All Forum Posts by: Jordan P.

@Chris Seveney Thanks Chris. Your observation that the expectation of sustained 40%-50% returns is either dishonest or unrealistic resonates with me. The math behind splitting the upside and both parties regularly achieving hugely outsized returns (20%+ each) over a long period of time just doesn't add up to me.

@Brady Durr Thanks for your input. Seems like there are other options out there and I over-generalized based on my limited experience.

@Patrick Desjardins Thank you. I was wondering how many passive investors negotiate JV terms heavily and how many simply pay retail. Also, I don't believe I'm missing the education component. I indicated multiple times that getting an education is well worth a premium if that's what the investor is looking for - no argument there. How common is the fixed rate loan funding? It would seem like that's basically an unsecured HML loan, which could be very expensive?

Depending on your strategy and level of participation (effort) required to operate the "business" relative to your other sources of income, your CPA may also find it defensible to classify your LLC buy-and-hold note income as passive, in which case you would not owe SE tax (truly 100% pass-through). At that point, the cost of setting up and maintaining an entity is deminimis relative to the protection and professional appearance you get in return.

Also @Dmitriy Fomichenko, while protecting your personal assets from legal action taken by someone involved in or related to your deals is of primary importance as @Dave Van Horn indicated, it can be beneficial in the other direction as well. An entity will be more effective in protecting your entity assets from personal debts. Your mileage will vary on this depending on the state and the creditor remedies the state allows, as well as their treatment of single member vs. multi-member LLC's, but by and large an LLC will make it much more difficult to recover personal debts from the entity.

Disclaimer: While I am an accountant I do not provide tax advice. Always consult your CPA and attorney.

@Kevin Dureiko @Edward B. @Roman M. Yes, agree - the market determines "fair" and if there was a shortage of capital, the market would adjust itself. And scale plays a huge factor in that, so understood as well, and thank you. I also understand I was sensationalizing the analogy by comparing totally different scales, but because scale is the defining difference, my analogy doesn't have any value. 

I will point out that if you look at my examples, I'm simply talking about actually achieving the advertised 50/50 split on an expected risk-adjusted basis or having a slight return bias to the investor who has 100% of their capital at risk vs. the bias to the sponsor who has only opportunity cost at risk but the toolkit necessary to execute the deal. I was not suggesting some crazy realignment of NPN sponsors doing deals pro-bono for investors. But when we see 50/50 JV's being discussed, they aren't really 50/50 because one side bears the risk of loss while only the upside is shared 50/50.

Finally, I'm happy - scratch that: willing and looking - to pay premium for education because I'm inexperienced with all this stuff (that's the "other intangible value" I mentioned in my long rambling OP). Education costs money either through making your own mistakes or paying someone to teach you how to avoid them, and I'm totally cool with that. In fact, in a niche like this, finding the right education is arguably priceless. I was asking more along the lines of someone who is perpetually a silent partner and has no desire to learn the ropes and do it themselves. Out of those folks, if they exist, has anyone continued to realize 20%+ passive returns over dozens+ of deals without fail under this structure or have their returns drifted closer to what you might be able to achieve (or close thereto) with less risk?

@Roman M. Yes, I guess that is the question and well put. My answer, not that anyone cares or might be surprised to hear after this thread, is that I wouldn't pay 50% of the upside and 100% of the downside if I just wanted to passively invest over the long term. The reason being is that it seems like folks are willing to pay up for the prospect/chance of hitting home runs every time because that's what they see in most of the case studies, and I believe over the long haul that's an expensive proposition for an investor if and when it turns out that the portfolio of deals is made up of a handful of home runs, a lot of doubles, a few singles, and a few strikeouts. And that is no fault or any criticism of any NPN guru out there sponsoring JV deals - they should charge the going rate - it's just my view on the laws of risky investments and large numbers exacerbated by splitting the upside in half.

@Jay Hinrichs Not saying it's not hard. Nowhere did I say the process is easy, the effort is light, and therefore those who are experienced and knowledgeable in it should give it away for cheap or free - see above. It's your second statement re: "HIGHLY risky" that is the crux of my question...how the risk vs. knowledge/sweat equity vs. reward gets distributed and the balance between those things.

@Edward B. Thank you and point well-taken on supply & demand and my numbers being hypothetical, but I'm very skeptical of regularly expecting 40%-50%+ each and every time (of which your cut if half) especially when you bear 100% of the risk of loss. Yes, maybe you've achieved that or better on a few deals, but the law of large numbers would indicate that out of 10 deals, maybe 1 or 2 (out of 100 maybe 10 or 15 of more) might go bad and those could wipe out some of your previous profits, knocking down your 20% to something smaller. I disagree with the analogy of going to work equaling an infinite return because I am paid a salary (flat fee) to work. Your analogy would be better suited if I were selling shares of my company's stock to new shareholders in return for half of the dividends and capital appreciation on their holdings over time. Or the shareholders of the company approved granting the CEO stock options equal to 50% of the company's market cap because he has more management knowledge and strategic vision than they do.

@Kevin Dureiko Thanks Kevin. I'm not suggesting that the sponsor doesn't get compensated fairly. My question is more along the lines of "what is fair?". Even deals put together by skilled and experienced investors have a risk of loss. These deals appear to be richer for the sponsor than other forms of REI investment, which is why I ask. Do those other forms require less knowledge, expertise and fewer relationships?

For example, I know nothing about syndicating apartment deals (another REI area I have no knowledge of!). But let's say a seasoned and experienced syndicator/sponsor went out to a group of deep pocketed investors and pitched a great lead on an off-market 200 unit apartment complex rehab/redevelopment opportunity with a projected annual return of 30% and a target holding period of three years. It would require a $10m capital investment for the purchase price and capital improvements, which the investors would fund entirely and in return they would receive half (15%) of the projected return and the sponsor would take the other half. How much investment capital would that syndicator walk away with after this pitch? My guess would be none. However in the NPN space this appears to be the norm, unless I'm mistaken. I understand the different project scales play a big role in this comparison here, perhaps a defining one, but the fundamental basis is the same.

@Roman M. To clarify, the all-in investment is $25k funded entirely by the capital provider, $0 from the sponsor. The return is also $25k, so total capital generated from the deal is $50k ($25k return of principal and $25k gain over 1 year = 100% ROI). The scenarios outline how the $25k gain is distributed after returning the capital provider's principal. The sponsor's return is undefined because they have no skin in the game - capital investment is $0.

Apologies, I know it's a lot of air math. It's a very verbose way of saying the typically advertised 50/50 JV split where one side provides the capital and the other provides the brains/know-how seems like a raw deal for capital providers.

I'll put my mind-numbingly long thought process into a separate post that you can choose to read or not...

It seems that elsewhere in REI, such as syndicated apartment deals etc., a deal sponsor that has little to no capital tied up in the deal gives up a preferred return to the capital provider(s) in exchange for some up front and/or ongoing sponsor fees and a percentage split of the excess return above the preferred return - whether 50/50, 60/40, 70/30 and so on. However it looks like most folks in the note space looking to JV on NPN's structure the JV as a 50/50 split of the total return between the capital provider and the sponsor. Thus the capital provider puts 100% of his or her capital at risk and receives 50% of the upside while the JV sponsor has no risk of capital loss and gets the same 50% upside with no tangible downside. This seems more favorable to the sponsor/manager than almost any other investment management structure I've come across.

To illustrate, let's assume a NPN 2nd purchased for $25k including workout costs. And let's also assume that the JV exits through the property via foreclosure and recoups the $50k UPB in exactly 12 months for a 100% total and annualized return. Now let's look at how the returns would be split under different JV structures:

(1) 50/50 (current popular model): Capital provider=$12.5k / 50%, Sponsor=$12.5k / infinity%

(2) 10% Preferred + 50/50 Excess Split: Capital provider=$13.8k / 55%, Sponsor=$11.3k / infinity%

(3) 8% Preferred + 55/45 Excess Split: Capital provider=$14.7k / 59%, Sponsor=$10.4k / infinity%

In this example the preferred returns don't actually equate to blockbuster dollar amounts - $1,250 and $2,150 for (2) and (3), respectively - but would go a long way to make the capital provider feel more secure in the deal and keep them coming back to the table for more deals. You might say "Okay, so you're questioning $1k or $2k? So what!"

True, but the picture changes when you start to adjust for risk. Let's assume the following probabilities associated with annualized returns on this example deal before it gets inked (no idea if these are realistic or not, but let's go with it):

Prob: 5%/10%/20%/30%/20%/10%/2.5%/2.5%

Return: 200%/100%/50%/20%/0%/-25%/-50%/-100%

So the deal has an 85% probability of breaking even or better and a 15% risk of loss, and an expected total return of 30%. Looks pretty good, right? Let's break this one down through the lens of the JV structures above:

(1) 50/50 Split: The capital provider is looking at the prospect of a mere less than 12% expected return because they are absorbing 100% of the 15% risk of capital loss and only 50% of the 85% probability of gain. This equates to only a 40% share of the total expected return on the deal, so 40/60 not 50/50, and is perhaps equally achievable via a good deal on a performing note. Certainly doesn't get me all excited.

(2) 10% Preferred + 50/50 Excess: The expected return for the capital provider goes up to 15%, which is now actually half of the total expected return and is "as advertised". Plus, as the example above illustrates, it only "costs" the sponsor $1,250 in the end.

(3) 8% Preferred + 55/45 Excess: This bumps the capital provider's expected return up to 16%, or 53/47 of the total expected return. To me, this looks much more attractive as a passive return relative to the risk assumed and other alternatives out there. The sponsor gives up a little more of the outsized returns to the investor, but keeps most of the low end returns in tact.

I'm not looking to offend anyone at all, so I hope no one takes it as such, but I'm having trouble seeing how being a silent partner providing capital to a NPN JV is attractive under this structure and 50/50 terms - or at least attractive enough to compensate for the additional risk over other alternatives. I'd love to have folks who have been capital providers and partners in the past (and received nothing else with intangible value in return - i.e., education, mentorship, etc.) chime in and share their experience. Thanks!

I'm curious where the seemingly commonplace 50/50 split for NPN joint ventures came from? Is it simply supply/demand in that this price still brings enough capital to the table to do all the deals sponsors are looking to do? If so, why? Do capital providers end up negotiating JV terms to something different than what is typically "advertised"?

+1 for Josh's book as I'm reading now.

 Jeff, I'm a newb as well, but I think you answered your own question within your question to some extent. #2 minus #1 is more or less the equity coverage/cushion you have in your investment (assuming 1st position and no junior liens). If you care about these numbers then you care about equity. It can be $0 but that doesn't leave you any downside risk protection in the event you have to foreclose and there are priority tax and mechanics liens that need to be made whole first. The bigger the cushion, the more downside protection you have. In NPL investments where foreclosure is a probable exit path, you keep the surplus proceeds (i.e., equity) after settlement of all other outstanding liens, so the greater the equity the higher the return potential.