Investor · Santa Rosa, CA · Member since 2012 · 2k+ posts · 7k+ votes
8y
@Kay Ferdous before you take in the hard-earned money of your friends and family, do yourself and them a favor and become an expert at multifamily operations and finance. Once you’ve done that your conversations with the investors will flow so much more naturally. And more importantly you’ll be in a better position to not lose their (and your) money, and to deliver the returns you are forecasting.
Case in point being this deal. If you tell your investors to expect the deal to throw off a 26.6% return (at the deal level) you are heading down a road of disappointment. Here’s why:
You are basing your return off of $712,500 of invested capital which represents a 25% down payment. More likely, you’ll need to raise closer to $1MM, maybe more. Closing costs, finance costs, syndication, lender, and real estate legal fees, utility and escrow deposits, first year insurance, cash reserves and any needed immediate capital improvements and upgrades all need to be funded in addition to the down payment. One of the biggest things that causes syndications and syndicators to fail is raising too little money. Then you are either stuck or in the uncomfortable position of making a capital call. If you calculate the returns off of this larger capital stack you’ll find the returns look a lot different than you predicted above.
I don’t know where this property is, how many units or when it was built, but chances are your economic vacancy will be a lot higher than 7%. And on the expense side, you are forecasting a 37% expense ratio. This could be right, or it could be 50%. I don’t know, but be sure you study the expenses carefully and adjust the property taxes for any reassessment that might take place post-sale.
I’m not saying all of this to pick on you, but to save you from the grief I went through when I was first learning this business. It’s a lot harder than it looks and harder than the books and gurus say. I wrote an article on my colossal fail on the BP blog, here’s a link if you’re interested: https://www.biggerpockets.com/renewsblog/colossal-fail/
As to your question on structure...put your investors in the front of the line. You take the back seat. Instead of pondering how to get your investors 8-12% so you can have the rest, first just focus on getting them the 8-12%. The rest will fall into place.
Here’s how this is done: your investors get 100% of the cash flow until reaching an 8% return. Once reaching that hurdle, you split the profits over the 8% 70/30 until your investors receive a 12% return. Once reaching that hurdle, you split profits over the 12% 60/40 until your investors receive a 15% return, and everything over that is split 50/50.
This structure incentivizes you to maximize performance and aligns your interests with that of your investor, while prioritizing the cash flow to meet your investors expectations. If you invest cash into the deal too, treat your cash just like your investor’s cash, you receive the same waterfall pro rata.
I see a lot of my “colossal fail” mistakes in the description of your deal. I learned so much from that experience that I went on to successfully acquire and operate hundreds of millions in multifamily real estate, but there is just no need for anyone to go through that experience to become a successful multifamily operator. Forecast more conservatively and you can grow with a lot less pain.
I think the more important thing is to make sure you really understand how to find, analyze and operate a MF building before you worry about the investor piece...or you won't have to worry about returns, because you won't have any. ;)
Investor · Santa Rosa, CA · Member since 2012 · 2k+ posts · 7k+ votes
8y
@Kay Ferdous before you take in the hard-earned money of your friends and family, do yourself and them a favor and become an expert at multifamily operations and finance. Once you’ve done that your conversations with the investors will flow so much more naturally. And more importantly you’ll be in a better position to not lose their (and your) money, and to deliver the returns you are forecasting.
Case in point being this deal. If you tell your investors to expect the deal to throw off a 26.6% return (at the deal level) you are heading down a road of disappointment. Here’s why:
You are basing your return off of $712,500 of invested capital which represents a 25% down payment. More likely, you’ll need to raise closer to $1MM, maybe more. Closing costs, finance costs, syndication, lender, and real estate legal fees, utility and escrow deposits, first year insurance, cash reserves and any needed immediate capital improvements and upgrades all need to be funded in addition to the down payment. One of the biggest things that causes syndications and syndicators to fail is raising too little money. Then you are either stuck or in the uncomfortable position of making a capital call. If you calculate the returns off of this larger capital stack you’ll find the returns look a lot different than you predicted above.
I don’t know where this property is, how many units or when it was built, but chances are your economic vacancy will be a lot higher than 7%. And on the expense side, you are forecasting a 37% expense ratio. This could be right, or it could be 50%. I don’t know, but be sure you study the expenses carefully and adjust the property taxes for any reassessment that might take place post-sale.
I’m not saying all of this to pick on you, but to save you from the grief I went through when I was first learning this business. It’s a lot harder than it looks and harder than the books and gurus say. I wrote an article on my colossal fail on the BP blog, here’s a link if you’re interested: https://www.biggerpockets.com/renewsblog/colossal-fail/
As to your question on structure...put your investors in the front of the line. You take the back seat. Instead of pondering how to get your investors 8-12% so you can have the rest, first just focus on getting them the 8-12%. The rest will fall into place.
Here’s how this is done: your investors get 100% of the cash flow until reaching an 8% return. Once reaching that hurdle, you split the profits over the 8% 70/30 until your investors receive a 12% return. Once reaching that hurdle, you split profits over the 12% 60/40 until your investors receive a 15% return, and everything over that is split 50/50.
This structure incentivizes you to maximize performance and aligns your interests with that of your investor, while prioritizing the cash flow to meet your investors expectations. If you invest cash into the deal too, treat your cash just like your investor’s cash, you receive the same waterfall pro rata.
I see a lot of my “colossal fail” mistakes in the description of your deal. I learned so much from that experience that I went on to successfully acquire and operate hundreds of millions in multifamily real estate, but there is just no need for anyone to go through that experience to become a successful multifamily operator. Forecast more conservatively and you can grow with a lot less pain.
Real Estate Investor · Encinitas, CA · Member since 2016 · 3k+ posts · 3k+ votes
8y
@Kay Ferdous So @Brian Burke gave the more detailed answer that I was trying to prod you to come up with. If you just look at your debt, you're far more likely to get a 20 year amortization than a 30 year. So debt is now $15K per month. A lot of commerical lenders will require 9 months of PITI in reserves so that's going to require (at least) another $150K to the fund raise. You want 1% so that's another $28K. You'll have to prepay insurance so that's $XK, commercial appraisals aren't cheap so that's $YK, and attorneys to set this up are $ZK, it just goes on and on. And that assumes this is a yield play and no renovations are needed. You're more likely to need >$1MM than <$1MM. And all new apartments go through some degree of stabalization their first year. Vacancy is far more likely to be 10% than 5% 😬
And if you don’t have all actual (necessary) expenses documented nobody will give you their money 🤷🏻♂️
Investor · Boston, MA · Member since 2014 · 232 posts · 165 votes
8y
@Kay Ferdous , I agree with everything @Brian Burke says and given his track record, experience, and how much excellent advice he gives out in the forums / blog every day, it would be wise to take his advice to heart.
One other thing I will add that has been helpful to me in structuring deals and "gut checking" them against other projects is to go on a site like realtyshares.com or another crowdfunding platform and download ~5-10 pro-formas from deals listed there. You can get a look at the waterfall structures, financial statements, capex projections etc.. then see if your assumptions are in line on a % basis.
For example, here is a deal I personally invested in with the only motive being to see how a "successful" syndicator structures their deals, manages a project, and communicates with investor.
Rental Property Investor · Barrington, IL · Member since 2017 · 208 posts · 310 votes
8y
@James E.I would love to hear more about your experiences with www.realtyshares.com. In addition to it being a good investment, do you feel like you are given enough information to learn much?
For those skimming this thread or who might have missed it, be sure to read @Brian Burke's blog post that he links to above. It is very eye opening and has me thinking about things in a different way.
Investor · Boston, MA · Member since 2014 · 232 posts · 165 votes
8y
@Bill F.@Scott Skinger sure thing - happy to do a screenshare or something too and show you how it all works behind the scenes. Thursdays and Fridays usually work best for me - send me a note and we can figure something out.
Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
8y
My real only comment is your mind set at the start... @Andrew Johnson@Brian Burke mentioned the reality of the numbers working.
however your sponsor mind set that your just trying to figure out how to pigeon hole your investors into 8 to 12% so you can keep the rest.. you have failed before you even started.. you have no project with out your money.. you have to honor the money first and foremost..
successful folks that do this I think at least when they start figure out how they can make a homerun for the money and if they can get some working wage or a little bit of kish out of the deal in other words flip flop your mind set.
how do I stand out from all the others out there and there are 1000s searching for investor capital.. And to mitigate your lack of experience.. return to investor is one way to mitigate that..
So maybe think about how you can make your investors 30% IRR or better and you got a shot.. because that is what others do every day. at 8 to 12% one can simply buy a nice performing note and call it a day why all the risk with a newbie sponsor and have to wait years to see if it all works.
Remember Brian and others are buying these assets from some sponsor or investment group many times that has failed..
