{"id":65932,"date":"2014-11-18T14:00:36","date_gmt":"2014-11-18T21:00:36","guid":{"rendered":"https:\/\/www.biggerpockets.com\/renewsblog\/?p=65932"},"modified":"2021-03-16T10:25:48","modified_gmt":"2021-03-16T16:25:48","slug":"2014-11-18-6-steps-to-structuring-a-solid-real-estate-deal-with-investors","status":"publish","type":"post","link":"https:\/\/www.biggerpockets.com\/blog\/2014-11-18-6-steps-to-structuring-a-solid-real-estate-deal-with-investors","title":{"rendered":"6 Steps to Structuring a Solid Real Estate Deal With Investors"},"content":{"rendered":"

Real estate can have a high barrier of entry because most deals require a lot of capital. This is a good thing for people who have cash because it reduces the amount of competition. However, this is a big problem for those of us who want to become real estate owners for the first time.<\/p>\n

I remember calling a random bank during my senior year of college (in the midst of the greatest recession since the Great Depression) and telling the banker that my goal was to buy twenty houses or so. The banker was stoked and asked me how much cash I had available for such purchases. When I told her I had about $2,500 in savings, she laughed and then hung up. I was devastated!<\/p>\n

I realized that I would need to cultivate investor relationships using my network if I wanted to achieve my real estate goals. I have been incredibly fortunate to find great capital partners (aka investors) over the past five years, and I have learned a lot about how to structure an agreement. Structure is important because it is going to determine how you get paid for all of your hard work and entrepreneurism. It is also important to structure deals appropriately so that you can get the right investors.<\/p>\n

Related:<\/strong> How to Structure Syndicated Investor Deals: What Kind of Legal Entity Should I Use?<\/a><\/em><\/p>\n

Below is the process I use when structuring my real estate deals:<\/p>\n

6 Steps to Structuring an Investor Deal<\/h2>\n

1. Figure Out Your Goal for the Project<\/h3>\n

In a lot of ways, this can be the hardest step. The easy answer is, \u201cI want to make money!\u201d However, it needs to be more sophisticated than that because no investor is going to invest in a project whose stated goal is so vague. It is likely helpful to put each project into one of the following two categories: long-term hold or short-term flip. The time periods for each goal can vary. For example, a short-term flip for an apartment building may take two to three years, whereas a short-term flip of a single family house can take as little as 45\u00a0days.<\/p>\n

The main point of figuring out your goal is to give your investor a sense of when they can expect a return on their money. It also gives you a foundation upon which to make operational decisions. For instance, if it is a long-term hold for an apartment building, then you are going to look for a tenant who will stay a long time, even if they pay a little less than another tenant. For a short-term apartment flip, it is important to bump NOI and so you are more likely to take a riskier tenant if they will pay a little bit more in rent.<\/p>\n

2. Create a Property Level Financial Model for the Deal<\/h3>\n

A property level financial model just looks at the return that the property generates without regard for investor structure and payouts. I look at this type of model as a first hurdle because it gives me a sense as to whether or not I\u2019m getting a good deal.<\/p>\n

My property level summary sheet usually looks something like what is below:<\/p>\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n
Purchase Price<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 7,400,000<\/td>\n<\/tr>\n
Down Payment<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 1,500,000<\/td>\n<\/tr>\n
Capital Expenditures<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 250,000<\/td>\n<\/tr>\n
Loan Amount<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 5,900,000<\/td>\n<\/tr>\n
All-In Cost<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 7,650,000<\/td>\n<\/tr>\n
Total Investor Capital<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 1,750,000<\/td>\n<\/tr>\n
Gross Rents<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 846,800<\/td>\n<\/tr>\n
Stabilized NOI (Year 2)<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 611,920<\/td>\n<\/tr>\n
Monthly Loan Payment<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 29,783<\/td>\n<\/tr>\n
Annual Loan Payment<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 357,392.98<\/td>\n<\/tr>\n
DSCR<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 1.71<\/td>\n<\/tr>\n
Free Cash Flow<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0254,527<\/td>\n<\/tr>\n
Cap Rate<\/td>\n\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 8.00%<\/td>\n<\/tr>\n
Cash on Cash Return<\/td>\n\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 14.54%<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

 <\/p>\n

There is obviously a lot more that goes into building this type of model, but from a big picture perspective, these are the most important details. The deal above is a long-term hold and provides solid cash flow. I like to incorporate debt into the property level financial model because it will give me insight into what type of structure I can get away with and still have investors be happy. For example, if the cash on cash for this deal was 8%, I would likely need to believe in a big value bump down the line and somehow work that into the investors\u2019 return, or they would never do the deal.<\/p>\n

The point of creating a financial model is to show you (and your investor) how much money you stand to make if the project does well. I have never built a model that was exactly<\/em> right — that\u2019s not the point. You want to build a model that is reasonable. It is easy to get excited about a prospective deal and have visions of millions of dollars in your bank account; trust me, I know. Building a good model allows you to look more objectively at the project and see if it is worth your time.<\/p>\n

3. Create a Model Based on Your Proposed Deal Structure With Your Investor<\/h3>\n

I almost purchased an apartment building in Chico, CA right by a state university. Student housing was my favorite idea at the time, and I was convinced that this project was going to be my ticket to wealth! The owner of the building was agreeing to carry back a large portion of the loan, but he wanted an above market rate on the loan.<\/p>\n

At first I thought it was going to be a great deal. However, once I factored in the structure, I realized I didn\u2019t stand to make all that much money because it was the wrong structure for that type of deal. In order to make sure I\u2019m mindful to prevent this type of situation, I add the following lines to my property level model to create a \u201cnew\u201d model that incorporates my deal structure with my investor:<\/p>\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n\n
Purchase Price<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 7,400,000<\/td>\n<\/tr>\n
Down Payment<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 1,500,000<\/td>\n<\/tr>\n
Capital Expenditures<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0250,000<\/td>\n<\/tr>\n
Loan Amount<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 5,900,000<\/td>\n<\/tr>\n
All-In Cost<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 7,650,000<\/td>\n<\/tr>\n
Total Investor Capital<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 1,750,000<\/td>\n<\/tr>\n
Gross Rents<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0846,800<\/td>\n<\/tr>\n
Stabilized NOI (Year 2)<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 611,920<\/td>\n<\/tr>\n
Monthly Loan Payment<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 29,783<\/td>\n<\/tr>\n
Annual Loan Payment<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 357,392.98<\/td>\n<\/tr>\n
DSCR<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 \u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a01.71<\/td>\n<\/tr>\n
Free Cash Flow<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 254,527<\/td>\n<\/tr>\n
Cap Rate<\/td>\n\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a08.00%<\/td>\n<\/tr>\n
Cash on Cash Return<\/td>\n\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a014.54%<\/td>\n<\/tr>\n
Capital Pref (7%)<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 105,000<\/td>\n<\/tr>\n
Sponsor Claw (2%)<\/td>\n\u00a0$\u00a0 \u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a030,000<\/td>\n<\/tr>\n
Cash after Pref<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 119,527<\/td>\n<\/tr>\n
Capital Proceeds<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 200,622<\/td>\n<\/tr>\n
Sponsor Proceeds<\/td>\n\u00a0$\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0 53,905<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n

 <\/p>\n

Here, it becomes quite clear where and how much I am going to make. It is important to start messing around with the numbers to see how things will play out. What if your NOI drops to $550,000 in year three? What if your loan goes up 50 basis points? These are all things you should understand.<\/p>\n

4. Adjust Your Proposed Structure So That the Deal Would Make Sense for You to Do<\/h3>\n

This is a crucial step. It is first important to figure out how you can make the deal work for you — before you worry about making it work for your investor. It is important to take care of your investor, but if you bring them a deal that doesn\u2019t work for you, then you may end up bailing on the deal, not performing because you aren\u2019t incentivized, or simply doing a ton of work and not being adequately compensated.<\/p>\n

Investors will tell you if the deal doesn\u2019t work for them. An important note is to be open and honest with your investors about how much each of you stand to make. There shouldn\u2019t be any surprises when it comes time to pay out the profits.<\/p>\n

5. Meet in Person With Your Investor and Discuss Your Proposed Structure<\/h3>\n

Be reasonable. Make sure you know what will make the deal worth your time, and don\u2019t go too far beyond that point. I understand (and advocate) taking a little bit less on a deal in order to get some experience. The key is to make sure that it\u2019s a balance, or else you may find yourself disenchanted with the whole real estate investing thing.<\/p>\n

Related:<\/strong> How to Find Investors To Fund Your Real Estate Deals<\/a><\/em><\/p>\n

If your investor comes back with a meaningfully different proposal, I always suggest taking time to think about it. Go home, go on a walk, and give yourself a day to work out whether or not you really want to do this deal.<\/p>\n

6. Create an LLC and an Operating Agreement<\/h3>\n

I prefer to use LLCs when owning real estate because they are simple and relatively cheap. I have created LLCs in California and Utah. Utah was very business friendly, and California was not at all. Most likely, you are going to create an LLC in the state you own the property, but it may be worth a fifteen minute Google search to explore other options. Many large companies use Delaware, for what it\u2019s worth.<\/p>\n

The operating agreement should be written up by a lawyer. It should outline all of the different aspects of the agreement that you and your investor came to. Most importantly, it should cover payouts.<\/p>\n

Structuring an agreement with an investor can be a daunting task. \u201cI don\u2019t want to lose my only<\/em> investor!\u201d is a thought that has run rampant in my mind. However, your time is precious, and there are plenty of wealthy people out there. Make sure that the structure will make you some money also.<\/p>\n

What would you add to this list? What’s worked for you when structuring a deal?<\/em><\/p>\n

Leave us comments below!<\/strong><\/p>\n","protected":false},"excerpt":{"rendered":"

Real estate can have a high barrier of entry because most deals require a lot of capital. This is a good thing for people who have cash because it reduces […]<\/p>\n","protected":false},"author":1685,"featured_media":65939,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[5524],"tags":[],"class_list":["post-65932","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-real-estate-investing-for-beginners"],"acf":[],"comment_count":0,"_links":{"self":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/65932","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/users\/1685"}],"replies":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/comments?post=65932"}],"version-history":[{"count":0,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/65932\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media\/65939"}],"wp:attachment":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media?parent=65932"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/categories?post=65932"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/tags?post=65932"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}