Road to Vertical Integration

Member since 2024 · 35 posts · 7 votes

Hi all,

Over the long-term I want to take my Real Estate company and vertically integrate. I've worked or Co-GPd on a few deals with groups that were vertically integrated (especially in regards to accounting and asset management) and I appreciated the control they have over the investment at all stages. Any tips that I can keep in the back of my head as I network and meet contacts that could be great potential candidates.

Are there any pitfalls I should be aware of?

For those who have vertical integrated – Besides having control, what financial advantages does this structure have? I can conceptualize the obvious ones but would like to know if there are hidden advantages that further sweeten the deal.

Excited to learn more to see if it's the right fit into my vision.

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Henry ClarkPro Member

Developer · Member since 2020 · 4k+ posts · 4k+ votes

@Don don’t know about food critic. I’ve only refused one dish in my life and that was from the best cook in the world. But tacos in San Diego were good.

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Mohamed YoussefBusiness Member
Accountant · Brea, CA · Member since 2018 · 121 posts · 64 votes
1w
@Shawn Benteti, I’d evaluate each function separately. Bringing asset management in-house may make sense before you have enough scale to support a full accounting team.
One pitfall is underestimating the overhead: salaries, software, supervision, and coverage when someone leaves. I’d compare those costs with what you currently pay outside providers, including the time you’ll spend managing the team.
On the accounting side, I’d keep property performance, management company profitability, and investor reporting distinct.

Otherwise, fees earned by your management company can make the overall business look healthy while an individual investment is struggling.
A less obvious benefit is faster feedback. Timely reporting can help you catch budget overruns or cash shortfalls early enough to act.
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Henry ClarkPro Member
Developer · Member since 2020 · 4k+ posts · 4k+ votes
1w
OP. Read your other posts. Recommend you work ground up on your approach. Your Scaling will be different at different stages for everything.
1. How much money do you have to invest? Don't answer. Say $100,000.
2. What financing mechanism will you use. Syndications GP/LP but how? What size will your portion of the downpayment be? Let's say 25% between you and another co-GP.
3. If you have $100,000 between you and the Co GP and your portion of the financing is 25% then you can do a $400,000 deal. Adjust to your syndication deal specs. But size the deals you can do. Don't go with assuming a $10mm LP raise at first.
4. Your first deals I would trim back the normal fees for this, fees for that, etc of a Syndication. You need to get deals under your belt and happy investors. Give them more of the meat and also reduce their risk.
5. Strengths and weaknesses- Your CO GP should offset your weaknesses for the first few deals.
6. It will take you 6 to 10 years to develop track record and trust. Make your deals simpler at first and shorter term. Say a 3 year exit strategy with zero payout during that time period. Easy value add projects, nothing Structural such as foundations, or tear out walls unless strategic. Add rental parking units. Etc. Try to stay away from as much Permitting as possible, to avoid project delays. Extra time means extra Interest. Means more Shaky LPs.
7. Banks- go local and smaller. Find out what their Federal Lending Limit is. Try to find one that can go up to $30mm. That will get you thru your first 5 to 7 years. Interest rate should not be your deciding factor. Make sure your Balloon period matches your exit strategy or a little longer. If you exit strategy is 3 years, make sure your balloon is 3 to 5 years. As you grow you will want to do deals fast. Stick with the same lender, so they Know your story and you. I think credit is and will be tight for new customers. 2 of our banks said they really aren't seeking new loan customers from a commercial standpoint. They will do existing customers.
8. Insurance- as mentioned go thru a Broker. Don't go with the cheapest as mentioned. Don't shop your coverage every year, maybe every 3.
9. Lenders- you have done financing more with the GP/LP scenario. I would approach your first few years more from a Bank financing standpoint and less on the LP side. But see if Bank will let you sale off portions of your position or paydown their loans, for 10 below.
10. LPs- I would set up, so you can sell off portions of the deal as it progresses. Say after Phase X, sell more to LPs. Less risk for them. You want to build up more LP history. Less about you making a killing.
11. Lenders- Ask for interest only during rehab/construction and Rent up phase. Say 12 months on Rehab. Then 12 months on Rent up.
Now you have traction. Its year 5 or 10. Switch lenders. Start charging more fees and taking a bigger bite. Less return for LPs. Switch insurers. Switch your CO-GP to skill sets you are weak on. Most of the skillsets you will be able to hire in. Operations, GC, Financial, etc. Move more to Marketing and Investor interaction. Change your Buy Box either to longer term, higher risk, more value Add, etc.
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- Don KonipolBusiness Member
  Investor · The Woodlands TX / Avon, CT · Member since 2009 · 6k+ posts · 10k+ votes
  1w
  I’m always amazed at the in depth detail and specific good advice Henry produces. All this while still running a self storage empire, investing in Teak plantations, and being a gourmet food critic!
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- Henry ClarkPro Member
  Developer · Member since 2020 · 4k+ posts · 4k+ votes
  1w
  @Don don’t know about food critic. I’ve only refused one dish in my life and that was from the best cook in the world. But tacos in San Diego were good.
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G. Brian DavisPro Member
Investor · Hatboro, PA · Member since 2016 · 3k+ posts · 867 votes
1w
I like vertical integration when there’s enough scale to justify it. Having more control can be a real advantage, but every new piece of the business also adds people, overhead and another thing you have to manage.
I’d start with the areas where you’re spending the most money or where lack of control is actually costing you. Then see if bringing that function in-house really improves the numbers.
I’d also be careful about bringing someone in just because they’re a good fit on paper. You want people who are really good at that specific job.
Done right, vertical integration can improve both the economics and the control of the investment. But I’d make sure the scale is there before building the infrastructure.
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Evan Polaski
Cincinnati, OH · Member since 2020 · 4k+ posts · 3k+ votes
1w
@Shawn Benteti I guess your definition of vertical integration and mine are a little different. WHen I read you "want to go vertically integrated" I assumed you meant building out an in-house/affiliated property management and construction management.

I would describe your desire to being a GP.

What you are essentially asking is; How do i build a business? Well, you do all of it. Accounting is easy to outsource with most any local accounting firm. But, the operations are where successful syndicators seperate themselves from the marketing heavy capital raisers you read about on these forums.

So, my advice is: you don't hire them out until you have it dialed in. If you don't know how to set business plans, prepare accurate budgets, appropriately forecast cash flows, who to call to appeal tax values, how to decrease (or limit the increase) on your insurance, oversee PMs (they will rob you dry if you aren't on them), set appropriate KPIs and incentive plans for both contracted and W2 people, then you need to master and feel comfortable with these things before you hire an employee.
But, beyond that, you run your deals, you assess your own weaknesses, or where work is piling up, or where you hate doing it, you outline those tasks and needs, and then post a job description and interview people. Then you pay them. Don't forget that you will likely be expected to provide benefits, which are typically 30-40% over and above salary. So a $100k/yr salary will cost you, as the employer, $130k-$140k. And generally, you get what you pay for. A $50k asset manager will likely be far less valuable to you than a $200k asset manager, especially if you are looking to offload responsibilities to them.
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Chris SeveneyBusiness Member
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Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
1w
I agree with Evan. To me, vertically integrated means running multiple business operations, such as construction, property management, and asset management. What you are looking to do is more of a GP, which does everything in-house. Now you can call it vertically integrated because I know a lot of GPs do not do their accounting and they outsource it, and some will manage the asset and some do not. I think having in-house accounting is critical based on being able to issue distributions and get the books done in a timely fashion so we can pour to investors.
Another that I think is the most critical that nobody mentioned here is investor relations, as the investor journey starts when they invest, but many GPs make it appear it ends when they invest. They look at investors as just somebody on the sidelines that you don't need to communicate with, which is the furthest from the truth.
How to get started, it's just like building any business:
- Map out a plan.
- Put the strategy.
- Create a budget.
- Look to engage and hire people.
Also, great comments on the difference between salaries and making sure you have the right people. Also determine if you're going to be in an office and hire people locally, or if you're going to hire people remotely. There's a lot to think about.
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