My wife and partner are looking seriously at investing 25-50k in a build in central austin. The proforma suggests an 11mo timeline and forecasts 25% profit, with 9% preferred return. What is the proper due diligence? Thanks!
Verify that the market is sound and the risk of market correction is low. Verify that the builder is experienced and trustworthy. Verify that the deal is good and supports those returns for the investor. Verify that the paperwork provides you adequate protection and contains the expected terms.
So tell me if I understand those terms correctly. If you invest $25,000, you hope to make a 25% return, which would be $6250, hopefully in 11 months. And the preferred return means that you are guaranteed 9% but you'll hopefully get the 25%? Or that if there is any profit, you get first dibs on it to get your minimum of 9%, which would be $2250. And if there is profit over and above that, it may go up to the 25%?
Or . . . I had another investor use the term "preferred return" and what he meant was that he was first guaranteed 9% on his $25,00000 ($2250), which was written in as part of the cost of the project for the use of his money, and then after that, profit was calculated and he took 25% of the total profit.
I would want to research the heck out of the person you are going to send $25k to in hopes of reducing chances of them going off the grid with your money. I am actually more worried about that than trying to figure out if the investment is good.
I second @John P. - need to verify court records, does this person appear with lots of judgements, anything on the criminal side?
What other properties do they own or manage? Go physically look at those properties. Verify their ownership independently. Look for clues of things that would have to be if the story is true. For example, if they own/manage 1000 units and they haven’t ever filed, much less completed, an eviction, that just makes no sense, no one’s that good at tenant screening.
-I wonder if there is a way to do this with an "escrow" type of account. If the investors put the money into an escrow account that a bank could confirm, then maybe the bank would lend on it with the escrow as collateral. The bank could lend in drafts like they do with construction loans. This would cut down on returns because of interest on the bank's loan
-Another option is to leave a bank out of it, and fund it just like a bank does. Have a system where funding is released after project benchmarks are completed.
@J Scott thanks for the reply! The market is close to downtown Austin. We’re researching the builder now and the principal partner is an experienced class act. The Central Austin market is well insulated from national and even regional fluctuations, and the projections are conservative. We’re going to get the pro forma and actuals on some previous projects. Thanks @J Scott
@Sarah Lorenz thanks Sarah! In this case, investors get preferred return until 9% is reached. After that, there is a 60/40 split between investors and principals. The numbers look conservative and the guy has a stellar reputation. Thanks for the response!
@John P. Thanks John P! He is a longtime acquaintance and has a stellar record, I just haven’t done this type of investing before, so want to make sure I am well versed in what research to conduct.
@William Coet Thanks William! This is an upfront investment with a well known investor/agent. Thanks for the reply!
stay away from development & peak market multifamily value ads. Stick with owner finance & mobile homes.
Ask for actuals on previous deals. Ask them for the name of a few references who have invested with them in the past that you can talk with and get their take on the principal and their experience. How do you know they are conservative in their underwriting? Because they said so or because they gave you hard data to compare their assumptions with? How thought out is their exit plan? Do they have a plan in place should their projected exit fall in the middle of a downturn? If multi-unit, what is their plan for getting occupancy rate up to speed? How does this compare with how the market has performed? (a big risk with multi-family new build is a market downturn happening in the middle of the project and tenants falling off to lower class properties, principal/builder not having any cash to hold out, and ending up having to exit for a loss).
In terms of returns, do they roll over the pref? Do they take their fees up front or only when the property performs? Do they invest in their own deal aka have "skin in the game?"
There are a lot of questions to ask and information to obtain, but these are some good starting points.
The most important thing is not how much money you make on a deal, rather how much you're able to keep! Since this sounds like a short term gig, the chances are your income may potentially be treated as a short term gain which will be taxed at your ordinary income tax rate. Now I don't know whether you're a W-2 guy or not and what your tax bracket it, but I strongly encourage you to look into the outcome.
In terms of the DD overall, research the area, the people you're investing in, and then the deal itself. You said you know the guy - do you know him personally or professionally as well? You've never worked/invested with him, have you seen his track record on the paper or was it all verbally shared with you? Ask for the proof in witting. In terms of the deal itself, ask them for their back plan(s): what if we hit a recession in the next 11 months, what are the options at that point. As you dig dipper, hopefully more questions will materialize.
@Matt Heerwald one of the very best ways to learn a good deal from a bad deal from a great deal is to look at 100 deals! Do this and you'll have 100% confidence in your evaluation. You'll know what to look for and you'll catch when critical pieces of the offering are missing. You'll literally develop what's often called a "finger tip feel" for a good deal.
Skip this critical step and you're adding a lot of risk to the equation. Be patient. Crawl before walking. :)
All the best!
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