All Forum Posts by: J Scott

Quote from @Brian Burke:

Quote from @J Scott:

 Exactly. If this is a multifamily value add, they're being aggressive somewhere.

This is what I'd verify first:

* Proforma rent growth

* Natural annual rent growth

* Expense ratio

* Absorption rates

Something is likely off.

 And one more big one:  Exit cap rate. 

Wow.  Not sure how I missed that one -- probably the place where the most operators are "fudging" the numbers these days...

Thanks Brian!

I'm a big fan of breaking down your business into two pieces: Acquisition and Fundraising.  Have someone manage the acquisitions piece and someone manage the fundraising piece.

Both are full-time jobs, and both require strong talent to do well.  I don't know too many people who have the skills to do both tremendously well, and if you look around, you'll see that many of the most prominent syndication companies are a partnership split along these lines.

Go listen to some podcasts that @Ashley Wilson (Bar Down Investments) has done, both here on BP and elsewhere.  She's my business partner, but she's also one of the best asset managers I've ever met -- she's managed thousands of units for both our company and for other well-known syndicators.

She did a great presentation at this past year's BiggerPockets Conference as well, but not sure if that was recorded/available.

Quote from @Ruchit Patel:

Quote from @J Scott:

Quote from @Ruchit Patel:

Some turnkey providers are also offering new construction deals. Insane returns with that, if done rightfully in a good area. I recommend everyone to do that for passive investment. 

Remember that returns are directly correlated to risk.  If new construction development could command lower returns, operators would offer lower returns.

 Do you mind elaborating on it, please? 

In any efficient market, expected returns and risk are correlated.  In other words, if you see an investment that projects higher returns, it means that the investment is going to be higher risk.

This is why we refer to US treasury bonds as the "risk free rate."  Because these are considered the safest invest around (lowest risk), they tend to also generate the lowest returns.  As you move into higher risk investments, the projected returns increase.  

Buying a stabilized property (a property that is in no need of repair or improvements) is going to be lower risk (and generally deliver a lower return) than a property that is in disrepair and needs either physical and/or management improvements.  At the same time, a property that is in need of repair is going to be a lower risk (and generally deliver a lower return) than a property that is being built from the ground up.  This is why stabilized properties might generate 6% returns, "value add" properties (properties in need of repair) might project 14% returns, and ground up construction might project 20% returns.  Higher risk; higher projected return...but also more that can go wrong and generate a loss.

Long story short, if you see one investment has projects a 10% return and another that projects a 20% return, it doesn't mean that the second one is better.  The second one is higher risk, and depending on your risk tolerance could be better or worse.  

This is also why you need to look at a lot more than just the returns.  You need to also evaluate the team that is operating the deal, the location of the deal, the property itself and the other potential risks.

Quote from @Chris Seveney:

@Jack S.

As mentioned that’s net. Questions I would ask are what is the exit strategy?

Also check others to see if those fees are online. A 16% IRR in todays environment with those fees seems very high or high risk.

Exactly. If this is a multifamily value add, they're being aggressive somewhere.

This is what I'd verify first:

* Proforma rent growth

* Natural annual rent growth

* Expense ratio

* Absorption rates

Something is likely off.

Quote from @Ruchit Patel:

Some turnkey providers are also offering new construction deals. Insane returns with that, if done rightfully in a good area. I recommend everyone to do that for passive investment. 

Remember that returns are directly correlated to risk.  If new construction development could command lower returns, operators would offer lower returns.

The big reason why you hear more about turnkey than syndication here on BiggerPockets is simply that many syndications require the investors to be accredited. And, for the most part, any of the folks here on BP are newer, less experienced, and don't have the financial resume to be accredited as of yet.

As for being able to model returns, every syndication is going to be different, though you will see a good bit of commonality among them. I would recommend that you find a syndicator you would like to work with, schedule call, and talk to them about what their typical returns look like for their deals.

My experience, most are happy to sit down with you and walk you through with a typical deal looks like, how they are underwritten, and what the return structure (and projections) are likely to be.

Quote from @Jack S.:

Quote from @Brian Burke:

@Jack S., I wrote a whole chapter on fees in  The Hands-Off Investor, but the quicker answer is that some of these fees are a bit on the high side.  The asset management fee is usually the most opaque fee because there are so many different ways to calculate it.  2% of gross income is double what I most often see, and it’s usually of actual gross income not estimated gross income.  Guarantor fees are most often a percentage of the loan amount, not purchase price, so this one is above market.  Disposition fees are still pretty common but are falling out of favor.  The rest of these fees seem fairly typical.

The fees are also related to the promote (profit splits).  Some sponsors charge higher fees and a lower promote, others may opt for lower fees and a higher promote.  For example, one common trick is for the sponsor to offer an 8% pref followed by an 80/20 split in an effort to attract investors who avoid 70/30 or 60/40 splits, but then charge an asset management fee of 1% of the asset value. Depending on how the investment performs, that structure could be way worse for the investor than the higher sponsor split with a 1% asset management fee based on gross income.

If you want to know how your $100K investment will perform, look at the package that the sponsor gave you. If it isn’t abundantly clear, you are investing with the wrong sponsor.  They should be showing you performance projections with the fees baked in.  If they show you projections without reflecting the fees, that’s a problem. 

Now whether those projections are believable or achievable is a whole other discussion.

Thank you for the response Brian. I have been reading your book and it's a source full of useful information. I clarified with the sponsor and the projection gain is after all the fees.

 This is what I was going to say. Typically the proforma projections that are provided by the sponsor are going to be net of all fees.  In other words, what you see in the projections is factoring in all of the fees from the deal.

Agreed with the guys above, but I will say that you are likely to see lower actual pref returns in the near future.

Many of the deals I'm seeing these days and many of the deals we are underwriting ourselves are showing very little cash flow in years 1 and 2, and while those deals still might be offering a 6% pref or a 7% pref, if you dig into the actual cash flow projections what you see are early years not actually hitting the pref target (but catching up in later years).

If you're looking for consistent returns from day one and are willing to give up a little bit on the back end, I would take a look at preferred equity funds or debt funds. You can typically hit 6% or 7% consistent cash flow in these vehicles, but you'll find that you're total return is capped somewhere at around 12%.

In my mind, it's a reasonable trade-off for those who are looking for consistent returns and lower risk.

Quote from @John Teachout:

Depreciation is a tax deferment, not a deduction.

True.  But, depreciation can also reduce your overall tax burden if used correctly.  Recapture is taxed at a maximum 25%, while marginal rates for ordinary income go up to 37%.  Trading ordinary income for depreciation can save a lot of money.