All Forum Posts by: Austin Fruechting

Good info and good post.  The statement I had heard was that majority of wealthy people have investments in real estate, not that they made their wealth through real estate.  I never fact checked it, but it makes it a very different statement. 

I think that cap rate and NOI for underwriting should be the long term average of expenses especially since I'm a long term buy & hold guy... and that number will usually look much different than the 12T P&L... so I agree and disagree, LOL. I fully agree with this last paragraph.  This discussion, even if I'm wrong, is of good benefit for anyone looking at investments to realize all sides of analyzing a property and to rely on their own analysis for their goals.

Ok.  Perhaps industry standard on the stuff you're looking at.  It's not industry standard to have it below the line on the stuff I have looked at, unless it's denoting a recent major renovation.  A 20-25 unit apartment building will average 1 HVAC replacement a year, that's not just a one time large thing. 

And I disagree with a major capex expense like a roof on a 25 unit building greatly skewing the cap rate, unless you are looking at a single years P&L then of course it does. The CapEx number for calculating a true cap rate should represent the long term average of all CapEx expenses. So the CapEx account should be 1/30th of the roof costs, 1 HVAC per year, etc etc.

Interesting. In my area that's all included, as it should be, because otherwise you aren't looking at actual NOI, and therefore not looking at a true cap rate. The only CapEx that wouldn't show is if someone did a major value add rehab. Other than that CapEx is an expense that should be a part of calculating the NOI

***albeit all expenses are generally underestimated to make it look better. 

Edit to add, by your market putting CapEx below NOI they are trying to sucker in unsophisticated or new buyers that take the pro-forma at its word. Bravo for actually digging in and doing your homework to not get taken in that.

Yep, pro-formas will almost always leave out some expenses and paint the rosiest possible picture they can. I always assume if I see something listed at an 8cap, in actuality its a 6cap just as you pointed out there.  The TRUE cap rate would be after all expenses including cap-ex.  

If that is a true 8cap, that NOI would already have property management fee accounted for.

I'm copying pasting some of my replies from another thread here; https://www.biggerpockets.com/forums/109/topics/419349-partnerships--whats-the-deal

I have done many properties on my own, and multiple partnerships very successfully. The majority of my portfolio is with partnerships and it how I was able to grow my holdings incredibly fast. All of my properties are buy and hold. My ownership equates to 58 of 95 total rental units in partnerships.

I have a VERY solid LLC Operating Agreement for the partnerships that lines out absolutely everything and all decisions. I am designated the master of the LLC and as such get to make all the decisions as far as daily operations and expenditures up to a certain amount. Then there is a "Major Decisions List" of things that require a majority decision. This includes things like refinancing, selling, expenditures over XXX, etc. That way there aren't surprises and everything is clearly lined out. It also includes everything in regards to ownership stakes, distributions, payouts at sale, etc.

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(1A) If they are happy with just getting a certain return over time that's closer to a hard money loan and structure it like that with a promissory note. They wouldn't be an actual partner in property, but just a lender for a certain return and you'd make payments back to them at the agreed upon interest rate and timeline.

(1B) Let's say we're looking at a true partner in the LLC and the cash investor gets a certain percentage ownership. You can structure this in any way you want to make it beneficial for all parties. Often, but not always, the cash investor gets a preferred return of 3-8% on their investment off the top, and then the rest is split according to the equity stakes. EXAMPLE: In one of my partnerships, the cash needed was $120,000. The annual cash flow should average to about $34,600 per year. My investors get 7% preferred return on the $120k per year so $8,400. That comes off the top leaving $26,200 to be split according to ownership percentages, which we have set at 50/50. I get 50% of the 26,200, so $13,100 and they get $13,100 + their preferred return for a total of $21,500. They get a great return and I'm happy to make $13k a year for putting the deal together and doing monthly bookkeeping and oversight. We hire property managers so I don't have to do any of that work. If I did I would either charge a property management fee to the LLC or take a larger equity stake for doing that.

(2A) If we sell (still using my partnership example) the way it works is mortgage gets paid back first, their investment second, and then whatever is left would be split 50/50. If we refinance it's the same thing. If we refinance and still hold the properties, they maintain their ownership percentage, but if they have all of their cash back there will no longer be the preferred return.

(2B) If they want bought out, but it's not majority to sell the properties, they can sell their ownership stake along with all benefits to any one at any time. I have right of refusal though so if they do get a qualified offer from someone for their share, I can choose to match the terms. If I don't their ownership and all interest will transfer to the new person. I have it in the operating agreement though that if that happens, the new person does not have voting rights. I didn't choose to go into business with the new person, so they have say in what happens.

(3) Get a VERY solid operating agreement that clearly spells everything out. The LLC will get the loan, although many banks will still underwrite the members and want personal guarantees from all members that own a substantial percentage (with my bank any partner that has more than 25% has to do this).

(4) Include everything you can possibly think of! It's better to have everything lined out before than to have any questions or disputes later.

There are endless ways to set up splits. It's all about finding the scenario that works for all parties given the investment you are looking at. The preferred return is not always necessary and not only included. Equity stakes can be whatever you want too... 50/50, 60/40. etc.

On another partnership, I injected cash into as well. The structure was similar. The cash represented 50% ownership and my expertise represented 50%.... I injected enough 40% of the cash needed, so I ended up with 70% ownership: my 50% plus 20% of the cash equity (0.5*0.4). The investor only gets the preferred return on the difference invested. So if it was 200k, I put in 80k, he put in 120k, he only gets the 7% on the 40k additional.  

Do you want to be a full time property manager?

I'll be between $6500-7000 a month in management fees with the units I'm adding (will be 139 total).  Still no desire to do it in house.  It would take other staffing and operating expenses that would eat a big chunk of that amount away.  I would just have a full time job being a property manager if I wanted to actually save anything.  

If I hired that part out too I'd maybe just break even, but then have all the headaches of small business ownership again.  I had a small retail business and I also started and sold a property management business.  

After I got into the property management business, I realized it would take approximately 200+ units before I would make anything notable if I wanted to just be the big picture guy and have a full staff that did the day to day.  I thought it would be much less until I actually hired people.  I severely underestimated what employees could accomplish when that person wasn't me.  But even if you find the right people, you still have cover during vacations, sick days, etc... or someone unexpected quits.  You may have to cover that roll for months as you try to find another quality staff member, which is hard as a small business with little to no benefits. 

I'd rather just find another deal to make more money. 

Brandon - The Rundown, what a random reference, but a good one! It's been a while, might have to watch that again this afternoon!

Oh, and good podcast too, enjoyed your story Meghan, keep crushing it!

I have all my numbers nailed down and that quote spot on.  Yes, my total management costs are flat 8%, no placement fee. 

Not all PM's rip you off on labor and just call tradesmen out that charge $100-150 service call for everything.  Both management companies I work with are large enough they have in house handymen that handle the majority of the work orders with a very reasonable fee.  My repair work would not be any cheaper if I called a handyman to do the little stuff.  

Yes it could be cheaper if I did the work... but that 2 minute fix can easily take an hour or two by the time you coordinate with a tenant, drive 20-40 min to the property, realize you need another part, drive 15 min to home depot, spend 15 min in home depot, drive 15 min back to the property, fix the issue in 2 minutes, then drive 20-40 min back home.