JF1500: Are You Ready To Become An Apartment Syndicator? Part 2 of 2 | Syndication School with Theo Hicks
The Importance of Investor Education
For part two of Are You Ready to Become an Apartment Syndicator, Theo will be telling us about the requirements for apartment investing education. You’ll need to know the lingo and be able to talk the talk as well as walk the walk when dealing with brokers, lawyers, investors, and everyone else you’ll cross paths within this business. Theo has four ways you can obtain the required investor education in order to do your own apartment syndications. If you enjoyed today’s episode, remember to subscribe in iTunes and leave us a review.
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Joe Fairless: There needed to be a resource on apartment syndication that not only talked about each aspect of the syndication process but how to actually do each of the things, and go into it in detail… And we thought, “Hey, why not make it free, too?” That’s why we launched Syndication School.
Theo Hicks will go through a particular aspect of apartment syndication on today’s episode and get into the details of how to do that particular thing. Enjoy this episode, and for more on apartment syndication and how to do things, go to apartmentsyndication.com, or to learn more about the apartment syndication school, go to syndicationschool.com, so you can listen to all the previous episodes.
Theo Hicks: Hi, Best Ever listeners. Welcome to another episode of the Syndication School series, a free series that focus on the “how-to” of apartment syndications. I am your instructor, Theo Hicks. Each week, we air a two-part podcast series about a specific aspect of the apartment syndication investment strategy, and for the majority of this series, we will be offering a free resource document or spreadsheet for you to download for free. All of the documents and all of the episodes can be found at SyndicationSchool.com.
This episode is part two of the two-part series entitled “Are you ready to become an apartment syndicator?” In part one, which was yesterday’s episode, you learned the experience requirements needed before becoming an apartment syndicator as it relates to business and real estate. And to do so, you answered a list of questions and you gave yourself a rating of one through 10 based off of your real estate and business background. If you were a five or higher, you are ready to start the syndication journey. If you are four or lower, then you need to spend a couple of years focusing on building a stronger real estate and business background.
If you’re a one through 10, regardless, this episode will go over the second thing needed before becoming an apartment syndicator, and that’s education.
Experience May Be the Best Investor Education
In the previous episode, when we had a conversation about experience, the reason it was important is because when you’re talking to various team members when you’re in the hiring process, or when you’re talking to potential passive investors, one question they’re gonna ask you is “What’s your background?” They’re gonna wanna know what your real estate background is and what your business background is, because, depending on what you’ve done in the past, they will or won’t have confidence in either investing with you or becoming a part of your team.
Assuming you pass the experience test, another thing that you’re going to need, which is kind of obvious, is an education… Because when you are talking to these team members and passive investors, once you pass that initial smell test, when they’re asking you questions about your investment strategy and what you plan on doing, if you don’t know how to talk the talk, then they’re gonna know that you are not ready to become an apartment syndicator.
Make the Lingo Part of Your Apartment Investing Education
For example, when you’re talking to real estate brokers, they’re gonna ask you what your investment criteria is because that’s how they are going to send you deals. If you don’t know what investment criteria means, or what the different components of your investment criteria are, then you’re not gonna sound very smart and they’re not gonna be able to send you a deal. And if you just say, “I want any deal”, then that also shows a lack of experience.
Also, when you’re talking to attorneys and mortgage brokers, they’re gonna ask you how you plan on structuring your partnership with your limited partners, and they’re gonna ask you what’s the return structure, what’s the preferred return offering, what’s the profit split, things like that… So, if you don’t know what those terms mean, you’re not gonna be able to answer that question.
At the same time, your passive investors may ask you any question they can think of, and it’s gonna involve using certain terminology that is specific to apartments and apartment syndications… So, overall, in order to effectively communicate with team members, you need to know the lingo.
The Four Ways You Can Increase Your Investor Education
In this episode, I wanna go over four ways that you can obtain this apartment syndication education. These aren’t the only four ways, but these are the four main ways, and the four best ways to get educated, as well as cover other aspects of the apartment syndication checklist as well.
1. Memorize the Terminology to Improve Your Apartment Investing Education
The first one, which may sound boring to you, but needs to be done, is you need to memorize the important terminology. This is a must. This is something that everyone who wants to become an apartment syndicator has to do. This is the first thing that Joe has his consulting clients do, and in fact, this is the first thing that Joe did himself.
When he was interested in becoming an apartment syndicator, he took all the important terms and created flashcards and carried those flashcards with him wherever he went. When he was taking the L train to work in New York, he had his flashcards. When he was reading different books, he used the flashcards as bookmarks, so that whenever he opened up the book to start reading again, right there was the flashcard in order to learn the apartment syndication lingo.
Now, I’m not gonna go over every single term on this episode, because it would be too long and it would probably bore you to death, but the free resource we’re going to give away with this podcast will be a list of all the important syndication terms. Go to SyndicationSchool.com, and under this specific episode, you’ll find a link to download all of the important apartment syndication terms.
Now, I will, however, on this episode go over a few of the top terms that you must know for apartment syndications, and that are not necessarily related to other non-apartment syndication investment strategies. If you’re a fix and flipper, a wholesaler, a single-family rental investor, or even a smaller multifamily rental investor, these are terms that you might not necessarily know or have heard before, but that you need to know when having conversations with team members and passive investors.
Term One: Internal Rate of Return
The first one probably the most important one is going to be internal rate of return, or IRR. In most investment strategies, the return factor that’s used would be cash-on-cash return for rentals, or for fix and flippers I guess it’s just a specific “I want to make $15,000 per flip.” For apartment syndications, the important return factor is the internal rate of return.
The internal rate of return is a rate that accounts for the time value of money. When people are investing in apartment syndications, they don’t want to just know what the cash-on-cash return is going to be, because the cash-on-cash return for one year is different than the cash-on-cash return for ten years. So if I make $100,000 in one year, versus $10,000 a year for ten years, the actual value of that money because of time is going to be different, with the one-year $100,000 being worth more than the 10 years of $10,000/year. So that’s what the internal rate of return is.
Usually, a passive investor is going to have a specific IRR target in mind, which means that you as an investor need to know how to calculate the IRR for your deals. It’s a very complex formula, typically, to calculate the IRR. You just use the Excel formula “IRR”, and what you need is the initial investment and the annual cashflows, plus the profit at sale. That will determine the IRR. And, again, if an investor makes $100,000 in two years, that IRR is gonna be much higher than if you make $100,000 in ten years, because of the time value of money. So that’s one important term that you need to know, internal rate of return.
Term Two: Occupancy Rates
Another important term – or, I guess, terms, are the occupancy rates. For smaller multifamilies or for rentals in general, the occupancy rate that most investors focus on is the physical occupancy rate. That is the rate of units that are occupied. If you’ve got 100 units and 90 are occupied, then your physical occupancy rate is 90%.
Now, the occupancy rate that matters more for apartment syndications is going to be the economic occupancy rate. If you have the same property, with 90 units occupied out of 100, your physical occupancy rate is 90%, but your economic occupancy rate is not necessarily going to be 90%, because it is the rate of paying tenants, not just the rate of tenants who are there.
For example, if those ten units that are occupied are all your highest grossing units, then your economic occupancy rate is gonna be lower than 90%. If 10 of those 90 tenants aren’t paying rent on time, or not paying enough rent, then your economic occupancy rate is gonna be lower than the 90%.
Essentially, you figure out how much rent you should be collecting if the units were 100% occupied, and you need to determine how much rent you’re actually collecting, and you take that number of how much rent you’re actually collecting, divide it by the gross potential rent, and that is going to be your economic occupancy rate.
Again, that’s important, because if you have 90 units occupied out of 100, and you say, “Oh, well I’ve got 90% occupied”, whereas, in reality, if those tenants aren’t paying and the units that are vacant are higher in rent, then your economic occupancy rate, which means the amount of money you’re actually making, is not reflective of that 90% number. So those are the two other important terms to understand.
Term Three: Debt-Service Coverage Ratio
These next three are going to relate to when you’re having conversations with mortgage brokers or with lenders, and when you’re trying to underwrite your deal. This is the third term I’m gonna go over out of the ten, and that’s the debt-service coverage ratio. Now, debt-service coverage ratio is relevant to other investment strategies, but it is going to be something that mortgage brokers take into account when they are determining the amount of money they’re gonna lend to you.
The debt-service coverage ratio is essentially a measure of the cashflow available to pay the debt obligation. If your annual debt service is $100,000 and your cashflow is $125,000, then your debt-service coverage ratio is [1:25]. If your debt service is $100,000 and your cashflow is $100,000, then it’s going to be a 1. Obviously, the higher the debt-service coverage ratio, the less risky the deal, because if you have a lower month or a lower year, you’ll still have the ability to at least cover the debt service, or the debt, or the mortgage payments.
Now, when mortgage brokers or lenders are underwriting a deal, there’s typically going to be a minimum debt-service coverage ratio that they’re willing to lend. For permanent agency debt, that number is gonna be [1:25]. When they underwrite the deal, the cashflow needs to be 25% higher than the actual debt in order for them to provide you a loan on the deal.
That’s an important thing to know because the property could have returns that meet your projections, but it won’t qualify for financing if the debt-service coverage ratio is too low, starting from day one… And they’re going to base that off of how the property is actually currently operating. If the way the property is currently operating doesn’t have a high enough debt-coverage ratio, then you’re gonna have to pursue a different form of financing.
Term Four: Loan to Cost vs Loan to Value
Number four is gonna be the difference between loan to cost and loan to value. These are two factors that the lender will take into account when determining how much money they’re willing to loan. Loan to cost is going to be a percentage of the total project costs; that’s gonna be the purchase price plus the capital expenditures, which is the renovation budget, whereas the loan to value is going to be a percentage of just the value of the property or the purchase price.
For example, a lender will say, “I’m willing to lend up to 80% loan to cost”, which means that they’re willing to provide financing on 80% of the total project costs. If the total project costs are a million dollars, then they’re willing to lend $800,000, and you have to come up with the other $200,000.
Loan to value – same thing. A lender will say, “I’m willing to loan up to 75% LTV”, which means, if the property is valued at a million dollars, they’re willing to loan $750,000 and you have to come up with the rest.
Again, if you don’t know what these terms mean and the lender says that, you’re not gonna know how to respond or you’re not gonna know what that means.
Term Five: Recourse vs Non-Recourse Debt
Number five is the difference between recourse and non-recourse debt. The difference between these two are whether you are personally liable if you are going to foreclosure and the collateral is not enough to pay the existing debt obligation.
For non-recourse debt, the lender can only go after the actual property, unless a carve-out is triggered, which is negligence or fraud. What that means, if you’re going to foreclosure or you default on a non-recourse loan, the lender could only go after the property, as long as the reason for default or foreclosure is not fraud or gross negligence. However, if you have a recourse loan, then that’s not the case. They can come after your personal assets.
The reason why this is important is because, when you’re talking to a loan guarantor, which essentially is the person who meets the net worth liquidity requirements and you have them sign on your loan so that you can qualify for the loan, they’re gonna wanna know if their loan is recourse or non-recourse. Because if it’s recourse, they’re gonna demand more compensation to sign on the loan, as opposed to it being non-recourse, because there’s a lot less risk for the non-recourse debt. So that’s number five, the difference between recourse and non-recourse.
Terms Six and Seven: Rent Roll and Profit and Loss Statements
Number six is a rent roll and profit and loss statement. These apply to smaller multifamily as well, but the rent roll is going to be a list of all the units and all the information you need to know about those units – who’s living there, what’s the rent, when did the lease start, when does the list end, what’s the security deposit, what are other fees that are being charged to that unit, and how much money does that unit owe.
Then a profit and loss statement is a detailed, itemized spreadsheet of all the revenue line items and all the expense line items. These are important because you are going to use these to initially underwrite the deal, and once you actually own the property, you’re going to need to look at the rent roll and profit and loss statement in order to compare how the property is actually operating to the budget you created, to make sure that you are staying on track.
And you’re also gonna send these to your passive investors. So, if they come back and ask you questions about something on the rent roll or profit and loss statement and you don’t know what it means, it’s not gonna look very good.
Next is there are a lot more revenue loss items on apartments than there are on smaller multifamily or single-family deals. What I mean by revenue loss is you’ve got your income coming in, and then these are items that aren’t operating expenses, but they are things that you are either losing or having to pay, that are taken away from being fully rented at a 100% economic occupancy rate.
For example, we’ve got vacancy loss, which is pretty standard – how much money are you losing in rent because of vacant units. These other four are not typical to anything but apartments. You’ve got loss to lease – that’s the difference between the market rent, which is the highest amount of rent you can demand based off of the difference between that market rent and the actual rent. So if you are renting a unit for $800 and you could be getting $850, the loss to lease is $50, and that’s technically considered a revenue loss because you could be getting that $50.
Another one is bad debt. Bad debt is uncollected moneys that are owed by a tenant after they move out. If their security deposit doesn’t cover a certain damage and they still owe you a couple thousand dollars, if you have a 300-unit property, you’re likely not gonna be able to collect every single piece of bad debt, so that’s gonna be a revenue loss that you can write off.
Next is gonna be concessions. That’s moneys offered to residents at move-in, to get them to sign the lease. Maybe you offer them a $300 referral fee, so if they refer someone, they get $300 off the rent. Or it could be a move-in special, where you reduce their first month’s rent or security deposit. Those are all considered losses because you could be making that money.
And then lastly, there is a unit loss, which means you have a model unit that could be rented, or you’re renting a unit to an employee for a discount.
These are all things you need to know when you’re looking at a profit and loss statement. You need to know what those are, and what is an acceptable amount to have, for example, for loss to lease or for concessions.
Term Eight: Preferred Return
Another important term, number eight, is a preferred return. A preferred return is the threshold return that you offer to your passive investors. It’s not a guaranteed return, but the first portion of the cashflow after you pay all operating expenses and debt service goes towards your investors in the form of a preferred return.
For example, if someone invested $100,000 and you offer 8% preferred return, then they should be getting $8,000 annually, before you as a syndicator receive money.
Term Nine: Proforma
Number nine is a proforma, which is going to be the budget you create prior to buying a property or submitting an offer. Your mortgage broker is going to want to see your proforma budget in order to underwrite the deal, and your property management company is also gonna want to see your proforma budget so they can confirm whether they can operate the property at those numbers.
Term Ten: Income Approach
The last term I wanna discuss is the income approach, which is the valuation method of apartments. Unlike residential properties, where it’s based off of the sales comparison approach, the value of an apartment is based off of the income. More specifically, it’s based off of the net operating income, which is the total income minus the operating expenses. So the value of the property is going to be the net operating income divided by the market cap rate.
The reason this is important is because the value of the property is based off of how much income you are bringing in, as opposed to the sales price of other apartments in the area.
Those are just ten terms that you might not have heard of before, that are very important to apartment syndications. In order to get the rest of the terms, again, go to SyndicationSchool.com and download the glossary of syndication terms, create flashcards and take them with you wherever you go. Read them once a day until you know these terms inside and out.
That’s the first way to obtain the education, and the one way that everyone has to do, at the very least. These next three are ways to expedite your education, as well as to check off other aspects of the apartment syndication process.
2. Boost Your Investor Education Through Conversations and Thought Leadership
Number two is to create a thought leadership platform that is interview-based. As you know, Joe has a podcast where he interviews investors, and one benefit of the podcast is you can decide who you interview. You can create a thought leadership platform and interview one apartment syndicator or one apartment-related professional every week. 52 weeks in a year, that’s 52 conversations with active apartment investors, active syndicators, active mortgage brokers, commercial brokers… Imagine how much you can learn from those conversations.
At the same time, you are becoming a thought leader, which would allow you to attract passive investors. You are networking with people who can help you with your business, so that will help you bring on actual team members. So again, you benefit from the education, and you also benefit from the networking abilities of a thought leadership platform. Now, we’re going to, in future episodes, go into detail on thought leadership platform, so, for now, I’ll just keep that as a placeholder.
3. Work with a Mentor to Gain Invaluable Investor Education
Number three, the third way to obtain an apartment syndication education would be to work under an experienced syndicator. There really is no better way to learn anything than to follow someone who is already successful in that thing. In this case, an apartment syndicator.
Now, I can personally attest to this, because three years ago I had some experience in real estate. I’d purchased a duplex, but I didn’t know anything about apartment syndications whatsoever; I didn’t even know they existed. And I started working for Joe, and in those three years, I’ve learned more about apartment syndications than I could have learned really any other way besides actually doing one.
Finding a Mentor
The way that you want to approach working for an experienced syndicator is you can just pay them and they can be your mentor. But a better way is to proactively add value to their business for free, for a certain amount of time, and then ask them if you can become an intern, or shadow them, or take on more responsibilities as it relates to their business. This is essentially what I did.
I attended one of Joe’s meetups, and he needed help with his podcast, and that’s really all he said. He said, “I want help expanding my podcast.” So, I told him that I would do that, even though I had no experience with podcasts… And I not only helped him with his podcast, but I also said, “Hey, maybe we should start a newsletter, and we can start a blog.”
I essentially added more value than what he actually asked for in the first place. Because of that, he trusted me and my responsibilities expanded to helping him out with his actual apartment syndication business, and again, as I mentioned, I’ve learned so much that I’m in the process of starting my own syndication business now.
So what you wanna do is find an experienced syndicator and research and find out their background and what they do, and then offer to add value to their business. Instead of just emailing them and saying, “Hey, how can I help you?” or “Hey, can you be my mentor?”, say, “Hey, I read your blog” or “I listened to your podcast” or “I went to your website and I saw that you are (for example) looking for properties in the Dallas-Fort Worth market, so if you have any deals that you want me to go tour for you, feel free to let me know.” Or you can send them a list of strategies for ways to increase their brand reach.
Really, it comes down to how creative you are and your unique skill sets and background. And again, you’re offering this service for free. Do it for a while, and then eventually ask for more responsibilities, or wait for more responsibilities to come, or ask if you can intern for them, or shadow them, or if they can be your mentor. So that’s the third way.
4. Read as Much as Possible to Improve Your Investor Education
The fourth way, of course, is to read the Best Ever Apartment Syndication Book. It’s a 400-page tome where we go over the entire apartment syndication process, from beginning to end. To buy that book, go to apartmentsyndicationbook.com. Again, 450 pages of the entire apartment syndication process, from start to finish.
These are the four main ways to obtain an apartment syndication education. First is to create flashcards with the important terminology, and to do so, download the free glossary resource at SyndicationSchool.com. Number two is to create a customized education through a thought leadership platform, which is an interview-based podcast, blog, YouTube channel, where you’re talking to active apartment syndicators or active commercial real estate professionals, and learning from them, and ask them whatever questions that you want.
Number three is to intern or have a paid mentorship with a syndicator. If you wanna go the intern route, proactively add value to their business for free before asking for any sort of help in return. And then fourth, pick up a copy of the Best Ever Apartment Syndication Book at apartmentsyndicationbook.com.
That concludes part two, the education requirements needed before becoming an apartment syndicator. You can listen to part one, which goes over the experience requirements, you can listen to the other Syndication School series, with the how-to’s of apartment syndications, and you can download the free resources – for this episode, again, it’s the glossary – at SyndicationSchool.com.
Thank you for listening, and I will talk to you next week.