Starting an Investment Company - When to Take Money Out

17 Replies

Hello Everyone


My name is Mark and I am an MBA student at SMU in Dallas. Two friends of mine from the program are interested in investing in rental properties and have a particular strategy in mind, but I want feedback from the BiggerPockets community. The idea is simple: we equally invest in a rental property in year 1, keep all of the cash flow from the asset in our LLC. Then in year 2 we buy another property, again keeping all the cash flow in the LLC. We plan to buy a house every year and keep cash flow in the entity until we have purchased enough houses (rough math shows it'll take about 8 houses or so) to where the cash flow from all our properties is then able to fund the down payment on following purchases. Just like compounding stocks we thing this could help us build a sizable portfolio and ultimately produce enough cash flow to where we could purchase multiple properties a year with the cash flow. The question comes as to when or how we might go about taking distributions. We don't want to fully liquidate the LLC annually because there will be costs that need to be funded, but want to start realizing some of the cash flow benefits as the plan matures.

Can anyone provide guidance or feedback on this? Thanks.

Mark

It's a nice plan. I wonder if one can secure a mortgage with newly started LLC. To me it would be a big obstacle.

@Kate J. we imagine that we will have to put personal guarantees or sufficient collateral to secure the initial lending on the first few properties. We are hoping at some point the portfolio itself could start to act as a more secure method of comforting our lenders. 


My initial thought was that if there is any leftover money after making the down payment once internal cash flow starts covering that expense that you could use that as the "dividend" but then need to forecast for forward expenses. Perhaps if there is enough cash to cover 1 year of annual expected costs (including maintenance and vacancy) and down payments clear then a distribution could be made?

The other idea is that ultimately we would like to 1031 our way into stronger quality assets, but our plan does not take appreciation into account whatsoever. We are looking for cashflow and any future appreciation is a bonus. 

Solid strategy, and it probably will need injections from you and your partners though to actually grow as quick as you want it. Map out your cash flows and you'll see how long it takes to come up with that second down payment. It does grow exponentially though after your 2nd investment though (which is great). To answer your question, you can start taking money out when you are done growing and have an adequate reserve fund for unexpected and expected capital expenditures/operating funds. One more note: Odds are that at least 1 of the 3 of you will want to start pulling out money earlier than others so you'll need to agree on buyouts, etc. before you get started.

@Mark Bookhagen definitely going to have capital calls each of those first few years until our cash flows will support future down payments. great tip on the buyouts and thought process surrounding future differing cash needs as well. 

Sounds like you have a great goal. My experience is that I manage a pool of capital. My job is to effectively deploy that capital and then get the capital back in the pool. The shorter the lifecycle, the faster i can ramp. The capital can return to me monthly (cash flow) but i find the fastest way to do that is refinance. The key is to find a property at a great discount. If you revisit your model but make an assumption that your cost basis for the property (cost of purchase and cost of rehab) remains under 75% of the property value then how much quicker can you achieve your goals?

@Mark Butler The strategy is simple and sound.

 Like @Kate J. said getting the loan will be the tricky part unless you plan on buying with all cash. The LLC won't have a D&B profile and even with a personal guarantee you'll need an income or be willing to pledge savings. Before that you'll need to find a bank that makes rental loans to LLCs. That is easier said than done.

Since you're doing this with friends you'll need to think through the operating agreement and have it drafted and/or reviewed by an attorney. At some point you may have to choose between a friendship and a business decision; a solid well thought out operating agreement can help avoid that situation. Things like dual signatures on checks over $xxx.xx, decision making for CapEx, when to liquid a non performing property, how valuations are conducted for a buyout... the list goes on.

Finally getting to your question, that's up to you guys, but my answer is when the LLC can no longer get a higher return than the members could in other ventures or individually.

@Bill F. my apologies, I didn't make it clear that this will be a side project and that me and my friends will all be working. We anticipate that this will require time but not a full time gig, atleast in the first few years. We do plan on implementing property management to avoid the 2:00am plumbing calls from tenants to reduce our time as well. We just hope to identify one or two great investment opportunities a year and then guarantee the loans. I'll be working for a real estate developer in Dallas and have interned there while in school for the last year, so my understanding of financing (while it can continue to improve) and various structures should come in handy.

Curious to see your thoughts (or anyone else that reads this) on strategy. I try to wrap my head around the rental market in general, and outside of bustling locations I can't understand how to appropriately market suburban rental properties. Thats why our team is thinking of implementing a student housing strategy closely located to college campuses that either exceed a certain size or are experiencing sound population growth. Yes dealing with college kids might not be great, but we will make sure to do our fair share of due diligence on tenants and implement a solid upfront deposit as a defense mechanism. 

There’s a podcast on BP where I think 3 or 4 guys got together and started partnering on deals but pretty quickly within a year or so they went into larger deals like small apartments and then up to like 100 units I think.

If you’re doing this with single family or student rentals 1/3 cash flow is going to be pretty hard to get excited about. 100 bucks a month isn’t real exciting. Just something to think about. Also make sure you have good relationships with your friends because this business can be hard. I’m not against partnering down the road but I think id have to have final say on a lot of the larger decisions.

When I was In school I tried to start businesses (not REI related) and my friends and partners just never wanted to work hard enough to make it work.

@Mark Butler You got the income covered, now you just need to find a bank!

I agree with @Caleb Heimsoth about working with friends. Not that it can't be done, but that it needs to be thought through. Its one thing if its a GP/LP situation, but all GPs who have little to no REI experience could have some growing pains. A ship only has one Captain kind of thing.

To learn the rental market, read the forums and trade pubs, going to REIA meetings will all pay dividends. There are so many niches you can focus on: Student rentals by SMU, C/D class homes in DeSoto, high end rentals in Preston Hollow(ok maybe not there, but you get the point), SFRs in Grapevine... It comes down to you and your partner's knowledge, skills, ability, time, and personality. Listen to the BP Podcasts to hear from people who specialize in those niches day to day to see what fits with your goals. I know there is at least one, maybe two, podcast just on student rentals.

Now if you and your partners haven't clearly articulated why you want to invest in RE, then no amount of research or modeling will help. Its a little more than finding great investments, getting the cash and handing them of to a PM. If you haven't had employees before you'll need to learn to effectively task and supervise, if you've never run a business before then someone will have to keep the state filing up to date, get docs to accountant, ect, ect. Having a good why will carry you through the boring time and bad times, like if you end up firing your PM and having to evict a tenant yourself while still working. 

Originally posted by @Mark Butler :

Hello Everyone


My name is Mark and I am an MBA student at SMU in Dallas. Two friends of mine from the program are interested in investing in rental properties and have a particular strategy in mind, but I want feedback from the BiggerPockets community. The idea is simple: we equally invest in a rental property in year 1, keep all of the cash flow from the asset in our LLC. Then in year 2 we buy another property, again keeping all the cash flow in the LLC. We plan to buy a house every year and keep cash flow in the entity until we have purchased enough houses (rough math shows it'll take about 8 houses or so) to where the cash flow from all our properties is then able to fund the down payment on following purchases. Just like compounding stocks we thing this could help us build a sizable portfolio and ultimately produce enough cash flow to where we could purchase multiple properties a year with the cash flow. The question comes as to when or how we might go about taking distributions. We don't want to fully liquidate the LLC annually because there will be costs that need to be funded, but want to start realizing some of the cash flow benefits as the plan matures.

Can anyone provide guidance or feedback on this? Thanks.

Mark

Others have touched on the issues with partnerships especially with friends. Getting loans into an LLC etc.

I would also say this, my wife and started out buying a house every year or so and now do a couple a year.  We have been very please with the results so far, but honestly most of our gains have been capital gains, and a ton of our cash has been reinvested to keep things going.  

We find that it often takes a year or so to find a property, get it fixed up, find tenants, build back up your working capital etc, and then do it again.

And then there comes a point (we are getting close), to where it becomes difficult to get the next loan. Your DTI, number of loans, credit scores all get severely impacted by the number of loans and will slow your path to more acquisitions over time.

We are finding deals we like to be few and far to come by. They are very difficult to find, and we generally believe that the best way to make money in this market is via some form of BRRR. I don't know that I would recommend a rehab in your first real estate investment unless you have someone with a construction background, but imo that is a place you might want to get to.

In summary, I think buying houses on a regular basis until the cash flow gets you future properties absolutely is the best way to go. Personally, and everyone is different, I would heavily consider going on your own and invest in specific projects with your buddies, or go it alone entirely vs all of you having the same LLC. That way if things go well, you end up in a lot of deals together, but if one of your buddies isn't as involved, there are no feelings hurt if you go a different direction on the next deal.

Most importantly, I  think of real estate investing as a crock pot, it takes a while until you have enough rentals fixed up and renting to the point where the cash flow from rents each month is meaningful.  

Best of luck to you!!!

Thank you to everyone that has been commenting on this post, it has been incredible helpful. @Bart H. definitely agree that there will be some fine tuning as things move forward and we are interested in exploring all aspects of the process by which we can take advantage of the real estate markets. My goal would be to even get into development someday given I'll be working for a commercial real estate developer after school and hopefully could apply my skills. The near term goal is to get a house our two under our belts not necessarily to make money but just to learn and hopefully that will point us in the right direction. I guess I am having trouble identifying discrepancies in sometimes what I hear on bigger pockets compared to what actual cash flows might look like. We are buy and hold focused off the bat and want to someday have that dream portfolio of as many doors (I'll use doors rather than houses as we hope to get some multifamily going), so when I hear that most of the podcast speakers focus on 15% cash on cash returns to their equity (or down payment) I then seem to turn around and have people discussing that it may not be that easy. Is that because of the current environment? Are these returns based on relying on rent growth? 

Any advice on the above would be greatly appreciated. 

Originally posted by @Mark Butler :

Thank you to everyone that has been commenting on this post, it has been incredible helpful. @Bart Hedgcock definitely agree that there will be some fine tuning as things move forward and we are interested in exploring all aspects of the process by which we can take advantage of the real estate markets. My goal would be to even get into development someday given I'll be working for a commercial real estate developer after school and hopefully could apply my skills. The near term goal is to get a house our two under our belts not necessarily to make money but just to learn and hopefully that will point us in the right direction. I guess I am having trouble identifying discrepancies in sometimes what I hear on bigger pockets compared to what actual cash flows might look like. We are buy and hold focused off the bat and want to someday have that dream portfolio of as many doors (I'll use doors rather than houses as we hope to get some multifamily going), so when I hear that most of the podcast speakers focus on 15% cash on cash returns to their equity (or down payment) I then seem to turn around and have people discussing that it may not be that easy. Is that because of the current environment? Are these returns based on relying on rent growth? 

Any advice on the above would be greatly appreciated. 

When you see a baseball player hitting .300 with 30 HR's and 120 RBIs vs .200 with 1HR and 10 RBI's, which one will stay in the big leagues? Or when you hear fishermen tell tales, do they tell you about the big one they caught or the one that got away?

OK, I am exaggerating to make a point, but there are at least three main things going on here. 1) many of the deals you are hearing about came from purchases during the financial crisis when property values were depressed, a lot of those investments have been sold and the money made. 2) When you hear 15% IRR, you are hearing both successful deals that are outliers, and 3) you are hearing deals by people who are really really good at their craft.

Many of the best returns are from pros who know both how to analyze deals and who are able to do value added things to improve value. Maybe its reconfiguring property for more space, or bedrooms, or they are doing large rehab projects to reposition the property for higher returns and sales prices.

Remember a good part of your return will come from debt pay down, depreciation/tax advantaged investing, and capital appreciation. A lot of your return on investment wont be realized until you do a cash out refinance, or sell your property. Or if you are a buy and hold investor, rents going up 3-5% per year that add up over time.

I think its always a great time to get into the real estate, and you can get outsized returns because real estate is an inefficient market. But we are also closer to a flattening of property price appreciation, if not a recession in the next year or two. its incredibly difficult to find decent deals. I think 15% will be more difficult to come by going forward without a little luck.

IMO the important things is to think about how will you and your buddies bring value to the property you buy? Will you live in it? do one of you know construction? maybe you have cash and investors?

Maybe you pick a target neighborhood or two and start viewing every single property that comes on the market. Drive the streets, get email blasts from MLS or even ZIllow. That way when a deal comes on the market in that area, you can immediately bid and you have a competitive advantage over everyone else.

I think the returns are there, you can make a lot of money over time, but a lot of that money will come from the paying down of debt and price appreciation. Don't expect huge cash flows that you can live on out of the gate. I suspect you will be reinvesting just about every dollar into your rentals for 5-7 years or more.

Best of luck, I think you have the right idea.

@Bart H. interesting, just seems like when I read on this forum and listen to the podcasts that 15% Cash on Cash seems to be a starting block for underwriting new deals by man investors, so if thats not the case, then what do I underwrite too? Or can I not benefit from real estate the way it sounds like people do in this community without recessionary activity beforehand, aka I need to learn to time the market?

@Mark Butler you should underwrite to whatever allows you to reach your goals in the time frame you and your partners have chosen. Figure out what goals you want (Cash Flow, appreciation, hybrid) set your goals and reverse engineer how you will get there. I set my goals in terms of IRR since you can include all of the four wealth generators from RE, not just cash flow.

Originally posted by @Mark Butler :

@Bart Hedgcock interesting, just seems like when I read on this forum and listen to the podcasts that 15% Cash on Cash seems to be a starting block for underwriting new deals by man investors, so if thats not the case, then what do I underwrite too? Or can I not benefit from real estate the way it sounds like people do in this community without recessionary activity beforehand, aka I need to learn to time the market?

As others have mentioned it has a lot to do with your goals. Cash on cash is just one metric to measure the effectiveness of a real estate investment. But remember you can increase your COC return by increasing leverage so that you have a smaller initial investment, or you can invest in areas with higher risk to increase your 'projected' cash flow. , ex a warzone. Or you can BRRR, so that when you refinance your cash invested is very low if not zero, so ANY return is very high.

As I said, I think you will find it tough if not impossible to fine a deal in Dallas right out of the gate to give you 15%+ cash on cash returns.  Those who are getting those returns are likely finding properties they can rehab and then refinance. 

@Mark Butler Since one never knows how long the partnership with friends may last (and hopefully yours will last forever), consider looking into "tenancy in common" structure for your partnership. Your attorney should be able to give you all the details of such partnership. I will just mention without going into the details that this structure allows each "tenant" to hold a transferable interest in a partnership.

If I can be of further service, feel free to PM.

Good luck!

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