedom, it will pay to learn the skills and mindset required to make this move to the right side. I have earned income in the E, S, and I quadrants but the I quadrant has been the most impactful. This is because of a concept I refer to as “Time Freedom”. Which to me, means having freedom and flexibility over your time. When you have more passive income than you have lifestyle expenses, you become financially free. This is where a new world of opportunities and possibilities open up and the world becomes your oyster.     

To Your Success

Travis Watts 

Disclaimer: Travis Watts does not provide tax, legal, or accounting advice. This material in this blog/article has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction, investment, or other change. 

 

Follow Me:  
FacebooktwitterlinkedinrssyoutubeinstagramFacebooktwitterlinkedinrssyoutubeinstagram


Share this:  
FacebooktwitterpinterestlinkedinFacebooktwitterpinterestlinkedin

Why Cash Flow Trumps Capital Gains – But Why Not Have Both?

Being a successful long-term investor takes knowledge and commitment. One of the best routes that investors can take to develop their passive income and overall capital is passive investing in real estate. While this is a select investing category, it comes along with a lot of different investment approaches.

 

Capital Gains Strategy

The capital gains strategy can be summed up as the art of buying and selling assets for a profit. To be successful with this passive investing strategy, you need to be able to identify undervalued assets quickly. This particular strategy is not about speculating on assets. Rather, it’s about knowing clearly the value of the asset compared to the market value.

 

A Quick Example

 

To help you better understand the capital gains strategy, let’s look at an example transaction. You purchase a single-family home for $150,000, knowing that it will sell for more on the current market. Then, you sell the home for $200,000. You’ve essentially made a gross profit of $50,000. You knew the home was undervalued. So, you purchased the home and resold it for the known market value.

 

As you’ve likely learned, knowing the value of the assets in the real estate market is key to your success. With the capital gains strategy, many individuals will pick a particular sector of this market to research and create their knowledge base around. For example, they may invest in only single-family homes, or they may invest in commercial buildings.

 

This Is NOT Speculating

 

One of the biggest misconceptions about the capital gains strategy is that it’s all about speculating. That’s not based on any truth. This strategy is about knowing the value of an asset. It’s about understanding the market. You’re not just hoping the property’s market value appreciates over time, as most properties do. Rather, you have information to back up that theory.

 

For example, let’s say that you know there is urbanization planned for a specific area in the coming year. You know that urbanization will bring in more people and increase the value of properties in that area. Therefore, your capital gains strategy will likely be to invest in properties just before the urbanization takes place. Then, you’ll see the urbanization through, and your properties will increase in value.

 

Eventually, you’ll sell the properties when they reach your desired selling price. This desired price will highly depend on your capital gains strategy. To help you to get the best price out of your assets, here are some tips you should always be following:

 

  • Only sell when your reason for buying the asset no longer holds true. Just because your asset increased in value doesn’t mean you should sell it right away. Rather, hold onto your asset until the reason you bought it no longer applies. For example, if you bought a property pre-urbanization. Hang onto it until the urbanization is completed, and the prices are stagnant.
  • Don’t sell just because the market is down. It can be very tempting to sell when the market goes down as you’re ensured some profit instead of none. However, the market always tends to fix itself with time. So, don’t let the market woes influence your selling decision.
  • Don’t ever speculate on profits. It would be best if you never let analysts talk you up on buying assets that don’t meet your investment criteria. You really must make sure that the asset is undervalued before you consider purchasing it.
  • Research, research, and research some more. Being a successful capital gains investor means knowing your market. To know your market, you’re going to have to invest some time doing some diligent research. Please don’t fall into the pitfall of purchasing a property because you invested a great amount of time researching it. Go into research knowing that you’re only going to take action on about 10 percent of the properties.
  • Always have cash flow to maintain discipline. Without cash flow, you may find yourself backed in a corner. The capital gains strategy requires diligence and patience. You need to have cash flow to continue investing and keep you from making unintelligent decisions regarding your investments due to lack of funds.

Cash Flow Strategy

The cash flow strategy is one that every passive investor must be putting into practice regularly. Cash flow investing is defined as the act of purchasing an asset and holding onto it with the expectation of a constant return. This return may be monthly, quarterly, or even annually. The point is that you expect to receive a consistent return at specific intervals that you know about before the purchase.

 

The return that your receive from the cash flow strategy may be in the form of dividends or rental income. The idea behind this strategy is that it allows you to build resources with a steady income over time. It’s commonly thought of as the retirement building strategy. However, it’s a great strategy for building capital and consistent passive income.

 

It’s All About The Long-Term

 

When it comes to the cash flow strategy, it’s all about long-term prosperity. Unlike other types of investments, you’re not focusing on the short-term movements in your market. This is ideal for newbie investors as they don’t get caught up in the panic of short-term market fluctuations and make illogical decisions regarding their assets.

 

As a cash flow passive investor, you don’t have to worry about timing the market to make a profit. You’re simply putting your money into earning a steady income from the asset over time. You don’t need to worry about factors like capital appreciation like you would with the capital gains strategy. This is what makes cash flow buying such as prized strategy for newbies in the wealth-building world.

 

It Still Takes Research And Planning

 

While the cash flow strategy is more newbie-friendly than the capital gains strategy, it still takes diligent research and planning to be successful. You must consider the potential state of the asset and future cost investments to keep it in prime condition. Your future income must be enough to sustain the asset’s maintenance alongside providing you steady cash flow.

 

You’ll also need to take into consideration the future earning potential of the property. Not all investments are good investments. You may find a property has great cash flow right now. However, it needs to continue that cash flow long enough for you to recoup your initial capital. Factors like natural disasters, civil unrest, and unemployment all need to be considered.

 

It’s best to stick to areas that naturally attract residents. Areas that are peaceful and have a plethora of employment opportunities. The cash flow strategy is all about ensuring that your long-term income will be there. When doing research, you’ll want to dismiss properties that are located in areas with high rates of civil unrest or few employment opportunities. These are indicators of significant risk for the property and your future income. Here are some other tips you should follow with the cash flow strategy:

 

  • It’s not all about the yield. While some properties may have a very high yield, they may not be going into the future. You need to assess the longevity of that yield before you make a purchasing decision.
  • The debt matters. When you purchase an asset, you need to consider the debt you’re using. Your strategy should include a proper payback for that debt. Also, realize that buying properties via debt can reduce your earning power.
  • History is a big indicator of the future. When you look at real estate, you’ll start to notice that history tends to repeat itself. Use this knowledge to asset past property history to see what it reveals.

Cash Flow And Capital Gains Are Keys To Passive Wealth Accumulation

Now, you should have a pretty good understanding of both the cash flow and capital gains strategies. While you may initially favor one over the other, the truth is that both are ideal for any passive investor. The cash flow strategy ensures that you have a steady income. The capital gains strategy allows you to build wealth at a faster rate when executed correctly.

 

Passive investing is all about making money for both the short-term and the long-term. While you can invest your time in purchasing assets for reselling later with the capital gains strategy, you’re still going to need income. That’s where the cash flow strategy comes into play. It ensures that you have a steady income to continue practicing your capital gains strategy.

 

Remember, you need steady income, so you don’t get backed into a financial bind. When you have consistent cash flow coming in, you can make decisions regarding your capital gains strategy with ease. When you don’t have the cash readily available, and you’re in a financial bind, it can lead to illogical decision-making. These illogical decisions are what kills many passive investors. Do yourself a favor and utilize both the cash flow and the capital gains strategy in harmony to ensure your best chance of success in building the wealth of your dreams.             

 

Follow Me:  
FacebooktwitterlinkedinrssyoutubeinstagramFacebooktwitterlinkedinrssyoutubeinstagram


Share this:  
FacebooktwitterpinterestlinkedinFacebooktwitterpinterestlinkedin

The CDC Eviction Moratorium – What You NEED To Know

You may have seen recent headlines referring to an “eviction crisis”: 

The COVID-19 Eviction Crisis: an Estimated 30-40 Million People in America Are at Risk – The Aspen Institute 

 

Experts fear the end of eviction moratoriums could plunge thousands of people into homelessness – CNBC

President Trump signed an eviction moratorium order that effectively bans evictions nationwide through the end of the year. According to the Centers for Disease Control and Prevention (“CDC”), the moratorium order has been issued to provide housing stability and to prevent the further spread of COVID-19. However, it is important to note that rent is NOT cancelled through the end of the year. Let’s dive into how this order effects landlords and owners of real estate…

 

According to the moratorium, there are stipulations in order to receive this “eviction protection.”

Those who are eligible must meet additional criteria before presenting their landlords with a declaration, which will be made available on the CDC website. This criteria includes: 

  1. The resident has sought all available government rental assistance
  2. The resident will earn no more than $99,000 in 2020 (or $198,000, if filing jointly)
  3. The resident can’t pay their rent in full due to a substantial loss of income 
  4. The resident is trying to make timely partial payments, to the extent they can afford to do so
  5. The resident would, if evicted, likely end up homeless or forced to live in a shared living situation

What to do if you (the landlord) receives a CDC Declaration from a tenant?

 

According to Colton Addy from Snell & Wilmer Law, if a landlord receives a CDC Declaration from a tenant, the landlord should respond in writing to the tenant to encourage the tenant to make partial payments of rent (and similar housing-related payments) to the extent the tenant is able, in accordance with the CDC Declaration. Additionally, the landlord’s written correspondence should remind tenants that the rental amounts are not forgiven and will ultimately need to be paid. 

 

Additionally, many tenants may not be aware of the government assistance programs that are available to tenants to help tenants pay their rent during the COVID-19 Pandemic. Landlords should include a list of available resources that tenants can use to pay their rent. The Department of Housing and Urban Development (HUD) has stated that nonprofits that received Emergency Solutions Grants (ESG) or Community Development Block Grant (CDBG) funds under the CARES Act may use these funds to provide temporary rental assistance to tenants. 

 

The following websites provide information on federal assistance that is available:

 

www.hudexchange.info/programsupport

https://www.hud.gov/coronavirus

https://home.treasury.gov/policyissues/cares/state-and-local-governments 

 

Additionally, landlords should include other programs that may be applicable in their jurisdiction. Landlords may also consider filing an eviction proceeding for one of the reasons permitted by the CDC Order, but landlords should use caution in pursuing such actions as eviction proceedings in the current climate are likely to draw additional judicial scrutiny.

 

Penalties:

 

The penalties for individuals who violate the Order are severe, including:

 

 

  • A fine of up to $100,000 and up to one year in jail, if the violation does not result in a death; or
  • A fine of up to $250,000 and up to one year in jail, if the violation results in a death.

 

The penalties for an organization violating the Order are even more severe.

In summary, the moratorium order provides temporary relief to those residential tenants facing eviction who submit the required declaration, through the end of the year.  The order, however, does not absolve a tenant from paying rent or restrict a landlord from applying penalties, interest, or late fees on the tenant’s account for non-payment of rent.  Additionally, the order does not relieve landlords of their debt service obligations if a tenant seeks relief under the order. 

 

Disclaimer: The materials contained in this blog post are for educational and informational purposes only. Nothing in this blog post is to be considered as the rendering of legal advice. Readers are advised to obtain legal advice from their own legal counsel. Additionally, please note that the orders and laws related to the COVID-19 Pandemic are changing on a daily basis and your jurisdiction may have stricter rules related to evictions in place. Please verify the rules currently affecting your property at any given time.

 

Follow Me:  
FacebooktwitterlinkedinrssyoutubeinstagramFacebooktwitterlinkedinrssyoutubeinstagram


Share this:  
FacebooktwitterpinterestlinkedinFacebooktwitterpinterestlinkedin

Understanding Commercial Real Estate Asset Classes

Real estate has historically been a preferred asset class because of its tremendous capabilities to build wealth. This is achieved through property value accumulation combined with debt reduction. At the same time, passive income can be generated by rental income. You may not realize, however, that there are many different property classes available for you to consider.

 

Why Property Classes Matter

 

As a passive investor, you understandably may plan to let an experienced property management company deal with maintenance, operations, and other aspects of running a tenant-occupied property. However, asset classes directly impact exposure to various types of risks, financing opportunities, and other factors. A greater understanding of the property classes will support your decision about which passive investing opportunity is right for you to pursue.

 

Multi-Family

 

A multi-family property has five or more residential units. A one to four-family home is considered a residential property and would qualify for residential financing. There are several important benefits of a multi-family property, and this begins with financing. Generally, lenders offer the most competitive rates, the longest loan terms, and the highest loan-to-value for these properties. For a passive investor who wants to benefit from maximum leverage, this is a popular option.

 

One of the reasons why a multi-family property is viewed as one of the least risky types of commercial properties to invest in is because everyone needs a place to live. Compared to other types of leases on commercial properties, a multi-family property generally has the shortest lease terms. This ranges between six to 12 months in many markets. Shorter leases work in the property owner’s favor when market rental rates are increasing steadily or rapidly.

 

Office Buildings

 

Office buildings generally have longer leases than multi-family properties have, but there is some variation in this. You can find some buildings with 12-month leases or with even shorter terms. When an office building has multiple tenants on long-term leases, it is considered to be much less risky than a building with only one tenant. However, when you are looking at the income potential of office buildings and related exposure to risk, the quality of the tenant must be considered.

 

From a financing perspective, lenders generally offer terms that are slightly less favorable than multi-family property financing for a multi-tenant office building. For a single-tenant office building, the lender usually will review the tenant and the lease terms carefully before giving a loan quote.

 

Compared to a multifamily apartment building, an office building may be more challenging to find tenants for. Because of this, units often remain vacant for longer periods of time. When a single-tenant office building is vacant, the unit is not generating any income until a new lease is signed.

 

Retail Properties

 

Retail properties are comparable to office buildings in many ways. They can have one, several, or dozens of tenants. The leases are generally longer in length, but this is not always the case. Financing terms are more favorable when there is a reputable, secure anchor tenant as well as multiple smaller tenants. Likewise, the financial risk of investing in retail properties is moderated by the quality and number of tenants.

 

Whether you are investing in retail or office buildings, always analyze the lease end dates carefully. Ideally, the lease end dates would be fairly spread apart so that occupancy and income generation are not significant concerns.

 

Mobile Home Parks

 

From the vantage point of a passive investor, a mobile home park is initially viewed as being comparable to an apartment complex. The property is occupied by multiple residential tenants who have relatively short-term leases. With this type of property, however, the mobile homes may be owned by the property owner or by the tenants. Therefore, the rental rate may only include lot rent or lot rent plus mobile home rent. This dramatically impacts the property’s income potential. It also affects property maintenance expenses and other related aspects of upkeep.

 

From a financial standpoint, manufactured or mobile homes are not considered to be real estate. Instead, they are classified as personal property, and they cannot usually be collateralized by a commercial loan. The commercial loan would cover the land and site-built improvements. If you purchase a mobile home park with park-owned homes, you would need to obtain a secondary loan for the homes or place a much larger amount of money down with your purchase. In addition, the value of park-owned homes would generally depreciate. Wealth building is affected by the number of mobile homes owned by the park.

 

Mixed-Use Properties

 

A mixed-use property is usually considered to be a combination of residential units with office or retail units on the same lot. These properties are common in urban areas, such as with a retail store on the street level and a few apartment units in the upper levels of the building. One of the benefits of a mixed-use building is that the property’s income is derived from a wider mix of tenants. Generally, however, you must still analyze risk based on the number of tenants, the lease terms, and the quality of the commercial tenants.

 

Commercial financing available varies considerably based on the overall unit mix. You may find more attractive financing terms when the majority of the square footage or the majority of the monthly rents are linked to multifamily occupancy.

 

Industrial Properties

 

The last major class of real estate is industrial. Industrial properties include distribution warehouses and manufacturing facilities. Long-term leases are common with these properties. One of the challenges associated with industrial properties is rooted in finding new tenants to fill vacancies. In many cases, these buildings are customized to meet the operational needs of the tenant. Because of this, considerable updates may be needed before the property can accommodate a new tenant.

 

Financing terms for industrial properties generally include a significant down payment, a higher interest rate, and a shorter-term length. These terms reflect the increased risk to the lender and to the investor. However, with the right long-term tenant, the owner of an industrial property may enjoy a healthy source of passive income and may never deal with a vacancy throughout the entire period of ownership.

 

Other Property Types

 

As you explore the many passive investing opportunities to build wealth, be aware that there are other commercial property types that fall outside of these four primary classes. Some of the more common types are self-storage properties, hospitality properties, stand-alone restaurants, and gas stations.

 

Self-Storage Properties

 

Self-storage properties are popular among those who are focused on wealth building because the income stream is diversified across many tenants. As is the case with other multi-tenant properties, a few vacancies will not generally create financial hardship for the owner. The lease terms commonly range from month-to-month to 12 months. In addition, upkeep on self-storage properties is relatively low because these are essentially warehouse-like structures. Financing terms on self-storage facilities may be aligned with those for a multi-family office or retail building in many cases.

 

Hospitality Properties

 

Hospitality properties are generally viewed as a riskier yet potentially lucrative type of property to invest in. The income is analyzed by multiplying the average daily room rate and the hotel’s occupancy rate over a specific time period. Income potential from these properties is vulnerable to economic conditions. Furthermore, operational costs and property upkeep can be significant. Because of these factors, lenders often require a substantial down payment and may issue a loan with a shorter term and a higher interest rate.

 

Special Purpose Properties

 

Many other commercial properties do not fall into these more significant classifications, and they could present excellent passive investing opportunities. These include amusement parks, golf courses, assisted living facilities, gas stations, stand-alone dry cleaners, stand-alone restaurants, and others. Notably, these property types are highly customized and may only be suitable for a specific type of business. Some of them, such as gas stations and dry cleaners, have potential environmental concerns. These may increase the cost of property insurance and dictate the need for an environmental impact report to be completed periodically. All of these property types may require significant renovations in order to be converted to a different use when the current occupant vacates.

 

As you continue to explore the many investment opportunities available that can generate passive income, keep in mind that the risk and the income potential for each of these property types are dependent on multiple factors. These include area demographics, the quality of the tenants, the local economy, and more. To maximize the opportunity to build wealth while mitigating risk, consider working with a skilled advisor who has a deep understanding of the local market and of property investing. 

 

Follow Me:  
FacebooktwitterlinkedinrssyoutubeinstagramFacebooktwitterlinkedinrssyoutubeinstagram


Share this:  
FacebooktwitterpinterestlinkedinFacebooktwitterpinterestlinkedin

How to Calculate Net Income and Distributions as a Passive Investor

Net Income and Distributions Across the Board

We don’t buy homes or invest into complexes because we expect to work forever.

Automated income, as it relates to you doing nothing, is a real potential in real estate. It’s one that I’ve achieved. Dedication in this business starts when you don’t see better options to invest in. A passive investor looks to real estate because they know that, with the right property, they’ll make money while sleeping.

Freedom is why some choose passive investing. I chose it because living the life you desire starts only when you have the time to. Wealth building is how I lead people into real estate and what I want you to keep a focus on. Being an accredited investor is great, but your financial decisions are as critical as your lifestyle ones.

Keeping these in mind, you’ll need to know how your net income and future distributions work. In general, net income is tallied as your investment returns minus any fees in generating that income.

How do Passive Investors Earn Financial Freedom?

Passive investors generate net income by first setting a “preferred return” based on their total investment. This preferred rate is how much, being in the form of a percentage, that they’ll receive. The income you set as your preferred rate is paid out residually. That is, there is no work required on your end to generate this income.

Wealth building is a lifelong commitment to financial excellence however.

No one makes great financial decisions all the time, so we need income diversity to balance our lives with. To grow money passively, you must think about your lifestyle alongside the distributions we pay out. Distributions, being the route that passive investors earn through, is what makes your freedom lifestyle possible.

Distributions—How They Work

Regarding property ownership, accredited investors receive their preferred return on a set time scale. Whether yearly or monthly, the income earned by a property investment gets “distributed” to all investors. Those who invested $200,000 with a preferred return of 12% will earn $24,000. This is paid out yearly or monthly.

A monthly distribution payment from a $24,000 return equals $2,000. Distribution payments can even come to you in larger amounts than your scheduled monthly or yearly quotas. Agents who you invest with must provide advanced payments in the event of them selling your investment property. “Cash-out refinancing” also occurs when a new loan is taken out on a property that’s already owned but has a profit margin in equity that you can partake in.

*Doing More with Distributions
Distributions aren’t the sole promise we give our investors. The quality of their lives is just as important as their ability to choose their net incomes. My goal is to keep investors aware of their responsibilities in balancing their lifestyles as much as their money. Following are some key points to help you live out both to their fullest:

Making Your Life Complete

Accredited investors receive their gains as net income, which is their realized profits from passive investments. Passive income, as it relates to financial freedom, is a type of residual income. It is a taxable sum, but we must first subtract your fees and losses from it. The total amount of your net income is based on your preferred rate. Investment losses are even tax deductible, yet taxes don’t apply to deferred investments.

Properties can be placed into IRAs, for example, and in doing so, you defer tax payments.

Only when you use or prematurely take out your net income will you encounter taxes. As a general rule however, the net income tracked from your scheduled distributions, when withdrawn, is taxed at a rate of 3.8% to 20%. Investors incur a rate of 20% depending on their income or level of distributions received.

Is Passive Income the Same as Active Income?

Active income, which is what you earn from “material participation,” is not labeled as capital gains.

Net income and capital gains are the same, but “capital gains” is a term used primarily within taxes. Any taxes on capital gains, which is net income, can be deferred or delayed by reinvesting it. Net income comes from passive earnings while gross earnings come from wages and salaries. The IRS says that as long as you don’t operate a business, your stake qualifies as a passive investment, being that all you did was invest.

*Which Deductions Can Be Made From Net Income?

You can, based on profits and losses, make deductions from the following:

– Any requirements needed to create your royalty income—i.e., fees
– Any investment expenses that arose miscellaneously
– Any loss due to state taxes on income
– Any casualties related to a property

What is it About Passive Investing Anyway?

A passive investor is someone who realizes their need for financial diversification.

These investors want to put their money to work without lifting a finger. The science that keeps investors “betting” on property investments is saturation. Even in times of peril, people will buy homes, pay rent and travel lodging. With an experienced agent helping them, there’s no season or natural disaster that calls for a passive investor to labor.

Property markets inspire these investors with the idea of long-term incomes.

Here are some key reasons to keep your investments diverse and passive:

1. Time in Your Hands—No Work on Your Mind

Being a financier enables you to use your personal time for diversification. As you put money into one asset, you are free to then research more investments without losing your initial one. In most investments, however, we’re required to give a lot of attention to them.

2. A Future to Look Forward To

Though short-term investments do work for passive financiers, we look at passive income as a long-term strategy. If you want to retire early, then look at the passive income of investment properties. The opportunities you find do promise a real future—not just a quick payday.

3. Investments That Last Lifetimes

Wealth is about building strong foundations within your finances. We choose passive assets because they’re built on the concept of longevity. Tomorrow, people will still be looking for residential, commercial and industrial properties to buy. Just don’t settle for an asset that pays you quickly but once. Investments that last lifetimes pay you indefinitely.

Do You Ensure Consistent Net Income for Investors?

We position our investors for steady profits in net income through the following:

Watching Market Conditions—We don’t need market conditions to tell us if we should invest into property ownership. We watch market conditions in order to know when. Being a long-term asset, investment properties are always worth considering. Since most economic pullbacks are temporary, a long-term hold on a property often brings you back to your profit level or higher. Additionally, finding properties at bargain prices is best done when you take advantage of market conditions as they arise.

Profiting Strategies—Steady profits are a result of good investing strategies. Finding a reliable asset is good, but knowing how you’ll purchase it, when and then where you’ll get out is how you create a strategy. Our entry point must always be when prices are low or favorable. The final step in an effective strategy is in knowing when to get out. We don’t need to anticipate failure, but knowing how to leave minimizes loss.

Using Due Diligence Each and Every Time—Every investor in a property market needs research to guide their decisions. Around the country, millions of people enter this industry, and their work makes competition a big factor. Entering a property investment should only occur once you research the details of its market.

Investing and Pushing Your Net Income Higher

It’s our desire for you to thrive as a wealthy individual. It’s our desire to also share a warm warning. If you think that success as an accredited investor doesn’t relate to your work in tracking net income, then you’re sadly mistaken. Through a property market, you have a real potential of making passive income to support your entire life through. The benefits of passive investments, however, are meaningless if you haven’t set your preferred rate of return.

Now is an ideal time to think about your wealth. How will your money go to work for you now that you know how? Thank you for being supportive throughout our relationship up to now. The favor I want to return comes from my passion to see you achieve more. Money management, financial and self-control are still major factors in your life of freedom. Follow us as we guide you into the rate of net income you seek.

Follow Me:  
FacebooktwitterlinkedinrssyoutubeinstagramFacebooktwitterlinkedinrssyoutubeinstagram


Share this:  
FacebooktwitterpinterestlinkedinFacebooktwitterpinterestlinkedin

How to Be a Hands-Off Investor

Real estate investing can be truly passive, but it might not be in the way you think. Being a “hands-off” passive investor can be one of the most powerful ways to make your money work for you. But before we dive into the benefits, let’s clarify what this type of investing is and explain how it is different from active investing.

Many investors starting out on their real estate journey envision buying and renting out a piece of residential property, such as a single-family home, condominium, townhouse, or perhaps a small multi-family complex like a duplex or triplex. Many investors mistake this business model as being “passive” because it’s easy to imagine the strategy playing out perfectly. After all, you simply buy a piece of property, rent it out, and then collect the checks every month from your tenants.

Sounds pretty passive – right?

But unfortunately, this is not a passive real estate strategy. Those of us who have used this model, we know at a bare minimum, that we must select a property to purchase, and then work with a property management company to make ongoing decisions about the property e.g. whether to fix or replace an appliance when problems arise, or how to address unforeseen issues when they pop up. Should you re-carpet or paint the property? When is a good time to do that? Which company or contractor should be used? If you choose not to outsource these operational tasks to a property management company, you will have to manage the day-to-day responsibilities on your own. In either case, this is an active investing approach because of the ongoing time commitment and asset management required. 

Try scaling this investing model to 20 properties and you quickly learn how active this investing model can be. Even if a rental property only required 5% of your time, you can see how 20 properties x 5% of your time = 100% a full-time job. There’s nothing wrong with using an active approach to investing, just be aware that it can be time-consuming and difficult to scale. 

What does a passive investing approach look like?

Passive investing is the strategy of acquiring income streams on autopilot. For example, as a passive investor, you make an upfront capital investment in a private placement offering (AKA real estate syndication) REIT, or stock and then receive an equity ownership stake in that investment, from which you are paid passive income or portfolio income. The biggest difference between active and passive investing is that you are not directly or indirectly managing the investment as a passive investor. It is 100% hands-off, in terms of your time commitment, after making the initial investment.  

You can passively invest in real estate in several ways. I mentioned REITs (Real Estate Investment Trusts) which are essentially companies that pool investors’ capital together to purchase large real estate deals. I also mentioned private placement offerings or “real estate syndications” where you can make direct investments in individual real estate. Private placement offerings are not publicly traded on the stock market and are usually structured as a Limited Liability Company (LLC) or Limited Partnership (LP). This is a structure in which you “pool” your capital together with other investors in an equity or debt-based investment, so you can enjoy the benefits of being a real estate investor rather than a landlord.  

5 Reasons Passive Investing Might Be Right For You:

 

  • Taxes

 

In an equity real estate private placement, there are typically tax-deferred cash returns that allow you to keep more of your earnings throughout the hold period of the investment.

This is one reason real estate (in general) can be a more powerful passive investment compared to other asset classes. Interest payments or stock dividends can be taxed at the highest income brackets. The pass-through potential benefit of real estate ownership allows a share of the depreciation and expenses to offset the distributed income you receive from the partnership. 

 

  • No Dealing with Tenants, Toilets or Termites 

 

When you are a passive real estate investor, you do not deal directly with the hassles of day-to-day management. Clogged toilet? You’re not going to get a call at 3 am. Broken garbage disposal? It’s not your responsibility to call a handyman or make an emergency trip to your property. 

 

  • You Don’t Have to Deal with Banks

 

Working with banks to obtain financing on your own properties can be difficult. Since the Great Recession of 2008-2009, banks started to require more documentation for you to get loans, and the loan underwriting process can be very time-consuming in itself. Not to mention banks will typically stop lending to you after you hold several mortgages due to debt-to-income ratio requirements. 

When you are a passive real estate investor, your investment is handled by a professional real estate investment company that already has relationships with banks and lending agencies. They navigate the bank financing so you don’t have to and the loans are based on the property itself and the loan guarantors (not you). 

 

  • Passive Investing Lets You Leverage the Expertise and Experience of Others

 

Quite possibly my favorite aspect of passive investing is the ability to leverage other people’s expertise and track record. In real estate, you have the option to go it alone (e.g. buying your own investment property) or you can leverage an experienced team to find and manage the deals for you. 

The fact is, there are people who devote their lives to learning the ins and outs of specific markets, building broker relationships, finding off-market deals, and becoming masters in a specific niche. As a passive investor, you have the opportunity to benefit from this deep education, without sacrificing your own time and energy. If you can’t beat them, join them. 

 

  • You Can Make Money While You Sleep

 

Passive investing in real estate can be as “active” as you choose to make it. Typically, you do your due diligence on the investment firm, market, and the deal, sign legal paperwork online and then transfer funds. As soon as your investment is processed, you become an equity owner in the real estate venture and can then start to realize the potential passive income and/or equity growth from the deal. In other words, you have the potential to make money while you sleep. 

What are the Risks?

Of course, real estate investing carries risks, just as investing in any asset class carries risk. When you invest in any asset, you carry the risk of the loss of your principal. In the case of both a stock or a REIT investment, this can result when the value of the investment goes down, either due to internal issues with the underlying asset, the company whose shares you’ve purchased, the real estate portfolio itself, or a downturn in the market. In either case, the value of your asset can decrease.

This is why it is so important that before you make any type of investment, whether in real estate or other asset classes, and whether active or passive, you must first do your own research and due diligence. No investment, person, or company can guarantee you a return or protection of all your principal. But your own due diligence can help you find safer and possibly more lucrative avenues to place your capital.

Conclusion

Having a passive investing mindset can be truly life-changing. However, real estate is only one asset class you can choose from. If you are interested in passive investment opportunities other than real estate, you can research other asset classes such as dividend stocks, tax liens, private notes, bonds, annuities, life insurance investing, ATM machines, venture capital, and many more. Creating passive streams of income is faster and simpler than it has ever been. One thing I have learned from speaking with thousands of passive investors, is nearly all of them wish they had started sooner. Don’t let that be a regret for you, keep up the education. Thank you for reading. 

To Your Success

Travis Watts 

Follow Me:  
FacebooktwitterlinkedinrssyoutubeinstagramFacebooktwitterlinkedinrssyoutubeinstagram


Share this:  
FacebooktwitterpinterestlinkedinFacebooktwitterpinterestlinkedin

“It is Too Difficult to Invest Out-of-State” Real Estate Investing Myth Debunked

There are three phases to a real estate rental investment. 

  • Find the deal
  • Acquire the deal
  • Manage the deal

Most real estate investors find it is easier to handle the three phases in a local market. 

Finding deals requires implementing lead generation strategies. Lead generation strategies are either remote (i.e., direct mail, online advertising, cold-calling) or in-person (i.e., bandit signs, driving for dollars, door knocking). If you are investing in your local market, you can take advantage of both lead generation categories.

Once you find a deal, you can drive to the home or building yourself to perform due diligence to determine and offer price. 

After you have acquired the deal, you can either self-manage or oversee a third-party property management company.

When investing out-of-state, your options for finding, acquiring, and managing deals are limited…or are they?

Theo recently interviewed Andrea Weule on my podcast, Best Real Estate Investing Advice Ever. She lives in the highly competitive Denver, CO market, so she buys rentals out-of-state. In that interview, Andrea debunks the myth that you cannot invest out-of-state and provides interesting ways to generate leads and perform due diligence remotely.

The first phase is to find a deal. Andrea finds her out-of-state deals in three ways. First, she works with a real estate agent who sends her on-market deals off the MLS. She says that ignoring the MLS results in ignoring low hanging fruit. 

Secondly, she creates a list of motivated sellers. Andrea’s targets home that have been owned for more than 20 years and where the owner is 55 years old or older. She finds that these owners are often motivated to sell. They are approaching retirement and are thinking about the next phase in their life, which may require the selling of their home.

Andrea uses ListSource to create this list.

Then, she sends a sequence of three mailers for each address. Rather than using a generic “we buy houses” letter, she creates a message that speaks more directly to the 55+ years old demographic. The letters include questions like “are you looking for your next adventure?” or “do you want to eliminate the stress of owning a home?” 

These first two strategies (direct mail and MLS) are remote lead generation strategies. The third strategy Andrea implements is traditionally performed in-person – bandit signs. However, rather than flying to the market and placing the bandit signs herself, Andrea hires someone local to the area.

The process is simple. She creates a job posting in the “gigs” section on Craigslist with the purpose of hiring someone to place bandit signs in the local market. Andrea sends them the bandit signs, which have a GPS tracker. The GPS tracker allows her to confirm that the sign was places in the correct location. Once the bandit sign is place, she requests that they send her a picture. Lastly, Andrea will send them their payment via PayPal.

Andrea uses a similar strategy for the second phase of the real estate investing process – the acquisition. If someone is interested in selling her their property, she performs basic due diligence to determine an offer price. 

Back to Craigslist. She will create another job posting. But this time, she is hiring someone to take pictures of the prospective property, as well as to do a Zoom Tour. With the combination of the pictures and video from the Zoom tour, she has all the information she needs in order to submit an offer.

 

Overall, it is a myth that it is harder to or that you cannot invest out-of-state. All it takes is a little creativity and the use of technologies.

Follow Me:  
FacebooktwitterlinkedinrssyoutubeinstagramFacebooktwitterlinkedinrssyoutubeinstagram


Share this:  
FacebooktwitterpinterestlinkedinFacebooktwitterpinterestlinkedin

Turn a Decade Into a Year – How to “Knowledge Hack”

I love helping other people cut the learning curve. There have been several instances in my life where I condensed years and even decades of time by using a simple “Knowledge Hack” strategy. 

 

I Have a Question For You…

Have you considered having a mentor? Is it worth your time to read books, listen to podcasts, watch how-to videos, and network with others? 

 

Today I was researching some of the most successful people in America from the Forbes 400 List and realized that almost all of them had mentors at some point, and many still have mentors today. 

 

A Few Examples Include:

 

  • Bill Gates had Ed Roberts as a mentor
  • Oprah Winfrey had Mary Duncan as a mentor
  • Mark Zuckerberg had Steve Jobs as a mentor
  • Warren Buffet had Benjamin Graham as a mentor
  • Sam Walton (And family) had L.S. Robson as a mentor
  • Michael Dell had Lee Walker as a mentor 

 

Rather than thinking about having a “mentor” think of the word “coach” instead. It’s essentially the same thing, but using the word “coach” helped me put all of this into perspective years ago.   

 

A Quick Story

From 2009 to 2015 I did everything on my own as an active real estate investor in the single-family home space. It wasn’t because I thought I knew it all, it was because I did not see the need for a mentor or coach at the time. 

 

What I finally realized in 2015 (after 7 years of trial and error), was there were other people in the active real estate investing space who were operating much more efficiently than I was. They had more connections and were finding better deals and had a broader range of skill sets and ultimately… they were more profitable than I was. I had to do some soul searching, self-reflection, and take a long, hard, look in the mirror. Was active investing really the best use of my time and skills? 

 

What Happened Next?

I made a decision to start partnering with investment firms who had better skill sets, track record, connections, and efficiencies than I did. I essentially “piggybacked” off their success by becoming a limited partner investor in other people’s private placement offerings (mostly in multifamily apartments). This provided a hands-off approach to investing where I had the best of both worlds. I could participate in real estate, which I love and enjoy, while not having to be “in the business” of real estate in an active way, which I did not enjoy. 

 

After dedicating some time to networking, reading, listening to podcasts, watching how-to videos and seeking mentors, I inevitably became a full-time passive investor in real estate. I left the active single-family strategy behind because I was tired and burned out from trying to do it all myself, trying to make the right calls and know all the ends and outs. In addition, the hands-on approach was taking too much time away from the things I loved doing. I had far less spare time because my real estate projects were consuming more and more of my availability. 2015 was the beginning of an entirely new education process that has been life-changing to say the least.  

 

Takeaway

Mentors can come in many forms. The best advice I ever received was to seek out a mentor or “coach” who is doing what you want to do and is successful at doing it…because success leaves clues. 

“If I have seen further than others, it is by standing upon the shoulders of giants” – Sir Isaac Newton

 

To Your Success

 

Travis Watts

Follow Me:  
FacebooktwitterlinkedinrssyoutubeinstagramFacebooktwitterlinkedinrssyoutubeinstagram


Share this:  
FacebooktwitterpinterestlinkedinFacebooktwitterpinterestlinkedin
people shaking hands in front of a house

Securing Capital and Commitments from Passive Real Estate Investors

You have a vision for where you will be in the booming real estate industry in the next few months, years, maybe even decades. The trick, though, is figuring out how to get there.

The reality is, it’s difficult to boost your bottom line in this business without raising real estate capital from passive investors who are looking for great deals. For this reason, it’s critical that you understand how to secure capital and commitments from accredited investors.

Create a Strong Investment Summary to Attract Investors

If you’re wondering how to secure capital investment, note that your first critical step is to create an impactful investment summary that will entice passive investors to commit capital to you for a particular deal. The investment summary is basically a business plan designed for your target investment property.

With the right documentation, you can effectively communicate your offering to potential investors. In addition, the process of drafting your summary will help you to think deeply about and address critical aspects of your potential deal. For example, as you think through your deal summary, you’ll be able to identify any gaps in the plan and take steps to remedy them. This will, in turn, boost your confidence and show your potential investors that you have something of value to bring to the table.

Questions to Address in Your Deal Summary to Attract Real Estate Capital

If you’re trying to find out how to secure capital investment, here are four important questions to answer in your investment summary, or your deal summary.

First, why are you investing in real estate? Second, why now? Also, why are you focusing on the specific market area associated with your potential deal? Fourth, why are you interested in that specific deal?

You can answer these questions in a few main sections of your investment summary, which we’ll go over below.

Your Real Estate Capital Deal Plan Introduction and Management Team

Your introduction should, ideally, be less than two pages. The intro is essentially a quick summary of yourself, including the fact that you’re a real estate investor and what you’re attempting to accomplish. You’ll also want to briefly spell out how your potential passive real estate investor can benefit from committing capital to you. Besides a solid ROI, what else can you offer them to add value to their own business or portfolio?

Next, you’ll want to explain who is on your team. For instance, maybe you are working with a real estate broker who happens to be the top specialist in investment properties in your city. Or maybe you have an accountant who personally owns several investment properties and thus understands your investing strategy. Perhaps you work with contractors who are able to provide you with renovations at low costs.

The stronger your management team is, the more appealing you’ll look to passive real estate investors, even if you don’t have a wealth of investing experience yourself. And the more likely you are to receive the funds you need to make your dream deal happen.

Your Real Estate Capital Investment Plan Opportunity

In your investment plan, you’ll also want to lay out what exactly you’re investing in. Also, emphasize why you’re so interested in this deal. For this section of your investment plan, it’s critical that you complete extensive market research. Be sure to provide plenty of details so that your future passive real estate investors will know where their money is going.

Your Real Estate Capital Deal Plan Investment Analysis

Crunching numbers is another important step when you’re seeking real estate capital and commitments from passive real estate investors. In this section, you’ll want to convince your future real estate investors why your target deal is such a great deal. After all, your passive investors’ main concern is losing money. Your goal should be to show them that you’re taking the necessary steps to mitigate real estate investment risks so that they’ll not only keep their money but also grow it.

Your Real Estate Capital Deal Plan Exit Strategy

Be sure to also highlight in your deal plan what your deal exit strategy is. Specifically, what will happen if you can’t rent out your new property, for example? Or what will you do if the market ends up crashing? This section of your plan should answer these questions so that your future passive real estate investors know that the capital they give you is protected.

Note that ideally, you should send your investment summary to potential investors in your database only after you’ve met with them in person. Building personal connections is an important step if you’re trying to secure commitments from passive investors.

Next Steps When Creating Real Estate Capital from Passive Real Estate Investors

Once you’ve created your investment summary, you can email it to your target investors. Next, you can conduct a conference call and follow up with them to see who is interested in partnering with you on your deal of interest. Finally, you can send the appropriate documentation to those who are interested in working with you.

As mentioned earlier, you’ll need to demonstrate to your potential investors a robust return on their investment. In addition, make sure that you show them a robust margin of safety. Your goal should be to buy an investment property for a low-enough price that adverse conditions in the market—like price declines in the market—are not likely to impede your and your investors’ gains long term.

Start Securing Capital and Commitments from Passive Real Estate Investors Today!

If you’re interested in attracting real estate capital for future deals, it’s critical that you understand how to build connections with passive real estate investors and market possible deals to them. Fortunately, you don’t have to figure out how to secure capital investment all by yourself.

Contact me today to learn how to secure commitments from investors and thus turn your dream deal into a reality. Or, work with me on one of my investment deals!

Follow Me:  
FacebooktwitterlinkedinrssyoutubeinstagramFacebooktwitterlinkedinrssyoutubeinstagram


Share this:  
FacebooktwitterpinterestlinkedinFacebooktwitterpinterestlinkedin
Palm trees surrounding a large apartment building at dusk

How to Make Your Passive Investors Aware of Potential Real Estate Investment Risks Without Ruining Your Chances

The greater the risk, the greater the reward, right? This old adage applies in many aspects of life, and real estate investing is one of them. The question, though, is what amount of risk is appropriate?

 

The reality is, the chance to purchase physical assets provides many investors with a sense of comfort. Plus, the fact that the real estate market has rebounded from the Great Recession of 2008 and has reached all-time highs lately makes this industry even more appealing to investors. Still, these investments may come with several risks that your passive investors should consider, rather than simply paying attention to the anticipated return.

 

Here’s a rundown on how to make your passive investors aware of potential real estate investment risks without ruining your chances.

The Risk of Commercial Renters Going Bankrupt

How stable and long-lasting is a commercial real estate property’s stream of income? That’s what ultimately drives its value. For instance, if Apple signs a 20-year lease with you, the price tag of this lease is much higher than the total amount of money you’d generate in an office building featuring many smaller tenants.

 

However, to make your passive investors aware of credit risk, show them recent news reports about Sears’ financial struggles. Sears used to anchor malls back in the 1990s, but these days, it is going through the bankruptcy process. The truth is, even tenants who are the most creditworthy can end up going bankrupt, so this is a risk that’s important for passive investors in commercial real estate to consider.

 

Demonstrate to investors how you’ll deal with renter turn around in a lucrative way so that, if this ever happens, they know you can recover easily.

Real Estate Investment Risks Include Leverage Risk

The greater the amount of debt you have tied up in a real estate investment, the greater the risk associated. In this situation, investors would be wise to demand more in return.

 

The thing about leverage is that can certainly help to propel a project forward quickly, in addition to increasing returns if everything is going well. However, if the loans associated with a project happen to be under stress—for instance, the return on the asset is not sufficient for covering the interest payments—an investor tends to lose large sums of money quickly.

 

The Leverage Rule

 

In light of the above, a good rule of thumb is not to let leverage exceed 80%. A return on an asset should primarily be generated from the real estate property’s performance—not through excessive reliance on leverage. So, be sure to instruct your passive investors to exercise caution when it comes to the amount of leverage used for capitalizing an asset. Also, remind them to ascertain that they receive returns that are commensurate with that asset’s risk.

Discuss with Them Any Structural Risk

Structural real estate investment risks aren’t related to a real estate property’s structure; rather, they have to do with the financial structure of an investment, as well as the rights provided to participants.

 

You need to tell your passive investors what their rights are based on their positions in a joint venture, like a limited liability company—for instance, whether they have a minority or majority holding. This will determine how much they’ll have to pay the person managing the company when the real estate asset is sold, as well as how much profit they’ll receive from the deal.

 

Also, how much equity is the manager investing compared with the limited partners? If limited partners are involved in deals with advantageous profit splits with the managers, and if the managers have a lot less cash invested in these deals, the managers are incentivized to take more risk. Make sure that your passive investors understand this structural risk concept before moving forward with a deal.

Liquidity Risk as it Relates to Various Markets

To make your passive investors aware of liquidity risk, ask them how they’ll exit an investment if they need to. Use two completely different cities to make your point about this type of risk.

 

For instance, dozens of investors might show up to place bids in a large real estate market like Houston, no matter what the market conditions may be like. Meanwhile, a real estate asset located in the city of Evansville in Indiana won’t draw as many market participants. This is an important consideration because it may be easier to get into the Indiana investment, but it will also be harder to get out of it.

Idiosyncratic Risk – Location, Location, Location

Idiosyncratic real estate investment risks are related to a certain property. Point your private investors to the current example of Wrigley Field to help them to understand a particularly important type of idiosyncratic risk: location risk.

 

Buildings behind this famous Cubs baseball field in Chicago have been used to host privately held rooftop parties. However, these assets are becoming bust investments because a brand-new video board will totally block their views into the field. Meanwhile, property values around The 606—Chicago’s high line— are rising.

 

Additional Idiosyncratic Risks

 

Other types to consider include construction risk. Construction makes a project riskier by limiting the ability to collect rent or profit during the construction period. In addition to construction risk, there are environmental risks, which may include workforce and political risks, budget overruns, and soil contamination.

 

Yet another type of idiosyncratic risk to factor in is entitlement risk. Entitlement risk is where a government agency that has jurisdiction over your project will not issue the necessary approvals for your project to move forward.

Start Making Smart Investments Amid Today’s Potential Real Estate Investment Risks!

Real estate investing does come with multiple risks, but if you and your private investors weigh the risks and the rewards wisely, you can enjoy great returns from one deal to the next. Learn more about finding and making great apartment deals from my and Theo Hick’s book, Best Ever Apartment Syndication Book.

Follow Me:  
FacebooktwitterlinkedinrssyoutubeinstagramFacebooktwitterlinkedinrssyoutubeinstagram


Share this:  
FacebooktwitterpinterestlinkedinFacebooktwitterpinterestlinkedin
red and white apartment building

What Every Passive Investor Should Know About Apartment Syndication Deals and Income

Last Updated: 3/12/19

Apartment syndication is becoming an increasingly popular real estate investment strategy for many reasons. Being a passive investor who is involved in apartment deals gives you the flexibility and freedom to use your time to pursue other ventures while still generating income.

While this is definitely a trending strategy today, apartment syndication is by no means simple. Learning the ins and outs of investing is crucial to becoming a successful real estate investor, particularly when it comes to closing deals. Here’s what every passive investor should know about apartment syndication:

The Basics

To start, gain a brief overview of apartment syndication from the perspective of a passive investor. Your role during an apartment syndication deal is to provide the general partner (GP) with capital to invest in the purchase of apartment complexes. This investment is similar to other investments in stocks or bonds but typically offers a much better return.

Essentially, you help fund the deal, which does not require that you be actively involved in the day to day management of the project. Most apartment syndications will require a minimum investment amount, so it is important to do your research and know exactly how much you are able to invest. Additionally, how often investors are paid depends on the general partner and overall business strategy. However, most investors are typically paid on a monthly or quarterly basis.

How to Make Money

There are two kinds of passive income investments when it comes to apartment syndication. You would be either an equity or debt investor. There are advantages to both investment types and which option you choose depends on your financial goals and risk preference. For equity investments, a passive investor is able to make money through 2 different aspects: preferred returns and profit splits.

  • Preferred Returns
    A preferred return is defined as “the threshold return that limited partners receive prior to general partners being paid”. This amount is typically between 2-12% per a year, depending on the investment.
  • Profit Splits
    Profit splits involves sharing the profit of the investment between general partners and passive investor or limited partners (LP). This could mean a 50/50 split or 80% to the LP and 20% to the GP. Typically most deals will involve a mix of both preferred returns and profit splitting.

For debt investments, a passive investor makes money from interest payments. The interest rate is typically set by the general partner and will vary depending on the deal structure. Debt investors will also usually get their investment capital back before the apartment syndication is complete and the property sold.

Becoming an equity or debt investor depends on your individual investment goals. All passive income investments are different and will require you to thoroughly research and review the deal in order to determine if it will make sense for you financially.

Types of Apartment Syndications

Every passive investor interested in apartment syndication should be aware of the two key types of deals that are available: a distressed property or value-add property. Each property type has its own specific opportunities and risks. A distressed property is defined as a non-stabilized apartment complex. This type of property likely suffers from poor operations, problems with tenants, outdated facilities, and more, which all contribute to an economic occupancy rate that is lower than 85%.

In comparison, a value-add property is defined as a stabilized apartment complex that is well maintained but is either outdated or operating inefficiently. This type of property is stable with an economic occupancy rate that is more than 85%.

Know the Business

Regardless of what deal you are considering as a passive investor, it is always important to know how the real estate business works. This includes understanding both the opportunities and risk associated with a particular apartment syndication deal. Take the time to really analyze and discuss the benefits of the deal with the general partner before making any decisions.

Some key terms to know and study:

  • Accredited Investor
  • Net Operating Income (NOI)
  • Cash Flow
  • Breakeven Occupancy
  • Internal Rate of Return (IRR)
  • Profit and Loss Statement
  • Exit Strategy

Here is a full list of important terminology, with definitions and examples, that will help when reviewing any apartment syndication.

Every general partner should be open and transparent when it comes to any potential risks involved with the deal. Every investment has risks, so don’t believe anyone that tells you otherwise.

Having experience in the real estate business, and particularly apartment syndication, is incredibly valuable when looking for new passive income investments. Be sure to discuss with the general partner all of the previous deals they have worked on and how they performed based on the business plan. This will give you an idea of the level of risk, particularly if the rest of the team is inexperienced.

The Bottom Line

When it comes to passive income investments it is important to work with the right group of investors and general partners in order to make sure that you are meeting your financial goals. Part of being a passive investor is giving your control to other partners who ultimately make decisions on how your money is invested. Having the right team of people will limit the amount of risk in your investment.

For more information about this type of investment, check out my comprehensive passive investor resources!

Follow Me:  
FacebooktwitterlinkedinrssyoutubeinstagramFacebooktwitterlinkedinrssyoutubeinstagram


Share this:  
FacebooktwitterpinterestlinkedinFacebooktwitterpinterestlinkedin
Top of cream-colored house and clear, blue sky

SFRs Vs. Apartment Syndications: Which Is The Better Passive Investment?

We’ve weighed the pros and cons of passive apartment investing versus investing in REITs, but what about another type of real estate — single family residences? To passively invest in single family residences (SFRs) is to purchase an SFR with the purposes of holding it as a rental property from a turnkey provider who handles every aspect of the transaction. To passively invest in apartments is to invest in an apartment syndication — a partnership between a sponsor who handles every aspect of the transaction and the passive investor who funds a portion of the down payment — and share in the profits.

 

Related: What is Apartment Syndication?

 

Since both strategies are passive, they’re equal in regard to control (or lack thereof). However, being two distinctive types of real estate, the benefits and drawbacks of each are different. So, in order to determine which passive investment strategy is better, let’s compare and contrast them based on three categories: time commitment, returns and risk.

 

1. Time Commitment

There is no such thing as a 100% passive investment. There are similar time commitments for both strategies: You must initially qualify the sponsor/turnkey provider, qualify their deals before investing and stay up-to-date on the progress of the deal after close.

There are also differences.

Because it is a one-unit residential property, understanding and evaluating an SFR is not that complicated. You likely have the education to acquire a passive SFR investment. On the other hand, apartments are a more complex asset class. Before becoming a passive investor, you’ll likely need to educate yourself on the apartment syndication process.

It’s easier to scale by passively investing in apartment syndications. After you’ve qualified the sponsor, it’s as simple as they send you a deal, and you decide whether to invest. For each SFR investment, you’ll select from a menu of deals. It can take months until you find one that meets your investment goals, at which point the process repeats itself.

Additionally, since you’re limited to the number of residential loans you can obtain, you’ll eventually have to either purchase SFRs with all cash or with creative financing, both of which take more time than traditional financing. For apartment syndications, you can usually invest any amount — although a minimum investment of $25,000 to $50,000 is common — an unlimited number of times without having to worry about securing or qualify for financing. This reduces your ongoing time commitment and increases your ability to scale.

 

2. Returns

In regard to returns, the two factors to address are cash flow and equity. Cash flow is the profit distributed to the passive investor on an ongoing basis, and equity is the profit captured at sale and/or refinance.

As a passive SFR investor, you have 100% ownership of the property, which means you receive 100% of the profits. Since an SFR has one rentable unit, the returns are more fragile. If you have one vacancy, you’re 100% vacant. If you have one maintenance issue or expensive turn, your cash flow for a few months to a few years can be wiped out.

As a passive apartment investor, you only have partial ownership of the property, which means you receive a smaller percentage of the profits. But, since apartments have hundreds of units, a few vacancies, evictions or maintenance issues have a lower impact on the cash flow. At the same time, you are typically offered a preferred return, which is a threshold return distributed to investors before the sponsor receives payment. A greater number of units combined with a preferred return results in more certainty as it relates to cash flow.

The value of SFRs is dependent not on the rents but on the market, which is out of your control. Sure, in an appreciating market, you could double the property value. But you could also get unlucky with a stagnating or depreciating market.

The value of an apartment is dependent on the revenue, not the market, which is in your — or technically, the sponsors’ — control. The sponsor can increase the rents through renovations and increase the revenue by offering certain amenities (i.e., coin-operated laundry, carports, storage lockers, etc.). Luck is removed and replaced with skill. If the sponsor executes the business plan and increases the revenue, the property value, and thus your investment, is increased.

 

Related: 27 Ways to Add Value to Apartment Communities

 

3. Risk

You have 100% ownership as a passive SFR investor, which means you participate in 100% of the upside and 100% of the downside. You hold all of the risk. Since you sign on the loan, you are responsible for 100% of the debt. Default on a payment, and you are the one who is impacted.

Again, the SFR cash flow is more fragile due to having one rentable unit. However, this risk is reduced once you’ve scaled to a certain number of SFRs. But having a passive portfolio of 100 SFRs is different than passively investing in a 100-unit apartment community. The SFRs are scattered across the market, which means you don’t benefit as much from economies of scale. Management and contractor (i.e., landscapers, maintenance people, etc.) fees are costlier. The benefit, however, is that you have 100% ownership of the 100 SFRs as opposed to partial ownership in the 100-unit apartment community, which means you’ll have a greater long-term upside potential.

Passively investing in apartment syndications is less risky because you aren’t signing on a loan. The risk is also reduced from day one because you are investing in multiple units right away as opposed to having to scale to hundreds of units. And with hundreds of units in one centralized location comes economies of scale, which means lower management and contractor costs.

 

Related: Active vs. Passive: Which is the Superior Investment Strategy?

 

The Winner?

Apartment syndications have a lower time commitment, more certain returns and less risk. SFRs have less scalability, more risk and fragile returns in the medium-term with a greater long-term upside potential.

Ultimately, the best strategy comes down analyzing the pros and cons of each and determining which one aligns the best with your risk tolerance, time commitment and return goals.

 

Want to learn how to build an apartment syndication empire? Purchase the world’s first and only comprehensive book on the exact step-by-step process for completing your first apartment syndication: Best Ever Apartment Syndication Book.

Follow Me:  
FacebooktwitterlinkedinrssyoutubeinstagramFacebooktwitterlinkedinrssyoutubeinstagram


Share this:  
FacebooktwitterpinterestlinkedinFacebooktwitterpinterestlinkedin
internal rate of return vs. cash on cash return

Internal Rate of Return (IRR) vs. Cash on Cash (CoC) Return: What Is the Difference?

When an apartment syndicator analyzes the results of their underwriting, and when a passive investor is deciding whether to invest in a syndicator’s deal, the two main return factors they focus on are the cash-on-cash return and the internal rate of return.

In this blog post, you will learn the definitions of these two important return factors, how they are calculated, and why they are relevant in apartment syndications.

 

What is Cash-on-Cash Return?

Cash-on-cash return (commonly referred to a CoC return) is a factor that refers to the return on invested capital. CoC return is the relationship between a property’s cash flow and the initial equity investment, which is calculated by dividing the initial equity investment by the cash flow. For the purposes of the CoC return calculation for apartment syndications, cash flow is the profits remaining after paying the operating expenses and debt service.

There are actually two different versions of the CoC return for apartment syndications: including profits from sale and excluding profits from sale. The CoC return factor excluding profits from sale will show passive investors how much money they should to expect to receive for each distribution during the hold period, as well as an average annual return on their investment. The CoC return factor including the profits from sale will show passive investors how much money they should expect to make from the project as a whole.

In order to calculate both CoC return factors, you need the initial equity investment amount, the projected annual cash flows, and the projected profit from sale for both the overall project and to the passive investors.

Here is an example of how to calculate CoC return for an apartment project:

 

 

Passive investors aren’t as concerned about the overall project’s CoC return but more so the CoC return to the limited partners (LP).

Here is an example of how to calculate the CoC returns to the limited partners based on an 8% preferred return and 70/30 profit split:

 

 

In this example, the average annual CoC return to the LP is 8.33%, which is good because it is above the preferred return offered. The overall CoC return for the five years is 185.72%. So, someone who invested $100,000 would make $85,720 in profit.

However, as you can see in the example above, the CoC return to the limited partner is below the preferred return percentage in years one and three. So, for this deal, the syndicators options are to review their underwriting assumptions to see if they can increase the cash flow, have the preferred return accrue and pay the accrued amount at sale or when the cash flow supports it (i.e. end of year two to cover the year one shortfall), or pass on the deal.

A “good” CoC return metric is subjective and based on the goals of the syndicator and the passive investors. However, a good rule of thumb is a minimum average CoC return excluding the profits from sale equal to the preferred return offered to the limited partners.

 

What is Internal Rate of Return?

The main drawback of the cash-on-cash return metric is that it doesn’t account for the time value of money. For example, receiving a 185.72% CoC return over a 5-year period is very different than receiving the same CoC return over a 10-year period or a 1-year period. That is where internal rate of return comes in.

The technical definition of internal rate of return (commonly referred to as IRR) is the interest rate that makes the net present value of all cash flow equal to zero. In layman’s terms, this equates to a project’s actual or forecasted annual rate of growth by isolating the effect of compounding interest if the investment horizon is longer than one-year, which CoC return does not.

If you have the data to calculate the CoC return, you can calculate an IRR for the overall project and to the passive investors. What is needed is the initial equity investment and the annual cash flows, with the final year including the profit from sale.

The IRR formula is complex (click here if you want to see the full formula), so for simplicity, the IRR() function in excel should be used.

Following the same example, here is the 5-year IRR for the overall project and for the limited partners:

 

 

Another IRR metric is XIRR. For the regular IRR calculation, the assumption is that the cash flows are distributed on a fixed, periodic schedule (i.e. annually, monthly, quarterly, daily, etc.). The XIRR function calculates the internal rate of return when cash flows are distributed on an irregular period.

In order to calculate XIRR, the additional data required are the exact days that the cash flow was distributed. Examples of instances where the XIRR would come into play are when the syndicator refinances or secures a supplemental loan to return a portion of the passive investors’ equity and when the syndicator sells the asset since the closing date likely will not be exactly 1, 2, 3, etc. years after purchasing the deal.

A “good” IRR metric is also subjective and based on the goals of the syndicator and their passive investors. For my company’s deals, we want a 5-year IRR to the limited partners of at least 15%.

 

The main difference between the cash-on-cash return and internal rate of return metric is time. If the investment is held for one-year, then the two return metrics are interchangeable. But if the projected hold period is more than a year, internal rate of return is more accurate.

 

Are you a newbie or a seasoned investor who wants to take their real estate investing to the next level? The 10-Week Apartment Syndication Mastery Program is for you. Joe Fairless and Trevor McGregor are ready to pull back the curtain to show you how to get into the game of apartment syndication. Click here to learn how to get started today.

Follow Me:  
FacebooktwitterlinkedinrssyoutubeinstagramFacebooktwitterlinkedinrssyoutubeinstagram


Share this:  
FacebooktwitterpinterestlinkedinFacebooktwitterpinterestlinkedin
how passive investors make money

How Do Passive Investors Make Money in Apartment Syndications?

Passive investing is one of the best ways to receive the benefits of owning a large apartment building without the time commitment, funding the entire project or obtaining the expertise require to create and execute a business plan.

A passive investor might not see the same returns as an active investor who is finding, qualifying and closing on an apartment building use their own capital and overseeing the business plan through its successful completion. But compared to other passive investment vehicles, like stocks, bonds or REITs, apartment syndications cannot be beat (assuming the passive investor has found the right general partnership and qualified their team).

The returns offered to the limited partner (i.e. the passive investors) vary from general partner to general partner. Before making the commitment to invest, the limited partners (referred to as the LP hereafter) should understand the general partner’s (referred to as the GP hereafter) partnership structure, which includes the type of investment structure and how the returns are distributed.

Typically, a passive investor is either an equity investor or a debt investor in an apartment syndication. In this blog post, I will outline these two investment structures and the types of return structures for each.

 

Equity Investor

Of the two main types of investment structures, being an equity investor is the most profitable, because they participate in the upside of the deal. However, they typically will not receive their initial equity investment until the sale of the apartment.

The equity investor is offered an ongoing return, as well as a portion of the profits at sale. Generally, after the operating expenses and debt service are paid, the a portion of the remaining cash flow is distributed to the LP. For some partnership structures, the GP will take an asset management fee before distributing returns to the LPs. I do not like this approach since it decreases the alignment of interest because the GP receives payment before the LP. So, my company puts our asset management fee in second position to the LP returns (which means we don’t get an asset management fee until we’ve paid the LP).

The most common ongoing return is called a preferred return. The preferred return ranges from 2% to 12% annually based on the experience of the GP and their team, the risk factors of the project and the investment strategy. The less experience and the more risk, the higher the returns. In regards to the preferred returns associated with the three main apartment syndication investment strategies, the GP will offer the highest percentage for distressed apartments and the lowest percentage for turnkey apartments, with value-add apartments falling somewhere in-between.

For example, on a highly distressed apartment deal, the GP may offer a 12% preferred return. However, since the deal will likely have a lower or no return during the stabilization period, the preferred return would accrue and be paid out to the LP in one lumpsum. For turnkey apartments, the preferred return will fall towards the lower end of the range because, since the apartment is already stabilized and minimal value can be added, there is less risk. For value-add apartments, the typical preferred return that is offered to the LP is 8%.

Conversely, the GP may not offer a preferred return but a profit split instead. For example, 70% of the cash flow is distributed to the LP and the remaining 30% to the LP. However, I do not like this structure for the same reason why I don’t like putting the asset management fee ahead the LP returns – a reduction in alignment of interest. Therefore, the GP will usually offer a preferred return and specify a split of the overall profits between the LP and GP.

This remaining profit split can range from 90/10 (i.e. 90% to the LP, 10% to the GP) to 50/50. A common variation on the profit split will include hurdles, using return factors like the internal rate of return (referred to as IRR hereafter) or cash-on-cash return. For example, the LP is offered an 8% preferred return and 70% of the total profits. But, once the LP receives a 13% IRR, they receive 50% of the profits thereafter.

Another example is the LP is offered a 6% to 8% preferred and 50% of the total profits. But, once the LP receives an annualized return of 12% to 16% (which would occur at sale), the GP receives the remaining profits. This is the most ideally structure from the GPs point of view.

The equity investor also participates in the upside of the deal, which means they are offered a portion of the sales proceeds.

The most common equity structure for value-add apartment deals is an 8% preferred return with a 50/50 LP/GP profit split. The next most common equity structure is an 8% preferred return with a 70/30 LP/GP profit split until the LP IRR passes a certain threshold (10% to 20% is the standard range), at which point the remaining profits are split 50/50.

 

Debt Investor

Of the two main types of investment structures, being a debt investor is the least profitable. However, the lower profitability comes with a lower risk. Once the GP pays operating expenses and debt service, the remaining cash flow must go to distributing the fixed interest rate to the debt investor. However, unlike the preferred return offered an equity investor, if the GP is unable to pay the fixed interest rate (assuming they are still able to cover the operating expenses and debt service), the debt investor can take control of the property. Hence, less risk.

Unlike the equity investor, the debt investor doesn’t participate in the upside of the deal. Instead, they are offered a fixed interest rate until the GP is able to return 100% of their investment.

Similar to the preferred return, the interest rate that is offered to a debt investor is based on the GP’s experience, the risk factors associated with the project and investment strategy. However, since there is an overall reduced risk involved with being a debt investor, the interest rate is typically lower than what the preferred return would be for a similar project.

Another difference between equity and debt investors is that debt investors will typically receive their capital back before the apartment is sold, which generally occurs after a refinance or securing a supplemental loan. A supplemental loan is a financing option that is secured on top of the existing financing on the property that is typically available 12-months after closing the initial loan.

 

What’s a Better Passive Investment?

Like any investment, the best partnership structure is based on the passive investor’s goals. For those looking for a low-risk investment vehicle to park their money for a few years while receiving a fixed return that beats inflation, then becoming a debt investor may be more appealing. For those looking for an investment vehicle that offers a higher ongoing return (although not guaranteed) and the potential for a large lumpsum profit at sale, then being an equity investor may be more appealing. And of course, diversifying between the two structures is also an option!

 

Want to learn more about passively investing in apartment syndications? Visit the Best Ever Passive Investor Resources page, the only comprehensive resource available to passive investor.

 

Subscribe to my weekly newsletter for even more Best Ever advice www.BestEverNewsletter.com

Follow Me:  
FacebooktwitterlinkedinrssyoutubeinstagramFacebooktwitterlinkedinrssyoutubeinstagram


Share this:  
FacebooktwitterpinterestlinkedinFacebooktwitterpinterestlinkedin
glossary of apartment terms

Glossary of Apartment Syndication Terms

A glossary of terms and definitions, listed in alphabetical order, used in apartment syndications for aspiring apartment syndicators and passive investors to study in order learn the industry terminology.

 

A

 

Absorption Rate: The rate at which available rentable units are leased in a specific real estate market during a given time period.

Accredited Investor: A person that can invest in apartment syndications by satisfying one of the requirements regarding income or net worth. The current requirements to qualify are an annual income of $200,000, or $300,000 for joint income, for the last two years with the expectation of earning the same or higher, or a net worth exceeding $1 million either individually or jointly with a spouse.

Acquisition Fee: The upfront fee paid by the new buying partnership to the general partner for finding, evaluating, financing and closing the investment.

Active Investing: The finding, qualifying and closing on an apartment building using one’s own capital and overseeing the business plan through its successful execution.

Amortization: The paying off of a mortgage loan over time by making fixed payments of principal and interest.

Apartment Syndication: A temporary professional financial services alliance formed for the purpose of handling a large apartment transaction that would be hard or impossible for the entities involved to handle individually, which allows companies to pool their resources and share risks and returns. In regards to apartments, a syndication is typically a partnership between general partners (i.e. the syndicator) and limited partners (i.e. the passive investors) to acquire, manage and sell an apartment community while sharing in the profits.

Appraisal: A report created by a certified appraiser that specifies the market value of a property. The value is based on cost, sales comparable and income approach.

Appreciation: An increase in the value of an asset over time. The two main types of appreciation that are relevant to apartment syndications are natural appreciation and forced appreciation. Natural appreciation occurs when the market cap rate naturally decreases over time, which isn’t always a given. Forced appreciation occurs when the net operating income is increased by either increasing the revenue or decreasing the expenses. Force appreciation typically occurs by adding value to the apartment through renovations and/or operational improvements.

Asset Management Fee: An ongoing annual fee from the property operations paid to the general partner for property oversight.

 

B

 

Bad Debt: The amount of uncollected money owed by a tenant after move-out.

Breakeven Occupancy: The occupancy rate required to cover all of the expenses of a property.

Bridge Loan: A mortgage loan used until a borrower secures permanent financing. Bridge loans are short-term (six months to three years with the option to purchase an additional six months to two years), generally having higher interest rates and are almost exclusively interest only. Also referred to as interim financing, gap financing or swing loans. The loan is ideal for repositioning an apartment community that doesn’t qualify for permanent financing.

 

C

 

Capital Expenditures (CapEx): The funds used by a company to acquire, upgrade and maintain a property. Also referred to as CapEx. An expense is considered CapEx when it improves the useful life of a property and is capitalized – spreading the cost of the expenditure over the useful life of the asset. CapEx included both interior and exterior renovations.

Capitalization Rate (Cap Rate): The rate of return based on the income that the property is expected to generate. Also referred to as the cap rate. The cap rate is calculated by dividing the net operating income by the current market value of a property.

Cash Flow: The revenue remaining after paying all expenses. Cash flow is calculated by subtracting the operating expense and debt service from the collected revenue.

Cash-on-Cash Return: The rate of return based on the cash flow and the equity investment. Also referred to as CoC return. Coc return is calculated by dividing the cash flow by the initial equity investment.

Closing Costs: The expenses, over and above the purchase price of the property, that buyers and sellers normally incur to complete a real estate transaction. These costs include origination fees, application fees, recording fees, attorney fees, underwriting fees, due diligence fees and credit search fees.

Concessions: The credits given to offset rent, application fees, move-in fees and any other cost incurred by the tenant, which are generally given at move-in to entice tenants into signing a lease.

Cost Approach: A method of calculating a property’s value based on the cost to replace (or rebuild) the property from scratch. Also referred to as the replacement approach.

 

D

 

Debt Service: The annual mortgage amount paid to the lender, which includes principal and interest. Principal is the original sum lent to a borrower and the interest rate is the charge for the privilege of borrowing the principal amount.

Debt Service Coverage Ratio (DSCR): The ratio that is a measure of the cash flow available to pay the debt obligation. Also referred to as the DSCR. The DSCR is calculated by dividing the net operating income by the total debt service. A DSCR of 1.0 means that there is enough net operating income to cover 100% of the debt service. Ideally, the DSCR is 1.25 or higher. A property with a DSCR too close to 1.0 is vulnerable, and a minor decline in revenue or minor increase in expenses would result in the inability to service the debt.

Depreciation: A decrease or loss in value due to wear, age or other cause.

Distressed Property: A non-stabilized apartment community, which means the economic occupancy rate is below 85% and likely much lower due to poor operations, tenant problems, outdated interiors, exteriors or amenities, mismanagement and/or deferred maintenance.

Distributions: The limited partner’s portion of the profits, which are sent on a monthly, quarterly or annual basis, at refinance and/or at sale.

Due Diligence: The process of confirming that a property is as represented by the seller and is not subject to environmental or other problems. For apartment syndications, the general partner will perform due diligence to confirm their underwriting assumptions and business plan.

 

E

 

Earnest Money: A payment by the buyers that is a portion of the purchase price to indicate to the seller their intention and ability to carry out sales contract.

Economic Occupancy Rate: The rate of paying tenants based on the total possible revenue and the actual revenue collected. The economic occupancy is calculated by dividing the actual revenue collected by the gross potential income.

Effective Gross Income (EGI): The true positive cash flow. Also referred to as EGI. EGI is calculated by subtracting the revenue lost due to vacancy, loss-to-lease, concessions, employee units, model units and bad debt from the gross potential income.

Employee Unit: An apartment unit rented to an employee at a discount or for free.

Equity Investment: The upfront costs for purchasing a property. For apartment syndications, these costs include the down payment for the mortgage loan, closing costs, financing fees, operating account funding and the fees paid to the general partnership for putting the deal together. Also referred to as the initial cash outlay or the down payment.

Equity Multiple (EM): The rate of return based on the total net profit and the equity investment. Also referred to as EM The EM is calculated by dividing the sum of the total net profit (cash flow plus sales proceeds) and the equity investment by the equity investment.

Exit Strategy: The general partner’s plan of action for selling the apartment community at the conclusion of the business plan.

 

F

 

Financing Fees: The one-time, upfront fees charged by the lender for providing the debt service. Also referred to as finance charges.

 

G

 

General Partner (GP): An owner of a partnership who has unlimited liability. A general partner is usually a managing partner and is active in the day-to-day operations of the business. In apartment syndications, the general partner is also referred to as the sponsor or syndicator and is responsible for managing the entire apartment project.

Gross Potential Income: The hypothetical amount of revenue if the apartment community was 100% leased year-round at market rental rates plus all other income.

Gross Potential Rent (GPR): The hypothetical amount of revenue if the apartment community was 100% leased year-round at market rental rates. Also referred to as GPR.

Gross Rent Multiplier (GRM): The number of years it would take for a property to pay for itself based on the gross potential rent. Also referred to as the GRM. The GRM is calculated by dividing the purchase price by the annual gross potential rent.

Guaranty Fee: A fee paid to a loan guarantor at closing for signing for and guaranteeing the loan.

 

H

 

Holding Period: The amount of time the general partner plans on owning the apartment from purchase to sale.

 

I

 

Income Approach: A method of calculating an apartment’s value based on the capitalization rate and the net operating income (value = net operating income / capitalization rate).

Interest Rate: The amount charged by a lender to a borrower for the use of their funds.

Interest-Only Payment: The monthly payment for a mortgage loan where the lender only requires the borrower to only pay the interest on the principal.

Internal Rate of Return (IRR): The rate needed to convert the sum of all future uneven cash flow (cash flow, sales proceeds and principal paydown on the mortgage loan) to equal the equity investment. Also referred to as IRR.

 

J

 

K

 

L

 

Lease: A formal legal contract between a landlord and a tenant for occupying an apartment unit for a specified time and at a specified price with specified terms.

Letter of Intent (LOI): A non-binding agreement created by a buyer with their proposed purchase terms. Also referred to as the LOI.

Limited Partner (LP): A partner whose liability is limited to the extent of their share of ownership. Also referred to as the LP. In apartment syndications, the LP is the passive investor who funds a portion of the equity investment.

London Interbank Offered Rate (LIBOR): A benchmark rate that some of the world’s leading banks charge each other for short-term loans. Also referred to as LIBOR. The LIBOR serves as the first step to calculating interest rates on various loans, including commercial loans, throughout the world.

Loan-to-Cost Ratio (LTC): The ratio of the value of the total project costs (loan amount + capital expenditure costs) divided by the apartment’s appraised value.

Loan-to-Value Ratio (LTV): The ratio of the value of the loan amount divided by the apartment’s appraised value.

Loss-to-Lease (LtL): The revenue lost based on the market rent and the actual rent. Also referred to as LtL. The LtL is calculated by dividing the gross potential rent minus the actual rent collected by the gross potential rent.

 

M

 

Market Rent: The rent amount a willing landlord might reasonably expect to receive and a willing tenant might reasonably expect to pay for tenancy, which is based on the rent charged at similar apartment communities in the area. The market rent is typically calculated by conducting a rent comparable analysis.

Metropolitan Statistical Area (MSA): A geographical region containing a substantial population nucleus, together with adjacent communities having a high degree of economic and social integration with that core. Also referred to as the MSA. MSAs are determined by the United States Office of Management and Budget (OMB).

Model Unit: A representative apartment unit used as a sales tool to show prospective tenants how the actual unit will appear once occupied.

Mortgage: A legal contract by which an apartment is pledged as security for repayment of a loan until the debt is repaid in full.

 

N

 

Net Operating Income (NOI): All the revenue from the property minus the operating expenses. Also referred to as the NOI.

 

O

 

Operating Account Funding: A reserves fund, over and above the purchase price of an apartment, to cover things like unexpected dips in occupancy, lump sum insurance or tax payments or higher than expected capital expenditures. The operating account funding is typically created by raising extra capital from the limited partners.

Operating Agreement: A document that outlines the responsibilities and ownership percentages for the general and limited partners in an apartment syndication.

Operating Expenses: The costs of running and maintaining the property and its grounds. For apartment syndications, the operating expense are usually broken into the following categories: payroll, maintenance and repairs, contract services, make ready, advertising/marketing, administrative, utilities, management fees, taxes, insurance and reserves.

 

P

 

Passive Investing: Placing one’s capital into an apartment syndication that is managed in its entirety by a general partner.

Permanent Agency Loan: A long-term mortgage loan secured from Fannie Mae or Freddie Mac. Typical loan terms lengths are 3, 5, 7, 10, 12 or more years amortized over up to 30 years.

Physical Occupancy Rate: The rate of occupied units. The physical occupancy rate is calculated by dividing the total number of occupied units by the total number of units at the property.

Preferred Return: The threshold return that limited partners are offered prior to the general partners receiving payment.

Prepayment Penalty: A clause in a mortgage contract stating that a penalty will be assessed if the mortgage is paid down or paid off within a certain period.

Price Per Unit: The cost per unit of purchasing a property. The price per unit is calculated by dividing the purchase price of the property by the total number of units.

Private Placement Memorandum (PPM): A document that outlines the terms of the investment and the primary risk factors involved with making the investment. Also referred to as the PPM. The PPM typically has four main sections: the introductions (a brief summary of the offering), basic disclosures (general partner information, asset description and risk factors), the legal agreement and the subscription agreement.

Pro-forma: The projected budget with itemized line items for the revenue and expenses for the next 12 months and five years.

Profit and Loss Statement (T-12): A document or spreadsheet containing detailed information about the revenue and expenses of a property over the last 12 months. Also referred to as a trailing 12-month profit and loss statement or a T-12.

Property and Neighborhood Classes: A ranking system of A, B, C or D assigned to a property and a neighborhood based on a variety of factors. For property classes, these factors include date of construction, condition of the property and amenities offered. For neighborhood classes, these factors include demographics, median income and median home values, crime rates and school district rankings.

Property Management Fee: An ongoing monthly fee paid to the property management company for managing the day-to-day operations of the property.

 

Q

 

R

 

Ration Utility Billing System (RUBS): A method of calculating a tenant’s utility usage based on occupancy, unit square footage or a combination of both. Once calculated, the amount is billed back to the tenant.

Recourse: The right of the lender to go after personal assets above and beyond the collateral if the borrower defaults on the loan.

Refinance: The replacing of an existing debt obligation with another debt obligation with different terms.

Refinancing Fee: A fee paid to the general partner for the work required to refinance an apartment.

Rent Comparable Analysis (Rent Comps): The process of analyzing the rental rates of similar properties in the area to determine the market rents of the units at the subject property.

Rent Premium: The increase in rent demanded after performing renovations to the interior and/or exterior of an apartment community.

Rent Roll: A document or spreadsheet containing detailed information on each of the units at the apartment community, including the unit number, unit type, square footage, tenant name, market rent, actual rent, deposit amount, move-in date, lease-start and lease-end date and the tenant balance.

 

S

 

Sales Comparison Approach: A method of calculating an apartment’s value based on similar apartments recently sold.

Sales Proceeds: the profit collected at the sale of the apartment community.

Sophisticated Investor: A person who is deemed to have sufficient investing experience and knowledge to weigh the risks and merits of an investment opportunity.

Subject Property: The apartment the general partner intends on purchasing.

Submarket: A geographic subdivision of a market.

Subscription Agreement: A document that is a promise by the LLC that owns the property to sell a specific number of shares to a limited partner at a specified price, and a promise by the limited partner to pay that price.

 

T

 

U

 

Underwriting: The process of financially evaluating an apartment community to determine the projected returns and an offer price.

 

V

 

Vacancy Loss: The amount of revenue lost due to unoccupied units.

Vacancy Rate: The rate of unoccupied units. The vacancy rate is calculated by dividing the total number of unoccupied units by the total number of units.

Value-Add Property: A stabilized apartment community with an economic occupancy above 85% and has an opportunity to be improved by adding value, which means making improvements to the operations and the physical property through exterior and interior renovations in order to increase the income and/or decrease the expenses.

 

W

 

X

 

Y

 

Yield Maintenance: A penalty paid by the borrower on a loan is the principal is paid off early.

 

Z

 

Are you a newbie or a seasoned investor who wants to take their real estate investing to the next level? The 10-Week Apartment Syndication Mastery Program is for you. Joe Fairless and Trevor McGregor are ready to pull back the curtain to show you how to get into the game of apartment syndication. Click here to learn how to get started today.

 

Follow Me:  
FacebooktwitterlinkedinrssyoutubeinstagramFacebooktwitterlinkedinrssyoutubeinstagram


Share this:  
FacebooktwitterpinterestlinkedinFacebooktwitterpinterestlinkedin
apartment investing offer

How the General Partner Submits an Offer on an Apartment Deal

Generally, the general partner (referred to as GP hereafter) in an apartment syndication has certain investment criteria to determine which deals to submit offers on. This criteria could be as sophisticated as requiring a projected internal rate of return and cash-on-cash return above a certain threshold, which is what my company does, or as basic as a cash flow per door.

 

Regardless of their investment criteria, an experienced GP will perform underwriting on tens, if not hundreds, of deals before finding one that qualifies for an offer. And once they do, there is a four-step process for submitting an offer.

 

Understanding this process is obviously important for those striving to syndicate their own apartment deals in the future. But it is important for those passively investing in apartment syndications to understand as well. If they are entrusting the GP with their hard-earned capital, they should know how the offer price and terms are calculated.

 

1. Pre-Offer Conversation

 

Before completing the underwriting process and submitting an offer, the GP will likely need to reach out to the listing real estate broker and their property management company.

 

If questions arise during the course of the underwriting process, the GP will need to get the answers from the listing broker before submitting an offer. For example, there might be a discrepancy between the rent roll and the offering memorandum in regards to the number of units renovated by the current owner. Or the properties used by the listing broker for the rental comparable analysis are too dissimilar to the subject property. Or the GP needs more information on the exterior capital expenditures completed by the current owner over the past few years. The GP should leave no stone unturned before determining an offer price.

 

Similarly, the GP should review the underwriting with the property management company who will manage the deal after acquisition in order to confirm the assumptions there were made.

 

Additionally, the GP should visit the property in-person. Ideally, the GP visits the property with their property management company and, if they plan on performing renovations after acquisition, a general contractor. Together, they should look at the condition of the big ticket exterior items, like the roofs, siding, parking lots, clubhouse, amenities (i.e. pool, fitness center, playground, etc.), landscaping and signage. They should interview the onsite property management company to understand the historical operations of the property. They should tour a handful of units, preferably the “best” and “worst” unit. Then, they should leave the property and drive a 2-mile radius around the property, making note of nearby retail centers, restaurants, employment hubs and other apartment communities. Lastly, they should visit these other apartment communities to gain an understanding of the local competition.

 

Based on the feedback from the real estate broker and property management company, and the in-person visit, the GP should update or revise any underwriting assumptions in preparation for submitting an offer. At this point, the GP will have better assumptions than those that were made by simply reviewing the rent roll and profit and loss statement. But, if they are awarded the deal, the GP will conduct more detailed due diligence in order to finalize their assumptions.

 

2. Determine an Offer Price

 

During the underwriting and pre-conversation phase, the GP will usually have an idea of the price at which the owner is wanting to sell. Sometimes, the sales price is explicitly stated but this is usually only the case for smaller apartment deals. For deals with 50 to 100 or more units, the listed purchase price will likely say “to be determined by the market.” If that is the case, the GP can usually get a ballpark number from the listing real estate broker or the owner. If not, then they may use the current market cap rate  and the current net operating income to get an estimated sales price.

 

However, the sale price the owner desires is fairly irrelevant when determining an offer price. Experienced GPs will set an offer price that results in projected returns that meet their investment criteria. For example, my company will set an offer price that results in, at minimum, a 8% cash-on-cash return and a 16% 5-year internal rate of return to the limited partners.

 

If the GP’s offer price differs greatly from the listed, stated or estimated sales price, it may be due to an error on the GP’s side or due to the seller making too aggressive of assumptions. If it is the latter, the GP can either walk away from the deal or submit their offer along with an explanation for why the offer is much lower than what the seller desires.

 

In addition to determining an offer price, the GP should also have a conversation with their lender or mortgage broker to obtain estimated loan terms to include in their offer.

 

3. Submit an LOI

 

At this point, if the results of the underwriting meet their investment criteria, the GP will submit an offer in the form of a letter of intent (referred to as LOI hereafter). The LOI should be prepared by the GP’s real estate attorney.

 

The LOI is not legally binding. Its purpose is to show the GP’s intent to purchase the apartment at the stated price and terms, which includes the purchase price, down payment amount, earnest deposit and the due diligence timeline.

 

For the earnest deposit, 1% of the purchase price is standard and goes hard (i.e. is non-refundable) once the inspection period is completed (30 to 45 days). However, if the GP is in a competitive offer situation, the earnest deposit terms can deviate from the norm, whether it is a higher deposit amount and/or a shorter time frame before it goes hard (with the most competitive offers having the earnest deposit go hard day 1). For example, on a recent deal, my company had a $200,000 earnest deposit go hard day 1.

 

The GP can have a conversation with their real estate broker about what they are seeing in the current market for earnest deposit and its terms. Or, the GP can base the earnest deposit amount and terms on their previous acquisitions in the same submarket.

 

After submitting the LOI, the GP may be invited to a best and final call with the sellers. This is when the sellers ask for the interested investors’ best and final offer. Then, the investors with the most competitive offers will be invited to a call with the sellers, which is basically an interview so that the seller can determine if the investor is capable of closing on the deal.

 

4. Submit a Formal Offer

 

If the sellers accept and sign the GP’s letter of intent or they are awarded the deal after the best and final round, the GP will submit a formal offer in the form of a purchase sales agreement. Similar to the LOI, this sales agreement should be prepared by the GP’s real estate attorney. The purchase sales agreement is a detailed contract that outlines all of the terms of the sale.

 

Funding the upfront costs

 

In addition to the earnest deposit, other fees paid prior to closing are the upfront bank fees. Since the earnest deposit is due soon after closing, the GP needs to know where these funds will come from prior to putting the property under contract. The GP may front these costs and reimburse themselves at the close. Another option is for the GP ask an investor to fund the earnest deposit and upfront bank fees and create a promissory note so that the GP is responsible for paying the investor back if they lose the money (which happens if the contract is cancelled after the earnest deposit goes hard). Or, the GP could partner with someone on their team that has those funds. Ideally, the party who funds the earnest deposit will fund the other upfront banks fees as well.

 

In terms of how much upfront cash is needed, a good estimate is 2.5% of the purchase price (1% for the earnest deposit and 1.5% for the bank fees). For example, a $10 million purchase price would require an estimated $3.5 million in equity (25% down payment, GP fees, closing costs and cash reserves) at close. Of that $3.5 million, the GP would need approximately $250,000 in cash to cover the earnest deposit and upfront bank fees to get the deal to the closing table.

 

To learn more about the apartment syndication process from the perspective of a passive investor, visit my passive investor resources page here.

 

Subscribe to my weekly newsletter for even more Best Ever advice www.BestEverNewsletter.com

 

 

Follow Me:  
FacebooktwitterlinkedinrssyoutubeinstagramFacebooktwitterlinkedinrssyoutubeinstagram


Share this:  
FacebooktwitterpinterestlinkedinFacebooktwitterpinterestlinkedin
REIT vs. Apartment Investing

Apartment Vs. REIT: Which Is The Better Passive Investment?

Originally Featured on Forbes.com here.

 

In real estate investing, there are two major strategies to choose from, and each can be used to pursue a variety of different opportunities. In passive real estate investing, two of the most popular investment opportunities are apartment syndications and real estate investment trusts, or REITs.

 

REIT is a company that owns, operates or finances income-producing real estate that generates revenue, which is paid out to shareholders in the form of dividends. An apartment syndication is when a syndicator (i.e., the general partner) pools together capital from passive investors (i.e., the limited partners) to purchase an apartment community while sharing in the profits.

 

In both cases, the passive investor is investing in real estate. However, the investment structures differ, which means that there are distinct pros and cons for each strategy. From my experience syndicating over $300,000,000 in apartment communities, when compared to REITs, I’ve found six pros and cons of passively investing in an apartment syndication.

 

1. Liquidity

 

With REITs, you have the ability to buy and sell like a standard stock. If you find yourself needing to pull out your capital, you can do so relatively quickly. Conversely, a passive apartment syndication is less liquid. Your initial investment is locked in until the end of the projected hold period. However, depending on the syndicator, there may be exceptions to this rule.

First, the syndication may have a clause that allows you to sell your shares of the company with the written consent of the general partnership. It is not as fast or as simple as selling shares of a REIT, but if an emergency were to arise and the syndication has such a clause, there is a process for reclaiming your investment. But overall, the passive apartment syndication is less liquid than a passive REIT investment.

 

In regards to liquidly, REITs win. REITs 1, apartments 0.

 

2. Barrier To Entry

 

To invest in a REIT, a large sum of capital isn’t required. Most REITs have no minimum investment, although they may require that you purchase blocks of 10 or 100 shares. That means you can invest in a REIT with less than $1,000, whereas apartment syndications have a higher barrier to entry.

 

First, you may need to be accredited, which means having an annual income of $200,000 or $300,000 for joint income for the last two years, or an individual or joint net worth exceeding $1 million. Additionally, apartment syndication may require a minimum investment. For example, my company requires a first-time minimum investment of $50,000 and then $25,000 thereafter. You can find syndicators that don’t require a minimum investment or for which you meet the accredited investor qualifications, but regardless, the financial barrier of entry is higher for apartment syndications than REITs.

REITs 2, apartments 0.

 

3. Diversification

 

With REITs, you invest in a diversified portfolio of properties that provide a blended return. Because the risk is shared across a pool of assets, you will not see major fluctuations in your returns and portfolio value. With a passive apartment investment, your return is directly tied to the performance of a single asset. If something negative happens to the property or the submarket in which the property is located, your projected returns will be reduced accordingly. However, the same logic applies to the upside as well.

Of course, this risk can be greatly reduced by only investing with apartment syndicators who follow the Three Immutable Laws of Real Estate Investing. Additionally, you can make up for the lack of diversification by investing in multiple apartment syndication deals, essentially creating your own personal REIT.

 

I’m calling this one a draw. So, the score remains: REITs 2, apartments 0.

 

4. Returns

 

The major benefit of passively investing in apartment syndications is the higher average returns. The total REIT return over the last five years (May 2013 to 2018) is 25.213%, including dividends and distributions. If you initially invested $100,000 in May 2013, your total profit by May 2018 is $25,213. As a comparison, my company does not purchase an apartment community unless the average annual return exceeds 9% and the five-year internal rate of return exceeds 16% to our passive investors. On a deal we purchased in 2015, we projected a 13.5% average annual return and a 20% five-year IRR to our passive investors, which would result in a total five-year profit of $102,805. As of this writing, not only are we on pace to exceed these projections, but we were able to refinance the property into a new loan and return about 40% of our passive investors initial capital. That is the power of apartment syndications.

 

Money is the crux of why people invest in real estate at all, so I’m giving apartments three points on this consideration. REITs 2, apartments 3.

 

5. Ownership

 

When investing in an apartment syndication, you also benefit from having direct ownership of the underlying asset. The major benefit of direct ownership is transparency — you see the actual asset you are investing in. As the general partnership progresses through the business plan, you will receive updates where, again, you can to see the actual asset, along with pictures of the updates and a variety of KPIs (rents, occupancy, etc.).

 

Another — and essential — benefit is having the direct contact information of the person calling the shots. If you have a question, you won’t have to worry about speaking with customer service or an automated phone service. Instead, you have direct access to the general partner who is managing the asset.

 

Another point for apartments: REITs 2, apartments 4.

 

6. Taxes

 

From a tax perspective, both REITs and apartment syndications will pass the depreciation benefits through to the passive investor. However, where these two strategies differ is with the profit at sale. For a passive apartment syndication investment, you have the opportunity to utilize the 1031 exchange tax instrument, which allows you to defer the taxes on your profit at sale by reinvesting in another deal with the same syndicator.

 

The final tally: REITs 2, apartments 5.

 

While the returns on both REITs and apartments have historically exceeded those of regular stocks as long as you are financially qualified and willing to tie up your capital for five to 10 years, passively investing in apartment syndications is, overall, the superior strategy.

 

Subscribe to my weekly newsletter for even more Best Ever advice www.BestEverNewsletter.com

Follow Me:  
FacebooktwitterlinkedinrssyoutubeinstagramFacebooktwitterlinkedinrssyoutubeinstagram


Share this:  
FacebooktwitterpinterestlinkedinFacebooktwitterpinterestlinkedin
“tax” written in check book with pen

The Five Tax Factors When Passively Investing in Apartment Syndications

DISCLAIMER: THIS IS FOR YOUR INFORMATION ONLY. SINCE I AM NOT A TAX ADVISORY FIRM, I REFER ALL GENERAL TAX-RELATED REAL ESTATE QUESTIONS FROM PASSIVE INVESTORS BACK TO THEIR ACCOUNTANTS. HOWEVER, I WILL SAY THAT INVESTORS OFTEN SEEK REAL ESTATE OPPORTUNITIES TO INVEST IN DUE TO THE TAX ADVANTAGES THAT MAY COME FROM DEBT WRITE OFF AND LOSS DUE TO DEPRECIATION. BUT I DON’T INCLUDE ANY ASSUMPTIONS ABOUT THESE TAX ADVANTAGES IN OUR PROJECTIONS.

 

In addition to the capital preservation and cash flow benefits, one of the main reasons that passive investors seek to invest in real estate opportunities, and apartment syndications in particular, is because of the tax benefits of rental property.

 

When a passive investor invests in a value-add apartment syndication, they will generally receive a profit from annual cash flow and the profit at sale. Being a profit, this money is taxable. However, for apartment syndications, there are five pieces of tax information that the syndicator and the passive investor need to understand in order to determine the tax advantages of investing. These are 1) the depreciation benefits, 2) accelerated depreciation via cost segregation, 3) depreciation recapture, 4) bonus depreciation, and 5) capital gains tax at sale.

Depreciation

Investment property depreciation is the amount that can be deducted from income each year as the depreciable items at the apartment community age. The IRS classifies each depreciable item according to its useful life, which is the number of years of useful life of the item. The business can deduct the full cost of the item over that period.

 

The most common form of depreciation is straight-line depreciation, which allows the deduction of equal amounts each year. The annual deduction is the cost of the item divided by its useful life. The IRS considers the useful life of real estate to be 27.5 years. So, the annual depreciation on an apartment building worth $1,000,000 (excluding the land value) is $1,000,000 / 27.5 years = $36,363,64 per year.

 

As one of the tax benefits of apartment syndications, the depreciation amount is such that a passive investor won’t pay taxes on their monthly, quarterly, or annual distributions during the hold period. They will, however, have to pay taxes on the sales proceeds.

Cost Segregation

Cost segregations is a strategic tax planning tool that allows companies and individuals who have constructed, purchased, expanded, or remodeled any kind of real estate to increase cash flow by accelerating depreciation deductions and deferring income taxes. A cost segregation study performed by a cost segregation engineering firm dissects the construction cost or purchase price of the property that would otherwise be depreciated over 27.5 years, the useful life of a residential building. The primary goal of a cost segregation study is to identify all property-related costs that can be depreciated over 5, 7, and 15 years

 

For example, my company performed a cost segregation on our portfolio for 2017. On one of the properties, we showed a loss from investment property depreciation of greater than 412% than we would have seen with the straight-line depreciation using the 27.5-year useful life figure.

 

To perform a cost segregation, the syndicator will need to hire a cost segregation specialist. This can cost anywhere between $10,000 and $100,000, depending on the size of the apartments.

Depreciation Recapture

Depreciation recapture is the gain received from the sale of depreciable capital property that must be reported as income. Depreciation recapture is assessed when the sale price of an asset exceeds the tax basis or adjusted cost basis. The difference between these figures is “recaptured” by reporting it as income.

 

For example, consider an apartment that was purchased for $1,000,000 and has an annual depreciation of $35,000. After 11 years, the owner decides to sell the property for $1,300,000. The adjusted cost basis then is $1,000,000 – ($35,000 x 11) = $615,000. The realized gain on the sale will be $1,300,000 – $615,000 = $685,000. Capital gain on the property can be calculated as $685,000 – ($35,000 x 11) = $300,000, and the depreciation recapture gain is $35,000 x 11 = $385,000.

 

Let’s assume a 15% capital gains tax and that the owner falls in the 28% income tax bracket. The total amount of tax that the taxpayer will owe on the sale of this rental property is (0.15 x $300,000) + (0.28 x $385,000) = $45,000 + $107,800 = $152,800. The depreciation recapture amount is $107,800 and the capital gains amount is $45,000.

Bonus Depreciation

One of the major changes with the Tax Cuts and Jobs Act of 2017 was the bonus depreciation provision, where business can take 100% bonus depreciation on a qualified property purchased after September 27th, 2017. This is definitely one of the tax benefits of rental property you should learn more about, so click here for more information on the qualifications and benefits of the change in bonus appreciation.

Capital Gains

When the asset is sold and the partnership is terminated, initial equity and profits are distributed to the passive investors. The IRS classifies the profit portion as long-term capital gain.

 

Under the new 2018 tax law, the capital gains tax bracket breakdown is as follows:

 

Taxable income (individual or joint)

  • $0 to $77,220: 0% capital gains tax
  • $77,221 to $479,000: 15% capital gains tax
  • More than $479,000: 20% capital gains tax

Annual Tax Statements

At the beginning of the following year, the syndicator will have their CPA create Schedule K-1 tax reports for each passive investor. The K-1 is a tax document that includes all of the pertinent tax information that the passive investor will use to fill out their tax forms.

 

If you’re interested in partnering with me and potentially gaining from these tax benefits of rental property, please fill out the form here.

 

Are you a newbie or a seasoned investor who wants to take their real estate investing to the next level? The 10-Week Apartment Syndication Mastery Program is for you. Joe Fairless and Trevor McGregor are ready to pull back the curtain to show you how to get into the game of apartment syndication. Click here to learn how to get started today.

Follow Me:  
FacebooktwitterlinkedinrssyoutubeinstagramFacebooktwitterlinkedinrssyoutubeinstagram


Share this:  
FacebooktwitterpinterestlinkedinFacebooktwitterpinterestlinkedin
Secure Passive Investor Commitments

5 Step Process for Securing Passive Investor Commitments for Apartment Syndications

There are three main steps to take an apartment deal from contract to close. First, the apartment syndicator performs detailed due diligence to confirm or update the underwriting assumptions. Next, the apartment syndicator secures a loan to finance the deal. Lastly, and the focus of this blog post, the apartment syndicator secures financial commitments from passive investors in order to fund the deal.

For apartment syndications, and the value-add investment strategy in particular, the syndicator will get a loan to cover the majority of the project costs. Generally, the costs that are not covered by the loan are the down payment for the loan (which is 20% to 30% of the purchase price or the purchase price plus renovations, depending on the loan), general partnership fees charged by the syndicator, financing fees (which are approximately 1.75% of the purchase price), closing costs (which are approximately 1% of the purchase price) and an operating account fund (which is approximately 1% to 3% of the purchase price).

In total, a syndicator should expect to require 30% to 40% of the total project costs in order to close on the deal. These remaining costs come from a combination of the general partners (i.e. the syndication team) and the limited partners (i.e. passive investors), with the majority generally coming from the limited partners.

The purpose of this blog post is to outline the 5-step process for securing financial commitments from passive investors after an apartment deal is under contract in order to cover this 30% to 40% of the project costs and close on the deal.

 

1 – Investment Package

From the syndicator’s perspective, one of the first steps towards securing commitments from passive investors is creating an investment package. Before closing on the deal, the syndicator underwrote the property, conducted a rental comparable analysis, visited the property in-person and negotiated a purchase price. During this time, they become extremely familiar with the property and the surrounding area. The purpose of the investment package is to take all of this knowledge gained by the syndicator from initially qualifying the deal and consolidating it into a digestible form so that the passive investors can review the deal and make an educated investment decision.

The form of and the information included in an investment package will vary from syndicator to syndicator, depending on their experience and the business plan. At the very least, the investment package will include the main highlights of the deal that are relevant to the passive investor. These highlights include the purchase price, the projected returns for the project and to the passive investors, an explanation of the business plan including the exit strategy, and the partnership structure. However, ideally the investment package includes much more about the underlying assumptions behind these investment highlights.

For example, my company creates an investment summary package which includes the following sections:

  • Executive Summary: a summary of the information that is relevant to the passive investor, which is expanded upon in later sections. This includes things like purchase price, return projections and the business plan
  • Investment Highlights: an explanation on why this apartment deal is a solid investment. This includes things like our value-add business plan, the debt terms, the exit strategy and anything unique to the specific deal or market
  • Property Overview: an overview of the property details. This include things like the community amenities, unit features, a property description, the unit mix and floorplans, and a site map
  • Financial Analysis: shows the underlying analysis and assumptions of the return projections. This includes things like the offering summary, debt summary, projected returns to the investor and the detailed proforma
  • Market Overview: an overview of the submarket and market in which the apartment deal is located. This includes things like job growth, demographic data, nearby transportation of developments and the rental and sales comparables that were used to calculate the projected rents

Mostly everything that a passive investor needs to know in order to make an educated investment decision should be included in the investment package.

 

2 – Passive Investors Notified about New Deal

Once the investment package is created, which could take anywhere from a few days to a week, the next step is for the syndicator to notify their investor database about their deal.

I highly recommend that a syndicator gets verbal commitments from passive investors and creates an investor database prior to looking for deal (here are over 20 blog posts on how to find passive investors). In fact, understanding how much money they can raise will determine the size of deal a syndicator should pursue. For example, understanding the they will require approximately 30% to 40% of the project costs to close, a syndicator with $1 million in verbal commitments can look for apartment deals in the $2.5 to 3.3 million range.

For my company, once we put a deal under contract and creates the investment package, we notify our passive investors about the new opportunity via email. In this email, we include the top two to three highlights of the deal, include a link to the investment package and invite them to a conference call where we will go over the deal in more detail. We set up the conference call using www.FreeConferenceCall.com and include the date and call-in information in this email.

 

3 – New Investment Offering Call

A few days to a few weeks after sending the notification email, my company hosts a new investment offering conference call. Here is a blog post I wrote that outlines my 7-step approach to preparing and conducting a successful new investment offering call. Read this post for more details, but the 7-step approach is:

  1. Get in the right mindset
  2. Determine your main focus
  3. Introduce yourself and your team
  4. Provide an overview of the deal, the market and the team
  5. Go into more detail on the deal, the market and the team
  6. Questions and answers session
  7. Conclude the call and send the recording to the investors

This is my company’s approach, but it will vary from syndicator to syndicator. Some syndicators will structure their presentations differently. Some syndicators may host a video webinar. Others might just send the investment package and/or a recording to their investors.

 

4 – Secure Commitments

After the new investment offering presentation, however the syndicator decided to approach it, the next step is to secure financial commitments from the passive investors.

If you are a passive investor, if the deal aligns with your investment goals, you can verbally commit to investing in the deal. How you make your commitment will vary for syndicator to syndicator. For my company, we send our investors a recording of the conference call and ask them to send us an email with their commitments (and whether they are investing as an individual or LLC) and we hold their spot until they review and sign the required documentation, which I will outline in the next section.

If you are an apartment syndicator, this process will vary depending on your experience level. When you are first starting out, you will need to be more proactive when securing commitments. A good strategy is to send emails to your investor database every week or two, inviting them to invest in the deal and providing them a new piece of positive information. You don’t want to send them an email that only asks them to invest. You want to provide a new piece of positive information like a due diligence report came back clean, a new development that was recently announced down the street, the rental comparable report came back and the rents are higher than what you projected, etc. Then, as you gain more experience and credibility from passive investors, they will come to you. Your goal should be to have 100% of the funding 30 days before closing. And once the deal is fully funded, don’t turn away interested investors. Instead, tell them that the deal is fully funded but that you will put them on a waiting list.

 

5 – Complete Required Documentation

The last step is for the passive investors to make their investments official by reviewing and signing the required documentation. There are five main documents that the syndicator needs to prepare (with the help of their real estate and securities attorney) and the passive investors need to sign in order to make the investments official. We will send our investors these documents to sign via Adobe Sign.

 

  1. Private Placement Memorandum (PPM)

The PPM is a legal document that highlights all the legal disclaimers for how the passive investor could lose their money in the deal.

Generally, a PPM will include two major components. One is the introduction, which includes a summary of the offering, description of the asset being purchased, minimum and maximum investment amounts, key risks involved in the offering and a disclosure on how the general partners are paid. The other section covers basic disclosures, which includes general partner information, offering description and a list of all the risks associated with the offering.

The PPM should be prepared by a securities attorney for each apartment deal. 

The PPM will also include funding instructions. Once the investor has signed the PPM and sent their funds, we will send them an email confirmation within 24 to 48 hours.

 

  1. Operating Agreement

For each apartment deal, my company forms a new limited liability company (LLC). My company is a general partner (GP). Our investors will purchase shares in that LLC and become a limited partner (LP). However, every syndicator should speak with a real estate attorney to determine which approach is best for them.

The operating agreement outlines the responsibilities and ownership percentages for the GP and LP.

The operating agreement should be prepared by a real estate attorney for each apartment deal.

 

  1. Subscription Agreement

Simply put, the subscription agreement is a promise by the LLC to sell a specified number of shares to passive investors at a specified price, and a promise by the passive investors to pay that price. For example, a passive investor that is investing $50,000 would purchase 50,000 shares of the LLC at $1 per share.

Like the operating agreement, the subscription agreement should be prepared by a real estate attorney for each deal.

 

  1. Accredited Investor Qualifier Form

The accredited investor form required is based on whether the offering is 506(b) vs. 506(c). Most likely, the general partner is either selling private securities to the limited partners under Rule 506(b) or 506(c). One key difference is that 506(c) allows for general solicitation or advertising of the deal to the public, while 506(b) offerings do not. But the other difference is the type of person who can invest in each offering type. For the 506(b), there can be up to 35 unaccredited but sophisticated investors, while 506(c) is strictly for accredited investors only. That being said, a syndicator should have a conversation with a securities attorney to see which offering is the best fit for them.

If the general partners are doing a 506(c) offering, they must verify the accredited investor status of each passive investor, which requires the review of tax returns or bank statements, verification of net worth or written confirmation from a broker, attorney or certified account. The accredited investor qualifications are a net worth exceeding $1,000,000 excluding a personal residence or an individual annual income exceeding $200,000 in the last two years or a joint income with a spouse exceeding $300,000.

If the general partners are doing a 506(b), they are not required to verify the accredited investors status – the passive investor can self-verify that they are accredited or sophisticated. In addition, for the 506(b) offering, to prove that the general partners didn’t solicit the offering, they must be able to demonstrate that they had a relationship with the passive investor before their knowledge of the investment opportunity, which is determined by the duration and extent of the relationship.

This form should also be prepared by a securities attorney, but only on one occasion (unless the accredited investor qualifications change).

 

  1. ACH Application

Lastly is the ACH application. This document is optional but recommended. It will allow the passive investor to receive their distributions via direct deposit into a bank of their choice.

Once a passive investor has committed to investing in a deal, the general partners should them these five documents to make the partnership official.

 

Want to learn how to build an apartment syndication empire? Purchase the world’s first and only comprehensive book on the exact step-by-step process for completing your first apartment syndication: Best Ever Apartment Syndication Book.

Follow Me:  
FacebooktwitterlinkedinrssyoutubeinstagramFacebooktwitterlinkedinrssyoutubeinstagram


Share this:  
FacebooktwitterpinterestlinkedinFacebooktwitterpinterestlinkedin
luxury apartment building

How a Syndicator Secures Financing for an Apartment Deal

Once a syndicator puts an apartment deal under contract, concurrent with the due diligence process is the process of securing investment property loans. Generally, debt is a part of the apartment syndicator’s business plan because of the benefits that arise from leverage. Rather than purchasing the apartment community with all cash, they obtain a loan for upwards of 80% of the value while benefiting from 100% ownership.

However, not all debt and apartment financing are the same. The type of debt and financing an apartment syndicator puts on the asset is highly dependent on the business plan. Also, different types of financing bring different levels of risks. Therefore, as a passive investor or an apartment syndicator, it is important to understand 1) the different types of debt and 2) the different types of financing. In doing so, you will be able to identify which combination of debt and financing is in your best interests based on the business plan.

Two Types of Debt: Recourse and Nonrecourse

Before diving into the two main types of loans, it is important to first distinguish the two types of debt – recourse and nonrecourse. According to the IRS, with recourse debt, the borrower is personally liable while all other debt is considered nonrecourse. In other words, recourse debt allows the lender to collect what is owed for the debt even after they’ve taken the collateral (which in this case is the apartment building). Lenders have the right to garnish wages or levy accounts in order to collect what is owed.

On the other hand, with nonrecourse debt, the lender cannot pursue anything other than the collateral. But, there are exceptions. In the cases of gross negligence or fraud, the lender of investment property loans is allowed to collect what is owed above and beyond the collateral.

Apartment syndicators almost universally prefer nonrecourse debt, while lenders almost universally prefer recourse debt. But, while nonrecourse is advantageous to the borrower for the reasons stated above, it generally comes with a higher interest rate and is only given to individuals or businesses with a strong financial history and credit.

Two Types of Financing: Permanent and Bridge Loan

Generally, an apartment syndicator will secure one of two types of loans when seeking apartment financing: a permanent agency loan or a bridge loan.

Bridge Loans:

The other most common type of investment property loan is the bridge loan. A bridge loan is a short-term loan that is used until the borrower secures long-term financing or sells the property. This loan is ideal for repositioning an apartment, like with the value-add or distressed apartment strategy.

Typically, bridge loans have a term of 6 months to 3 years, with the option to purchase an extension of a year or two. They are almost exclusively interest-only. For example, with a 2-year bridge loan, the investor would make interest-only payments for two years, at which point the investor must pay off the loan, refinancing, purchase an extension, or sell the property.

The bridge loan is an LTC (loan-to-cost) loan at 75% to 80%, which means the lender will provide funding for 75% to 80% of the total project cost (purchase price + renovation costs) and the syndicator provides the remaining 20% to 25%.

Generally, bridge loans are nonrecourse to the borrower and have a faster closing process. Also, since they are interest-only, the monthly debt service is lower. However, the disadvantages are that they are riskier than permanent loans because they are shorter-term in nature. Before the end of the term, which will likely occur before the end of the business plan, the syndicator must refinance or sell. And if the market is such that permanent financing isn’t available or if the business plan didn’t go according to plan, the syndicator is in trouble.

Permanent Agency Loans:

A permanent agency loan is secured from Fannie Mae or Freddie Mac and is longer-term compared to bridge loans. Typically loan term lengths are 5, 7, or 10 years amortized over 20 to 30 years. For example, with a 5-year investment property loan amortized over 25 years, the syndicator would make payments for 5 years at an amount based on a loan being paid off over 25 years. At the end of the loan term, the syndicator will either have to pay off the remaining principal, refinance into a new loan, or sell the asset.

The permanent agency loan is an LTV (loan-to-value) loan at 75% to 80%, which means the lender will provide funding for 75% to 80% of the value of the apartment and the syndicator provides the remaining 20% to 25%.

Generally, permanent agency loans are nonrecourse. However, value-add or distressed investors likely won’t be able to have the renovation costs included in the loan. Additionally, depending on the physical condition and operations, the asset may not qualify for permanent financing.

Compared to bridge loans, the interest rate is lower, and you may be able to get a few years of interest-only payments. Also, since these loans are longer-term in nature, they are less risky. The permanent loan is a set-it-and-forget-it-loan where you won’t have to worry about a balloon payment or refinancing before the end of your business plan.

Closing Thoughts

When securing apartment financing, the most important thing is that the length of the loan exceeds the projected hold period, which is law number two of the Three Immutable Laws of Real Estate Investing. In doing so, as long as the syndicator follows the other two laws (buy for cash flow and have adequate cash reserves), the business plan is maintainable during a downturn. This law will usually be covered with the permanent loan. However, if the syndicator secures a bridge loan that will come due in the middle of the business plan, they better have a plan in place well ahead of time, whether that’s an early refinance or purchasing an extension.

 

Overall, the type of debt and financing a syndicator secures is based on their business plan. Bridge loans can be great for value-add investors, as long as they buy right, plan ahead and have an experienced team in place. And permanent financing is great because it is less risky and is a set-it-and-forget-it type of loan.

 

But regardless of the business plan and type of investment property loans, the syndicator should always have a conversation with a lending professional before securing financing for a deal.

Follow Me:  
FacebooktwitterlinkedinrssyoutubeinstagramFacebooktwitterlinkedinrssyoutubeinstagram


Share this:  
FacebooktwitterpinterestlinkedinFacebooktwitterpinterestlinkedin
person opening the door of a hotel room

18 Creative Ways to Market Apartment Rental Listings

One of the 11 responsibilities an apartment syndicator has as the asset manager of an apartment community is maintaining and maximizing the economic occupancy. For value-add investors, this involves renovating the units and upgrading the community amenities in order to increase the rents, thus increasing the cash flow and returns.

 

However, no matter how beautiful the newly upgraded apartment community is, the syndicator still needs to implement a marketing strategy in order to fill the units with high-quality residents. Ideally, the syndicator hires a property management company that already applies the best marketing practices. But it is still their responsibility to oversee the management company and make sure the marketing strategy is being implemented properly.

 

Therefore, whether you are an apartment syndicator or a passive investor in syndications, it is helpful to understand the main ways to effectively market rental listings to attract the desired resident – one who pays rent on time and is courteous to their neighbors – and increase overall economic occupancy.

 

Here is a list of 18 creative ways to market an apartment rental listing to accomplish the above stated goals:

 

  1. Create a landing page, either standalone or as a part of your website, that captures the information of potential residents
  2. Create a direct mailing campaign and send it out to people living in similar buildings, inviting them to move into yours by offering some sort of concession (i.e. reduced rent for the first month, reduced security deposit, waive the application fee, etc.) and highlighting the major selling point of your community compared to theirs (i.e. direct garage access, new fitness center, BBQ pit, etc.). This strategy could anger local owners, so if you decide to do this, don’t expect to be popular and expect others to do it to your residents
  3. Contact the Human Resources departments at all the major employers in the area, letting them know that you own an apartment in the area and asking if they can direct new hires to your community
  4. Create a resident referral program where you offer current residents a flat fee ($300 is standard) if they refer someone that signs a lease
  5. Set up an open house and invite members of the local community to attend. Having a model unit and offering refreshments is helpful
  6. Offer special pricing to soldiers, police and first responders, like 50% off the first month’s rent
  7. Design a “for lease” banner and put it near the entry of your property, or near an area that has high foot or car traffic
  8. Design and place flyers at local establishments that are frequented by your resident demographic, like laundry mats, hair salons, nail salons, gyms, coffee shops, etc.
  9. Purchase advertisements in the local newspaper
  10. Post “for rent” listings to Craigslist, Zillow, Realtor.com, Apartments.com and other free online rental listing services
  11. Partner with a real estate broker or agent and advertise your apartment community on the MLS
  12. Create a Facebook advertisement, which allows you to select criteria to hyper-target your preferred resident
  13. Create a Facebook page for your apartment community, posting weekly content to generate a following and posting your rental listings
  14. Pay close attention to the nearby landmarks to cater to that audience, like colleges, military bases, large corporations, etc.
  15. Provide good old-fashioned customer service. Be responsive and timely with requests and questions. If doesn’t matter if you are a marketing wizard and get hundreds of responses to your rental listings if you don’t pick up the phone or respond quickly to emails, politely answer their questions and get them one step closer to viewing the property and signing the lease
  16. Call all residents who have previously notified you that they plan on leave at the end of their lease, asking them about their reason for leaving to see if it is something that can be addressed
  17. Send marketing material or gift baskets to businesses and employers surrounding your community
  18. Follow-up with old leads that are older than 90 days

 

Some of the strategies are free and just require effort on the part of the syndicator and/or property management company. Others will require an upfront investment or result in a short-term reduction in income. Therefore, it is important that the syndication team understands the marketing strategy prior to closing on the deal so that they account for these expenses in the underwriting.

 

What about you? Comment below: What strategies do you implement to fill vacancies at your rental properties?

 

Subscribe to my weekly newsletter for even more Best Ever advice www.BestEverNewsletter.com

 

Follow Me:  
FacebooktwitterlinkedinrssyoutubeinstagramFacebooktwitterlinkedinrssyoutubeinstagram


Share this:  
FacebooktwitterpinterestlinkedinFacebooktwitterpinterestlinkedin
apartment building during fall

The Ultimate Guide to Performing Due Diligence on an Apartment Building

After putting a deal under contract, the due diligence process for an apartment building is much more involved and complicated in comparison to that of a single-family residence or smaller multifamily building. For the real estate due diligence process on an SFR or smaller multifamily building, the lender will likely only require an inspection report and an appraisal report in order to provide you with financing. Then, for your own knowledge, you’ll perform your own financial audit, comparing the leases and rent rolls with the historical financials to make sure the rental rates are in alignment.

When you scale up to hundreds of units, the increase in the number of potential risk points is such that the lender will require additional reports prior to financing the deal, and you will want to obtain additional reports before deciding to move forward with the deal.

For the apartment community due diligence process, you’ll want to obtain and analyze the results of these 10 reports:

  1. Financial Document Audit
  2. Internal Property Condition Assessment
  3. Property Condition Assessment
  4. Market Survey
  5. Lease Audit
  6. Unit Walk
  7. Site Survey
  8. Environmental Site Assessment
  9. Appraisal
  10. Green Report

In this ultimate guide, I will outline the contents of each report, how to obtain them, the approximate cost of each (for apartment communities 100 units or more) and how to analyze the results. This should be a great introduction to how to do due diligence on real estate, and you can build on this for your unique deals.

1 – Financial Document Audit

The financial document audit is an analysis that compares the apartment’s historical operations to your budgeted income and expense figures you set when underwriting the deal.

For the audit, a consultant will collect detailed historical financial reports from the sellers, including the last one to three years of income and expense data, bank statements, and rent rolls. The output of the analysis is a detailed spreadsheet of the asset’s historical income, operating expenses, non-operating expenses, and net cash flow which are compared to the budgeted figures you provided.

The summary will take on a form that is similar to a pro forma, with the income and expenses broken down into each individual line item for an easy comparison on your end. They will also provide you with an executive summary document, which will outline how to interpret the audit, what data was used to create the audit spreadsheet and an explanation of any figures that deviate from your budget.

To obtain this document, you will need to hire a commercial real estate consulting firm that specializes in creating financial document audits. An approximate cost for this report is $6,000.

When you initially underwrote the deal, you set the income and expense assumptions based on how you and your team will operate the property once you’ve taken over. These assumptions came from a combination of the trailing 12 months of income and expense data and the current rent roll provided by the seller and the standard market cost per unit per year rates for the expenses.

Once you receive the results of the financial audit report, part of your real estate due diligence is to go through each income and expense line item and compare them to the assumptions in your underwriting model. Ideally, the consultant that performed the audit already compared the results to your provided budget, made adjustments based on their expertise and any inputs you provided, and commented on any discrepancies.

If any discrepancies were found or if the consultant recommended any adjustments, discuss them with your property management company to see if you need to update your budget. If you and your management company come to the conclusion that the budget needs to change, make the necessary adjustments to your underwriting model.

2 – Internal Property Condition (PCA) Assessment

The internal property condition assessment (PCA) is a detailed inspection report is an integral part of your real estate due diligence because it outlines the overall condition of the apartment community.

A licensed contractor will inspect the property from top to bottom. Based on the inspection, he or she will prepare a report with recommendations, preliminary costs, and priorities for immediate repairs, recommended repairs, and continued replacements, along with accompanying pictures of the interiors, exteriors, and the items needing repair.

Being an internal report, you will be responsible for hiring a licensed commercial contractor to perform the assessment. An approximate cost for this assessment is $2,500.

During the underwriting process, you created a renovation/upgrade plan for the interior and exterior of the apartment community, which included the estimated costs. Once you receive the internal PCA, compare the results to your initial renovation budget.

The results of the internal PCA are preliminary costs, not exact costs. However, they will most likely be more accurate than the assumptions you made during the underwriting process. Therefore, if there are discrepancies between the contractor’s estimated renovation costs and your renovation budget, update the underwriting model to reflect the results of the internal PCA.

Hopefully, your initial renovation assumptions were fairly accurate. And ideally, if you made very conservative renovation cost assumptions, you discover that you over-budgeted and can reduce the costs in your underwriting model.

3 – Property Condition Assessment

The property condition assessment is the same as the internal property condition assessment, except this one is created by a third party selected by the lender. The cost is approximately $2,000.

Analyze this reports the same way that you analyzed the internal PCA. Then, compare and contrast the results of the two PCAs. Maybe the lender’s contractor caught something that your contractor did not, and vice versa.

4 – Market Survey

The market survey is a more formal and comprehensive rental comparison analysis than the one you performed during the underwriting phase, which is why it is a necessary part of your real estate due diligence.

For the market survey, your property management company will locate direct competitors of the apartment community. Then, they will compare your apartment community to each of the direct competitors over various factors to determine the market rents on an overall and a unit type basis. A few key points on the market survey analysis is to make sure that your property management company uses apartment communities that are upgraded similarly to how your apartment community will be post-renovations and not in its current condition. These should also be in similar neighborhoods and built within a similar time period.

When initial underwriting the deal, you set your renovated rental assumptions based on a combination of performing your own rental comparable analysis and, if the sellers had initiated an upgrade program, proven rental rates. Compare the results of the market survey to your initial renovated rent assumptions. If there are any discrepancies, update your underwriting model to reflect the results of the market survey and complete this portion of the real estate due diligence.

5 – Lease Audit

Your property management company will collect all of the leases of the current residents at the apartment community and perform an audit. They will analyze each lease, recording the rents, security deposits, concessions, and terms. Then, they will compare the information gathered from the leases to the rent roll provided by the owner, recording any discrepancies.

Unless the current property management company was extremely incompetent, the discrepancies should be minor, if there are any at all, and it should affect your financial model.

6 – Unit Walk

A question my apartment syndication clients ask a lot is “when I am performing real estate due diligence, do I need to walk every single unit?” The answer is a resounding yes! And that is the purpose of the unit walk report.

During the unit walk, your property management company will inspect the individual units. The purpose of the unit walk is to determine the current condition of each. So, while conducting the unit walk, they will take notes on things like the condition of the rooms, the type and condition of appliances, the presence or absence of washer/dryer hookups, the conditions of the light fixtures, missing GFCI outlets, and anything else that stands out as a potential maintenance or resident issue.

Once you receive the unit walk report, compare the results to your interior renovation assumptions to determine the accuracy of your interior business plan.

Do the number of units that require interior upgrades match your business plan? Is there unexpected deferred maintenance that wasn’t accounted for in your budget? Are there a high number of residents who will need to be evicted once you’ve taken over the operations?

Using that data, you can create a more detailed, unit-by-unit interior renovation plan and calculate a more accurate budget. Make any adjustments to your interior renovation assumption on your financial model.

Most likely, your property manager will perform the market survey, lease audit, and unit walk report, and they will usually do it for free. However, ask the property manager how much they will charge you for these three reports if you do not close on the deal. And if you have to hire a 3rd party to create these three reports, the cost is approximately $4,000.

7 – Site Survey

A site survey resembles a map and shows the boundaries of the property, indicating the lot size. It also includes a written description of the property.

There are a lot of third-party services that can conduct a site survey. A quick Google search of “site survey + (city name) will do the trick. I recommend reaching out to multiple companies to get a handful of bids for your project. The approximate cost for the site survey is $6,000.

The site survey report will list any boundary, easement, utility, and zoning issues for the apartment community. Generally, if a problem is found during the site survey, the bank will not provide a loan on the property. So, if something does come up during this real estate due diligence report, your options are limited and should be addressed on a case-by-case basis. If the problem can’t be resolved, you will have to cancel the contract.

8 – Environmental Site Survey

The environmental site assessment is an inspection that identifies potential or existing environmental contamination liabilities. It will address the underlying land, as well as any physical improvements to the property, and will offer conclusions or recommendations for further investigations of an issue is found. The environmental site assessment is also performed by a 3rd party vendor selected by your lender. The approximate cost is $2,500. Similar to the site survey, if the vendor identifies an environmental problem, the lender will not provide a loan for the property. Again, these issues should be addressed on a case-by-case basis.

9 – Appraisal

The appraisal report is created by an appraiser selected by your lender and determines the as-is value of the apartment community. The cost is approximately $5,000.

The appraiser will inspect the property, and then calculate the as-is value of the apartment community. The two appraisal methods that will be used to determine the value of the property are the sales comparison approach (i.e. comparing the subject property to similar properties that were recently sold) and the income capitalization approach (i.e. using the net operating income and the market cap rate).

Once you receive the appraisal, you should compare the appraised value to the contract purchase price as part of your real estate due diligence. The lender will base their financing on the appraised value, not the contract price. Therefore, if the appraisal comes back at a value higher than the contract price, fantastic! That’s essentially free equity. However, if the appraised value is lower than the contract price, you will have to either make up the difference by raising additional capital or renegotiate the purchase price with the seller.

10 – Green Report

The Green report is an optional assessment that evaluates potential energy and water conservation measures for the apartment community. The report will include a list of all measures found, along with the associated cost savings and initial investment.

The report is created by a 3rd party vendor selected by your lender. The approximate cost is $3,500.

The green report, which is the only document that won’t disqualify a deal, will outline all of the potential energy and water conservation opportunities. It will list all of the opportunities that were identified, the estimated initial investment to implement, the associated cost savings and the return on investment. Deciding which opportunities to move forward with should be based on the payback period and the projected hold period of the property.

An Example of Green Options

For example, the following energy efficient opportunities were identified at an apartment project my company assessed:

  • Dual pane windows
  • Wall insulation and leakage sealing
  • Roof insulation
  • Programmable thermostats
  • Low-flow showerheads and toilets
  • Interior and exterior LED lighting
  • Energy Star rated refrigerators and dishwashers

After analyzing the investment amount and cost savings, the opportunities we implemented, and the associated savings and payback periods were:

  • Low-flow showerheads: 1-year payback, $16,827 annual savings
  • Exterior LED lighting: 14.4-year payback, $3,236 annual savings
  • Pool cover: 1.5-year payback, $409 annual savings

The reasoning behind the low-flow showerheads and pool cover was that we planned on holding the property for 5-years, so, once we paid back the initial investment amount, it was pure profit. We ended up losing money on the exterior LED lighting project. However, we installed these lights to increase resident safety.

You will find that the green report will list ALL opportunities, even if the payback period is absurdly long. If we implemented all the opportunities identified in the example above, the overall payback period would have been 91.9 years, with the longest payback period being 165 years for the Energy Star rated dishwashers. Unless we decided to hold onto a building until we died or unit they’ve discovered an immortality serum, we stuck to the opportunities that either resulted in a payback period lower than our projected hold time or address a resident safety concern.

How to Pay for the Due Diligence Reports

Usually, the costs of the real estate due diligence reports will not be due until closing. So, when underwriting the deal, make sure you are taking these costs into account when determining how much equity you need to raise.

Other times, you will need to pay for a due diligence report upfront. If this is the case, you can do one of two things. You can pay out-of-pocket and reimburse yourself at close. Or, you can take a loan from a third-party (maybe one of your passive investors) and reimburse the initial loan amount with interest at close.

Review the Results of Your New Underwriting Model

Based on the financial document audit, market survey report, lease audit report, and green program report, you will either confirm or update your income assumptions. The financial document audit will help you confirm or update your expense assumptions. The two property condition assessments and the unit walk report will lead you to confirm or update your renovation budget assumptions. Based on the appraisal report, you will either confirm the accuracy of the purchase price or determine that you have the property under contract at a price that is below or above the as-is value. And based on the site survey and environmental survey, you will determine if there is anything that disqualifies the deal entirely.

Once you have received the results of all 10 real estate due diligence documents and made the necessary adjustments to your underwriting model, you need to re-review your return projections. If you had to make drastic changes to the income, expenses or renovation budgets in the negative direction, then the new return projections will be reduced. In some cases, the return projections will be reduced to such a degree that the deal no longer meets the return goals of you and your investors. Also, if an issue came up during the site survey or the environmental site assessment, which is rare, it will need to be resolved prior to closing. If the seller is unwilling or unable to address these issues, your lender will not provide financing on the property, which means you will have to cancel the contract.

If the updated return projections fall below your investor’s return goals, adjust the purchase price in your underwriting model until the projected returns meet your investor’s goals again. Then, explain to your real estate broker that you want to renegotiate the purchase price and state the reasons for doing so.

If the seller will not accept the new contract terms, don’t be afraid to walk away from the deal. At the end of the day, it is your job to please your investors, which means providing them with their desired return goals.

 

Are you a newbie or a seasoned investor who wants to take their real estate investing to the next level? The 10-Week Apartment Syndication Mastery Program is for you. Joe Fairless and Trevor McGregor are ready to pull back the curtain to show you how to get into the game of apartment syndication. Click here to learn how to get started today.

Follow Me:  
FacebooktwitterlinkedinrssyoutubeinstagramFacebooktwitterlinkedinrssyoutubeinstagram


Share this:  
FacebooktwitterpinterestlinkedinFacebooktwitterpinterestlinkedin