Starting out with a Waterfall Distribution Model

[Chase Beasley]

Hello all -

I have been in the development realm for a few years and am looking to make my first investment within the Southeast but am slightly weary to the time required to begin with rentals. 

That said, I have many friends who are investors, restaurateurs, bar owners etc and have had great success in growing their restaurant, bar or investment portfolio by completing waterfall distribution models and attaining private lending. 

I have just finished building out a thorough distribution model of attaining a small portfolio of homes to flip but was wondering if anyone has pursued this avenue by way of renting?

I also have more legwork to do in having my attorney help with private lending requirements etc. but was wondering if anyone has had success with this type of avenue or if it is something that would be advised not to do from the start. 

Thanks

Chase

[Dan Mahoney]

@Chase Beasley Sure, a waterfall would work for rental properties.  I think there are at least three reasons why most rental property investors use simpler arrangements:

1) There is not as much upside potential in residential rentals as there would be in an operating business like a restaurant.  But not as much downside risk, either.  Because of this, the preferred or guaranteed return is going to be more important to investors than having a piece of the upside, which might not turn out to be worth much.  All of the complexity in the waterfall is how to split up the upside.  It may not be worth the effort if the upside potential is not that big.

2) When you are setting up an operating business like a restaurant, you have multiple parties involved and you need to worry about each party's incentives.  You want to motivate each party to put in the necessary effort and make good decisions.  I have co-owned two restaurants, so I have some experience structuring these kinds of deals.  It's hard.  The incentive structure in rental real estate is quite a bit simpler. 

3) Banks are very comfortable lending against real estate, so investors typically have less equity and/or mezzanine type capital they need to syndicate in the first place.

All this being said, you can write almost anything into an LLC agreement, so if you have a structure that works for your sources of capital, go for it.

Of course, I am not a lawyer and you should consult yours before you do anything.