Best use of $3M in starting capital

22 Replies

A family member has decided to sell his business overseas and invest all his capital in real estate in the US. He is bringing $3M with him.

He would like to buy properties cash and rent them out. Each property he wants to buy would cost about $140K and will give him $850 NET cash flow per month.

In an effort to get the most "bang for the buck" I would suggest him to, instead of paying cash for, let's say, 20 houses, put a 25% down payment and finance the remaining, allowing those same $3M to get him about 85 of those $140K properties, which would now generate a $350 positive cash flow (after servicing the mortgages).

The only question here is........

Is getting 85 mortgages something even remotely possible to achieve? How would you guys go about using those $3M in 70% LTV real estate deals?

He is in luck.  Blanket loans are back.  He should be able to obtain portfolio loan.

He would like to buy properties cash and rent them out. Each property he wants to buy would cost about $140K and will give him $850 NET cash flow per month.

So, rents are $1700 a month?  Or is that net number based only on taxes and insurance?  If he seriously wants to own 85 properties he will:

1) be using a PM.  I'm in favor of self management, but one person cannot manage 85 properties without working 80-100 hours a week.

2) be doing one or more evictions at all times.

3) be dealing with at least one psycho tenant that is wrecking the place at all times.

4) be replacing a roof at all times. Roofs last, what, 20 years?  85 properties means four roofs a year.  And appliances, sewer lines, furnaces, etc.

Assuming those numbers are correct he's making 7% on his money.  With kind of cash and that fairly modest return expectation, triple net properties would be an option.  

Personally I like hard money lending.  Lower effort and should be able to get double digit returns.  But you fore go the potential of appreciation.

@Jon Holdman   Thank you for the info.

The rents would be around $1200 and I'm deducting, Property taxes, insurance, property management fee and HOA from that figure to get the $850 NET.

I'm also in agreement about using a property management company. I only have 5 properties and have a company taking care of them (specially because I live in NYC and the properties are in TX).

Regarding being a hard money lender, I  never thought about it, isn't that super risky? I mean, cant you lose you're money if the borrower screws up?

And just going back to my to my original question, how do you think he could use the $3M as down payments for 85 properties?

Thank you very much for your help!

Lucas

Has he considered leveraging $3M to buy a $10-12M apartment building?  It's a lot less hassle than owning 85 homes.

Yep, you're overlooking a bunch of other expenses that will crop up over time, capital (like those roofs) and vacancy.  The rule of thumb I'm using is the "50% rule" which says that for a large portfolio and over the long term expenses, capital and vacancy will average out to 50% of the gross scheduled market rents.

Probably couldn't get 85 with that money.  There are other costs besides the down payment.  But could get a bunch.  I'd seriously consider larger properties rather than dozens and dozens of SFRs.  Such as an apartment complex or a larger apartment building.  

Do realize that even with SFRs he's not going to get 80 30 year fixed loans.  Might get 10 of those but the rest are going to be something like 15 year fixed, or shorter balloon loans with long amortization periods or ARMS.

Yes, you can absolutely lose money making loans.  For the last several years I've done it through a broker who pools the money and makes loans.  So, the risk is well spread out.   Defaults do happen, and the pool typically just takes the property back deed in lieu.  So, the hits associated with that are spread out.

I used to do them directly and did have one default.  Me and a business partner did that loan, got eight payments then the borrower got caught doing unpermitted work.  We took the property deed in lieu, finished the work and sold it.  We did take a loss on the sale, but it was only slightly more than the interest we had received, so the overall loss was small.  Nevertheless, we expected to earn the money and did not, so that's a different sort of loss.

He should purchase a hotel. Someone can manage it for him, and if he chooses to manage it himself, it will be a lot easier and more effective than owning 80 something properties.

Maybe he should purchase some rental properties, and some notes with high interest rates to keep his investing diversified. I see performing notes with high interest rates as better than a rental. Dealing with a borrower vs. a renter would be less of a headache. We have experience with both. Worse case scenario with a borrower, is they stop paying and you foreclose, with a tenant, they stop paying and you evict. However when evicting you also risk the tenant damaging the property. When foreclosing, if the loan to value was evaluated in a safe manner, you should have enough equity in the house to fix it and sell it without loosing any capital. 

Thank you @Nick Wing . What exactly do you mean by notes? Where do you get them? (Sorry for the newbie questions, but I'm really not familiar with these) You can PM me if you prefer. Thank you!

Thank you for the detailed information, @Jon Holdman . When using a broker as a hard money lender, how does that affect the profitability? The broker gets a commission or a percentage of the interest? How exactly does the fact that you use a broker minimizes or "spreads out" your risk? Thank you!

@Lucas Bonasio  Just my personal opinion but with that amount of capital he can buy an apartment complex that's what I would do.

"Notes" are loans you make.  @Nick Wing  and I are suggestion variations on the same strategy - lending.  I'm suggesting originating new notes in the form of hard money loans to rehabbers.  Nick is suggesting buying existing notes.  "Performing" means notes that are getting paid.  "Non-performing" would mean notes that have defaulted.  Either can be bought and sold.  On Wall Street they call these "bonds" but they're more or less the same thing as a "note."

If you make direct loans you have a couple of issues.  Say you have $300K to lend and a borrower wants $250K.  If you're making, say, 12% on the loan then you're making 12% on $250K and (maybe) 1% on the remaining $50K.  So your effective return is 10.2%.  And when that loan pays off it will take some time to get another one out.  During that time the money is earning the 1%.  I call that "lumpiness".  While you might be getting 12% on the loan, your returns are reduced by the lumpiness.  Further if you do have a default, like we did, you may have a loss on that money.  We effectively lost about $2000 on a $150K investment over the period of 15 months.  That hurts your returns.

With a pool, or a big enough pot of your own cash, like your friend, the lumpiness is reduced because a large portion of the cash is invested most of the time.  And a default is spread over the pool.  So rather than one lender bearing the full impact of the default and others avoid it completely, everyone involved takes a little of the pain for the defaulted loan while continuing to earn returns on the other loans in the pool.

The broker does take a cut of the returns.  He keeps all the points on the loans and a cut of the interest.  In exchange he does all the work.  It is truly a passive investment.

With that much cash I would honestly spread it around.  Buy some SFRs, some apartments, do some lending.  I'd also put part of it into stocks and bonds, and hold some in cash.

1 mil in heathcare real estate reit. They NNN healthcare real estate. Dividend 6% ish.

2 mil in multi unit or best selected A properties or any combination Reit vs A props.

If he wants hands on then 1 mil or more for 2 or 3 year round VBRO house/chalet/beach pads.

Thanks,

Matt

Lucas you will get  a thousand answers on here.

Most investors with large amounts of capital go into larger properties.

The scale is easier and cheaper to manage around 4 to 5 % versus 10% on little houses ( if you have a bunch of houses in the same area you can get cheaper but it is doubtful to land that many at a price you like).

What's likely more to happen is to buy in  a ton of different areas with a ton of PM companies to oversee as they will not usually cover the whole area. 

You need to find out if your relatives goal is equity growth or cash flow??

The benefit to larger loans above 2 million is you can CMBS, private loans, pension, insurance etc. that do not care he is coming from overseas. You can land non-recourse on the loans. So if you put 25% down say on a strip center for 1 million to buy a 5 million center and obtain cash on cash in the teens annually then the other 2 million and properties are not affected. Most of my high net worth clients desire non-recourse as they have businesses, properties, etc. they do not want to put at risk.

With the smaller properties you are dealing with local to regional banks that want full recourse against you. The loan term is smaller in commercial say 5 years fixed at 25 year amort. versus larger lenders who will go out 10,15,20 years in commercial. 10 is usually the sweet spot.

It is true if he goes residential he will hit  a ceiling because of how those are structured. Often time I find people have a certain idea in their mind when they call me and discover it's much different then they thought.

Hope it helps.  

How about a diversified portfolio of REIT's?

All of the excitement of owning real estate without any of the headaches that go with owning real estate!  

Incredibly liquid and transaction costs are minuscule compared to what 85 houses will generate (lol).  Depending on the modesty of lifestyle, the majority of dividends can be reinvested in the "business".

The potential for growth is tremendous.

That's what I would do with 3M dedicated to real estate investment if I had limited/zero experience with real estate/property management.

There's no way to answer that question for you. The answer is dependent on a lot of other things. Such as: 

  • What is his experience in real estate?
  • What is his age?
  • Does he have other income?
  • What is the economy like in the area where he wants to invest? 
  • What is the demand for properties?
  • What are prices like in the area, is $3 million a big number or starting property? It depends on the area. Here in Orange County, CA it doesn't buy that much, other areas it's a lot of money! 

That's just a few of things that could affect the decision. Maybe instead of SFR homes, older homes (think maintenance) he would want newer houses. He may possibly want to consider other types of real estate, such as commercial (leased to national tenant, etc.) multi unit residential, office building, commercial condos, there's just so many things a person could do!

Some great advice and info above, particularly from Jon and Joel. With that amount of capital, it is wise to diversify a bit (not too much), buy larger multi family deals (better economies if scale), and make sure you are educated enough in each strategy so you don't get burned. Mitigating risk is accomplished through education, experience, and due diligence.

Originally posted by @Nick Wing:

... Dealing with a borrower vs. a renter would be less of a headache. We have experience with both. Worse case scenario with a borrower, is they stop paying and you foreclose, with a tenant, they stop paying and you evict. However when evicting you also risk the tenant damaging the property. When foreclosing, if the loan to value was evaluated in a safe manner, you should have enough equity in the house to fix it and sell it without loosing any capital. 

Sorry, but I've been in plenty of REO properties where the borrower damaged the property - kitchen cabinets removed completely, flooring removed leaving only the sub-floor, graffiti expletives directed at the bank painted on walls, plumbing damaged, water left running in upstairs bathroom with drain and overflow blocked, etc. Not to mention lots of deferred maintenance that the borrower failed to perform.

So the risk of damage isn't eliminated; you might have fewer incidents but you can't expect it to be zero.

All IMO,

Flaw #1.Investing all in Real Estate

Flaw #2 Getting as leverages as he can for the sake of more more more,

Some people like to sleep at night knowing the investment is safe. Getting leveraged for the sake of more certainly carries alot of risk. If he is looking for safe secure cash flow then all that leverage is not the way to go. If he wants to build a good portfolio it would contain stocks,bonds and real estate.  To put all of your eggs in one basket(real estate ) is risky and is as sturdy as a one legged stool. 

I like the idea of diversification. I would not do all sfr's. I would put some money into a passive index fund, some into a few trust deeds, and the rest into real estate, maybe an apartment complex. Or some variation of that. We originate trust deeds in California. With a well-diversified portfolio, risk can be minimized.

@Lucas Bonasio   I'd pay cash and buy properties from  the cash flow. He could then leverage the new purchases keeping the original F&C. At 6% he'd have 180k to play with assuming he doesn't need that much to live on.

He sounds like a smart guy. What does he want to do?

He could buy stuff all over and write off the travel expenses to check out his properties. What fun?

If this guy made $3M on his own, why does he need anyone's help determining what to do with it? 

@Lucas Bonasio  Mobile Home Parks are extremely safe investments compared to hotels or apartments. I would recommend buying a large MHP and hiring a single manager. It will be much easier to deal with and has less turnover, and a single manager. I am a little biased however since that is my specialty. However MHP owners from my experience seem to have been the only ones who made it through the last crash.  

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