JF1725: Answering Apartment Syndication Questions From Best Ever Listeners #FollowAlongFriday with Joe and Theo
We received a couple of great questions over the last week, and decided to answer them today on Follow Along Friday. Joe will answer a question about getting a potential seller to want to sell, as well as responding to a question about who controls the bank account in an apartment syndication. If you enjoyed today’s episode remember to subscribe in iTunes and leave us a review!
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“Get curious, what could be their motivation?”
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Joe Fairless: Best Ever listeners, how are you doing? Welcome to the best real estate investing advice ever show. I’m Joe Fairless, and this is the world’s longest-running daily real estate investing podcast, where we only talk about the best advice ever, we don’t get into any of that fluffy stuff. We hate that fluffy stuff.
With us today, Theo Hicks. We’re gonna do Follow Along Friday, where we talk about the entrepreneurial adventures – usually we talk about this – that we are doing, and more importantly, the lessons we’re learning along the way. However, today we’re gonna be answering two listener questions, and Theo Hicks is going to read the first question and we’ll dive right in.
Theo Hicks: As you said, let’s jump right in. The first question is from Michelle. She said:
“Hi, Joe. I found a potentially KILLER off-market apartment building deal near me. 99-unit, three-building portfolio, bought back in 1979, just over the 39-year expiration of the depreciation tax benefits law. The owner is in his 90s and bought these buildings when they were originally built. I just called him today, but he couldn’t hear me, so his wife took the phone. As I was trying to build rapport and ask her if they might be interested in selling, she said no and hung up.
Have you ever send a letter of intent to a seller like this [unintelligible [00:02:05].02] to entice the seller to sell?”
Joe Fairless: Well, to answer your question directly, the answer is no, I haven’t been in this situation where someone has an opportunity that I came across, I reach out to them and they hung up on me… So I haven’t been in this situation. However, the concept or the structure of the conversation that we’re about to have about this situation I have been in, and I think most real estate investors have been in a similar structure of this type of deal or situation. The structure is as follows – you want to buy a property, and in order to buy the property you have to be attractive to the seller, so that the seller realizes that you are the solution to their problems. That’s basically what’s happening. So that’s why I wanted to answer your question on the show, because your question goes much deeper than what meets the eye. It’s actually “How do we become attractive to sellers, so that we can get more deals?”
The first tip I have for you is get curious. Because when we’re curious, we tend to ask ourselves questions, and when we’re curious, we tend to ask other people questions, and we tend to uncover information that can be helpful for us to identify the answers to those questions that we’re having. So how I would approach this specific situation, and obviously this is gonna apply to the larger situation of trying to become attractive to sellers for deals, is I would reach out to this person again, whether it is through a phone call, or whether you said in your e-mail — I think you mentioned that the owner is in his 90s; I’m not sure how old his wife is, but perhaps a written note would be more appropriate for them, versus a phone call, or — probably not e-mail, but a written note to them.
It might take a little bit longer of a courting process, but just having a written note, and that way you can put your best foot forward and you can go in with pure intentions. So number one is get curious; ask yourself some questions – what could be their motivation? What are some things I could do to help them out in a situation? What are some challenges they might be coming across?
Then when you’re curious — the first thing is to get curious; the second step is going with pure intentions. Because if you go in with pure intentions, then you’re all about serving them, and people can pick up on that. If you are just looking to get the transaction done – that may or may not work, depending on the personality on the other side of the table. But if you go in looking to help solve some challenges that they might have – holy cow. How beneficial is that for them, and then consequently how beneficial would that be for you.
So what I would do in your situation is 1) I’d get curious, I’d start asking some questions to myself, and then 2) draft a letter to them and just simply learn more about their situation while introducing yourself to them, and saying “Hey, I’m not sure where you’re at in the stage of what you’re looking to do with these properties. I can tell you that you might be worried about tax liability when you sell them; you might be looking to get a chunk of cash quickly, you might be looking to spread it out over the next ten years… I’m not sure. What I can tell you is I have experience purchasing these properties in your area, and I’d be happy to talk about some solutions to any of these challenges you might be coming across, to help you and your family out.”
That’s the approach I would take. I wouldn’t force-fit or shove an LOI over to them, because that’s just not gonna work. And Michelle, by you writing “Hey, should I do the LOI?”, I think you already kind of picked up on it that that wasn’t gonna work, and that’s probably why you reached out to us. So that’s the one-two step process, or the one-two punch I would do. 1) Get curious. 2) Go in with pure intentions. In this case, write them a letter, and then go from them.
If they don’t answer the first letter, write them another letter. Most people like getting letters. I can tell you my mom – she loves getting handwritten letters from me, and I would say at minimum it’s something that if you’re handwriting them letters, do it five, six times, maybe every two weeks, or something, at minimum it’s just something that they’re able to occupy their mind with a little bit; it helps stimulate their mind, and they’re getting letters… It’s probably not a bad thing regardless, for them, even if they don’t do a deal with you. So you’re probably helping them out anyway by just writing some handwritten letters.
Then if they write you back – or when they write you back – and obviously, you always put your phone number in the letters, but if they call you or write you back and say “Hey, not interested”, then just let it be. Let this 90-year old gentleman and his wife – let them do their thing, let them decide what they wanna do. Maybe check in six months down the road, but I personally would just let them go about their business; I wouldn’t write them any more letters if they say don’t do it.
Theo Hicks: I agree with everything you just said. Just to elaborate a little bit, and then another thing that I wanted to mention as well, that might not be an ideal fix for this particular situation, but just a new way to think about finding off-market deals in general… But when you mentioned you want to approach the person based on who they are, so someone who’s in their 90s, as you mentioned, is most likely gonna want a letter… And then the curious part – obviously, you wanna ask yourself questions about the deal, but I think based off of Michelle’s comment, it sounds like things might have been going fine until she asked to buy the property; that’s when the person hung up…
So Joe, when you were explaining what to put in the letter – obviously, the purpose of that letter is to buy that property, but you don’t wanna just come out and say “Hey, I buy properties. Can I buy your property? Are you looking to sell right now?”, because obviously that didn’t work… So position it a different way. Ask them if they’re having any challenges, present potential challenges, as Joe mentioned, and instead of saying “Do you wanna sell it to me?” or “I’ll buy your property”, just say “Would you mind speaking on the phone with me, so I can present you with some potential solutions?”
Something else I wanted to mention too, and Joe, let me know if you think this is crazy, but… I interviewed a guy – actually, twice. The last two times I did interviews I interviewed the same person; his name is Preethi. He buys multifamilies in Boston and converts them into condos, and he finds all his deals by door-knocking. Typically, in Boston, these multifamily homes are actually owner-occupied by a family who owns it and they’re living in one unit, and then they’d be renting out the rest of it… And someone who’s in their 90s, they’re gonna appreciate the letter, but who knows – you might have success actually going there in person.
Now, it could go horribly wrong as well, but people do door-knock, and people do find success with door-knocks… But of course, there’s also going to be a lot higher — I wouldn’t say risk, but a more likelihood of it turning sour, I guess, compared to just on the phone or a letter, because they’re not in front of you… But I know it does work, and it sounds like for this particular situation, if you really want this deal, and assuming that they’re close, you could just send them a letter and mention that you plan on stopping by on some day, to present these potential solutions. And if you don’t get a phone call or a message back saying “Don’t show up”, then you can show up. Just don’t do it out of the blue, I guess. Probably let them know first, just in case they don’t want you showing up, or they’re worried about meeting people in person.
Ever since I interviewed Preethi and he talked about door knocking, I’ve just thought that it’s kind of a solution to a lot of different issues people face, particularly when looking for off-market deals.
Joe Fairless: Yeah, and that’s gonna work better for single-family homes, because with large multifamily properties if you show up at my door at my house, asking to purchase my property, there might be violence. That’s so over the top, I would be furious. But with a single-family home it probably works a lot better.
I will tell you in this example, since we’re talking about a specific example – but then also how it over-arching applies to other deals – with this example what I would do is I would use that as a last resort, where in my (say) sixth letter I would write in the letter “Just in case you are not able to reply via a written letter, then I’m just gonna stop by on Saturday at 2 PM and bring you a gift basket for it being Veteran’s Day, or Memorial Day Weekend”, or something like that. Just make up a reason for giving them a gift that’s relevant. “If that time doesn’t work, then feel free to give me a call and let me know and I won’t stop by.”
That way you’re giving them a heads up – you’re coming over, but you’re also giving them a way out to call you and say “Don’t show your face on my property”, and then show up and see if it works. So yeah, I’m with you on that.
Theo Hicks: I’ll make a note to not just show up at your house out of the blue, asking to buy…
Joe Fairless: Oh, you can show up at my house any time, Theo Hicks…
Theo Hicks: [laughs]
Joe Fairless: But here’s some random person asking to buy a property of mine, and you show up at my house – that’s way too much.
Theo Hicks: Alright, so that was Michelle’s question. The next question – it’s also interesting – is from Rich. It is all about apartment syndication;
“The GP (general partnership) controls the business plan. I assume they also control the checking account associated with the project. How does one protect themselves from the general partnership embezzling funds from the operational account? Is there an auditing protocol of some kind of protect the passive investors from outright theft?”
Joe Fairless: Yes, and let’s talk about. First off, Rich, I enjoyed our conversation yesterday. Rich reached out to Ashcroft Capital, so I talked to him yesterday… But he submitted this question a week ago. We had already had this in queue to talk about on Follow Along Friday.
A little bit of context to this question that he didn’t mention in the question, that I can add and he’s okay with me adding this, is that Rich lost $300,000 on an investment, because the woman who he was investing with – a note investor – committed fraud, and consequently she went to federal prison. I don’t know if she’s still in prison or not, but he lost $300,000 and still has not recouped that. So that is the reason why he is asking this question about checking to make sure that the general partner is not embezzling funds from the operating account.
Now, the short answer is — well, I’ll approach it in two ways. One is I’ll tell you what you can do to have some checks and balances before the deal, which quite frankly isn’t a whole lot, but then after the deal closes, you can do a whole lot more… Because there is no money for a shady general partner to take before the deal, but you can do some due diligence prior to the deal… But really, if they were gonna steal money from the entity, then they’d have to do it afterwards, because that’s when the money is in the bank account.
So here’s some things you can do before, but really we’re gonna focus our time on what you can do after the deal closes to make sure everything is on the up and up. Before the deal closes, what you can do is 1) just look at the structure of the deal, make sure that there’s an 8% preferred return, make sure that the general partner is getting paid an asset management fee only if they are actually performing and they’re returning the preferred return. Now, these are things that aren’t gonna prevent someone from stealing money, but it’s just making sure that the deal itself is set up so that you have alignment of interest.
In addition to that, you can ask them for the previous deals that they have done, and then look those deals up on sec.gov and make sure that they’re registered with the SEC. You can just go to sec.gov, look up the entity that owns the property, and it will be registered under sec.gov. Those are some things you can do before the deal. And obviously, check references, check references’ references, check references’ references’ references… If you go three degrees, three layers deep of people, you’re gonna get a good picture of what they’re all about, and then google them. But those are things you’re probably already doing, and it doesn’t directly answer the question you’re asking about how do you make sure they’re not embezzling money; but there is some prep work that needs to be done on the front-end to mitigate the risk of getting in with a group that are criminals.
So now let’s talk about once the deal closes. Once the deal closes, I have listed four things to take a look at. Well, really three, and then there’s a fourth that I’ll just mention. One is, as I mentioned earlier, making sure that the deal is registered on sec.gov. You are a limited partner in a deal; you have ownership in an entity that should own the property. You can go on sec.gov, look up the entity that you’re an owner in, and make sure that offering is registered on the website. So that’s number one.
Number two is you can ask the general partner to send you what’s called the special warranty deed. That special warranty deed shows that the entity you are an owner in purchased the property. It’s notarized and has signatures. So that’s the second thing you can do. And then the third thing is — again, to directly address your question, you were asking about a general partner stealing money; well, looking to see if it’s registered on sec.gov – I get it, that doesn’t directly address if they’re stealing the money, but it certainly will give you an indication of if you should continue to look further or not, if they have an offering that they’ve raised money for, but it’s not actually registered with the SEC. That’s a big red flag.
The second is the special warranty deed – same thing; that’s a big problem if they don’t have a special warranty deed to show the entity that you are an owner in actually purchased the property… What the hell happened then? What did your entity actually do? So if they don’t have that, there’s a big problem.
The third is ongoing financials. Here’s where you could really check… If someone is very crooked, then there’s probably always gonna be a way that they can manipulate the profit and loss statement and the balance sheet. I’m sure they care recreate a document and make it look like something that it’s not. But when you get the profit and loss statement and the balance sheet – and this is the fourth thing – if it comes from a third-party property management company, which we use, it would have to be a major, major, major scam, where they’re also bringing in the third-party property management company into their scam. What are the chances of that actually happening…?
So I think if you look at the registration on sec.gov, number one, number two, look at the special warranty deed, number three, look at the profit & loss statement as well as the balance sheet (because that’s gonna show cash on hand), and number four, if they are working with a third-party property management company, you’ve pretty much got enough checks and balances in place to make sure that everything’s on the up and up, and you’re 99.9% of the time gonna be good. There’s always an outlier with anything in life, but I think those are four things you can do and feel pretty darn confident that everything is going how it should be going.
Theo Hicks: Alright, I have nothing to add to that. I appreciate that. Rich, Joe has already answered your question, and anyone else who is potentially facing a similar situation, or wants to know what to do to avoid Rich’s situation, now you have your solution.
To wrap things up, let’s go to the trivia question. Last week’s trivia question was “In 2018 the total jobs increased by a little under 2%. How many MSAs experienced job growth of 3% or greater?” Very specific question. Obviously, I kind of reevaluated and will move away from these types of questions in the future, but for now the answer was nine. So if you were the first person to get that right, you should be receiving a free copy of our first book.
Joe Fairless: Do you know what I said?
Theo Hicks: Six.
Joe Fairless: Six. Okay. I wasn’t too far off.
Theo Hicks: With Price is Right rules, you were close. This week’s question – I thought this was interesting. The profession with the highest rate of owner occupied home ownership is 90.4%. I think the average is in the sixties. What is that profession? This isn’t a trick question, it’s not some obscure job industry… So what profession has the highest rate of home ownership?
Joe Fairless: Real estate agents?
Theo Hicks: That was number two. It was really close.
Joe Fairless: Alright, alright.
Theo Hicks: So I’ve already eliminated that one from contention. What is number one? I think real estate agent was in the mid-eighties. Like 85%. So that’s a good guess, Joe.
Joe Fairless: Well, it was pretty blatant. I wish I got it right, but I’m glad there’s something else out there that’s number one. I’m interested to hear the answer next week.
Theo Hicks: Alright. And then lastly, the Best Ever Apartment Syndication Book review of the week – this week it’s from Dylan, who said:
“From starting with minimum knowledge of apartment syndication, I can say this book dramatically increased my understanding in the apartment syndication process from A to Z. If you’re serious about using other people’s money to create a successful real estate portfolio, then don’t think twice. The book provides actionable advice, but also asks the hard questions about who you have to become to be a successful apartment syndicator.”
Joe Fairless: Dylan, you’re the man. Thank you for investing your time in writing a review. I know your time is valuable, and I appreciate it. Best Ever listeners, I hope you got a lot of value from today’s conversation. I hope you have a best ever weekend, and we’ll talk to you tomorrow.