If you are being pressured into a deal, that should be your 1st red flag. I'm not talking about being prompt with wiring funds, I'm talking about someone trying to convince you to move forward when you aren't ready. Do your homework, check references and the active partner's track record. Active sponsors should be able to quickly provide information on past and present deals as well as the investors that they currently serve.
Speaking of pressure, expect some additional follow-up from the active partner during the purchase and sale timeline. There will be deadlines that are important to meet and sometimes you may 'feel' pressure - this is normal to ensure your investment runs smoothly.
Once a property is renovated & stabilized, it should be a very hands-off process if done correctly. The only requirement should be to verify the funds that are wired into your bank account!
Each sponsor (the active partner running the deal) will have their own history and business structure. The person running the deal should be able to show you specific deals they have done.
If the sponsor is under contract on a property, there are some things to consider:
- Is this a heavy value add deal?
- Has the sponsor done a deal like this before?
- Are there strong market fundamentals where the property is located?
How much are all parties investing in a deal?
This information should be explicitly outlined in the business plan and legal documents.
The active partner, "sponsor," will sometimes invest alongside the other members that hold shares. Depending on the sponsor’s track record, a deal may exceed expectations and they may choose not to invest. Many active partners are guarantors for bank financing and they are required to keep cash reserves on their balance sheets for lending purposes and emergencies. If there are other deals during the year that the sponsor is working on, they might have money set aside to keep deal flow for other investment partners. Many sponsors are the 'guarantor' on the secured loan for the property thereby facilitating the need for a liquid personal balance sheet.
There are many ways to structure a deal - larger deal sponsors will not have room for non-accredited investors.
Due to strict SEC guidelines, the active partner may not accept money from individuals that don’t meet a certain income and net worth thresholds. If you have a personal relationship with a syndicator, there are other guidelines that allow you to passively invest if you don’t meet the SEC’s definition for income and net worth.
Make sure that you know the terms that are outlined regarding profit sharing and distributions. You don’t want to be caught off guard in a deal that has lots of fees that really cut into the amount of money going back into your pocket. Review the expected returns so you know how long it will take to get your initial investment back.
Typical holds of 3-7 years are expected in apartment investing deals. Note the 10-year business plan that outlines the returns and expectations in the event of a market correction.
Is there a "longer hold clause" in the agreement?
Most legal agreements will allow for a much longer hold period…sometimes an “indefinite” hold period. The reason for this is that you don’t want to be forced to sell a property if there is a market downturn.
What's the goal of the specific property you are investing in?
The goal is to optimize value to hold through a down market until recovery. Investing in property is not like buying stock that you can sell on a whim through your trading account. Consider your investment fairly illiquid as buying, selling, and holding property is a time consuming process. If you do need to get out of a deal, there should be provisions in the legal documents that allow you to do so…but that process takes time as well.
Some things to ask yourself:
- Are you going to need the money you are investing to pay living expenses?
- Do you have other liquid assets that you could use in the event you need to cover unforeseen life events?
- What rate of return are you expecting? Does that match the business plan?
Beware of hidden fees!
Make sure that if there are fees in the deal that it doesn't impact your projected returns.
This is a list of typical syndication fees:
NOTE - Viper Ventures LLC does not charge any acquisition, disposition, or active partner management fees thereby accelerating the amount of money going back into your pocket!
Just like deal structure, there are many ways to share profits. Know if the deal sponsor has clauses and stipulations that allow passive investors to be pushed out of the deal.
Sponsors can include milestones that change distribution rates and equity shares during the business plan. If your eyes are crossed and you don’t understand the deal, you probably aren’t alone. All of these items will be laid out in the investment summary.
When reviewing the plan, consider this:
Educate yourself on the following terms:
Preferred Return – The threshold return that limited partners are offered prior to the general partners receiving payment.
Internal Rate of Return – The rate needed to convert the sum of all future uneven cash flow to equal the equity investment. This is a financial metric that measures the value of your money compared to time.
Cash-on-Cash Return – A rate of return that determines the cash income on, or in proportion to, the cash invested, measured annually.
Equity Multiple – The amount of money you expect to make over an above the amount of money initially invested.
Projected vs Actual Returns - Many business plans include projections as property purchased for higher than average profits generally need to be renovated, updated, or changed in some way. Just because a plan shows a 20% return, doesn't mean that is actually feasible! Do your own math and check the assumptions in all numbers and planning.
Investments carry risks. Nothing is really “recession proof” however there are some sound business strategies that protect potential downsides in apartment real estate.
A Conservative Mindset
The number one goal is capital preservation. As much as we like to make money, we need to make sure that we aren’t losing money! To make these goals attainable, a conservative approach to underwriting the property in question is needed.
Here are a few examples of what the business plan should include:
It is the brutal truth that you could lose all your money…so do your homework! On a more positive note, it is highly unlikely that you will lose everything because property historically has risen in value. The US community has shifted and massively changed since 1950. Population growth directly affects housing demand.
Most Americans don't like living under bridges and out in the elements. Nevada and Arizona have had sweeping population growth since 1950. This statistic coupled with the retired and millennial population preferring to stay mobile and rent versus own has generated a demand for multi-family properties.
*Renovated class C properties are leading the Phoenix market and are what Viper Ventures LLC specializes in currently.
This could be debated either way but usually it makes more sense to split your money between multiple deals to protect yourself from a potential downturn in the market.
Each deal will have it’s own challenges and opportunities. In a syndication, the active partner will be the strongest driving force to make sure that the investment returns are met. A great property run poorly is actually worse than an average property run really well.
Each investor’s financial situation is unique to that person so there aren’t steadfast rules that apply to everyone...dumping all your eggs in one basket is not for most but only you can decide.
The IRS provides many legal tax benefits to property owners that aren't afforded to other investments. These added tax benefits are also passed on to part-owners of apartment buildings. It is possible to offset gains in real-estate returns and potentially pay little to no tax on the cash-flow from your investment.
These benefits are passed to investors that hold equity through:
How frequently are distributions made in apartment ownership?
This varies between deals - quarterly is the industry standard.
If a deal is a very heavy value add (on-going renovations), distributions may not happen during the 1st year due to $0 in cash-flow. Once a deal is stabilized and fully-occupied, quarterly or bi-annual distributions are generally accepted forms of profit distributions.
The active partner may "freeze" distributions if there is an economic downturn to protect against any future loss due to unforeseen circumstances.
How often will communications and updates be sent out?
Updates should mirror the frequency that distributions are sent out. If there are other business related activities going on at the property such as renovations, expect more updates during that process.
A responsive and trustworthy sponsor should feed you information on your investment…that is one of their jobs!
An apartment syndication is simply the act of pooling resources (time, money, knowledge, man power) to achieve a larger goal than any one person would be able to achieve on their own.
The assembled team is vital to the property's operation and cash-flow.
There is usually an active partner or general partner (the 'syndicator') that runs the deal and there are passive investors that are not involved in the day-to-day operations.
An accredited investor is an individual who meets one or more of the following requirements:
How involved am I as a passive investor?
Typically, not involved at all.
Many people think that the primary reason passive investors aren't involved is that the active partner knows what they are doing and wants full control in order to implement the most sound and effective business plan. While this is true to a certain degree, it is by no means the most important factor. The main goal in an apartment syndication is for capital preservation.
By limiting the roles and voting rights, we eliminate the passive investor’s liability beyond their initial investment in the event of a law suit, loan default, or some other unforeseen event.
It is common to create significant value through forced appreciation by way of renovations. Once renovations are complete and the property is stabilized, the active partner may seek new financing with a higher assessed property value and either refinance the property or obtain a second supplemental loan.
Why would you take out another loan or obtain a new loan?
Once a property is operating and generating higher cash flow, the value of the property is higher. Apartments that are 5+ units are valued differently than residential properties that are 4 units or less based on income that they produce. Simply stated, the more income you receive, the more the property is worth on paper and in value. By obtaining a new loan via a refinance or supplemental loan, you are essentially pulling money out of your investment to put back into your pocket tax free.
Unlike the sale of a property that drives potential tax implications, a refinance does not drive any taxable events because the IRS considers the equity in your property your money and thereby does not require you to pay capital gains tax.
Can I invest with my LLC or Trust?
The short answer is YES.
This process entails a slight difference in how you sign and fund the deal, with no added degree of difficulty. You need to consider unrelated business income tax in some of these instances so please seek the counsel of your CPA or financial planner.
Can I invest with my IRA?
Many shy away from using their IRA in an apartment community because it seems complicated - it’s not.
Your money sitting in funds is 100% legal to move into a passive apartment community and also has the blessing from the IRS to be invested and tax deferred! While you can’t invest in real estate directly through an employer-sponsored 401(k), you can choose to roll a former employer’s 401(k) account into an individual retirement account (IRA). Prior to moving funds into a new account, ask if the current account already allows you to “self-direct” the funds to invest in real estate; if no, then all you have to do is simply move the money into an account that gives you the control to invest in real estate. (takes about 2-weeks to transfer over)
IRA and 401(k) managers aren’t going to tell you that you can self-direct your money because then they don’t get their fees.
That nasty “F” word; FEES.
NOTE - This list is not all inclusive but a good guide to what should be considered - please consult with legal counsel for any legal questions.
For each property, there is a separate and unique legal operating agreement that outlines the following:
• Investor shares and equity percentage owned
• Articles of the organization
• Capital account rules & contribution stipulations
• Changes in control of the legal entity
• Company’s method of accounting
• Stipulations for a deceased member, deceased spouse, or divorce
• Distribution expectations
• Rules for disposition and sale
• Economic risk of loss
• Event of dissolution & dissociation
• Initial capital contributions of members and managers
• What a ‘majority’ vote means
• Duties and expectations of the active members running the project
• Outline of the debt rules and restrictions
• Membership interests (money, net losses, net profits, notices)
• Organization expenses and expectations
• Permitted & authorized transfer of ownership
• Legal definition of the subject property
• Special majority voting rules
• Federal income tax treatment
• Acts requiring special or unanimous vote of members
• Limitation of liability of the manager (i.e., active partner)
• Stipulation on the use of the property’s bank accounts
• Appointment rules of a new manager
• Manager’s conflicts of interest & rules for compensation
• Fiduciary duties of the manager
• Meetings of members
• Priority and return of capital contributions
• Books of account and records
• Member’s capital account
• Loans • Restrictions of transferability, withdrawal, and permitted transfers
• Right of first refusal
• Buy/sell options
• Voluntary purchase options
• Conflict of provisions
• Purchase price, terms, limitations on payments
• Dissociation of a member
• Rights of assignees, substitute members, additional members
• Dissolution and liquidation of assets
• Articles of termination
• Amendment or modification of Operating Agreement
• Attorney fees and laws
• Dispute resolution
• Heirs, successors and assigns
• Notices and references
• Representation by counsel
• Rights of creditors and third parties under the agreement
• Time periods and waivers
You cannot pick the “perfect” market, but using some of these principles, you will arm yourself with the data used to start your search.
When you are starting out and trying to pick what markets to invest in, consider these resources for evaluation:
• US city data www.usa.com/
• Census (“Demographic and Housing Estimates”) www.census.gov/
• Integra Realty Resources (IRR)—Annual Viewpoint www.irr.com/research
• CBRE Biannual Cap Rate Survey www.cbre.us/research-and-reports/North- America-Cap-Rate-Survey
• Marcus & Millichap Annual US Multifamily Investment Forecast www.marcusmillichap.com/research/researchreports
• Zillow Annual Consumer House Trends Reports www.zillow.com/research/zillow-group -report-2016-13279/
• US Bureau of Labor Statistics www.bls.gov/
• Rich Blocks Poor Blocks www.richblockspoorblocks.com/
• Milken Institute www..milkeninstitute.org/ explore/research-and-analysis
• Best Places to Live www.bestplaces.net/
• National Multifamily Housing Council www.nmhc.org/
• American Apartment Owners Association www.american-apartment-ownersassociation.org/
You can be part of a complex system that allows investors to hold equity in tangible property that generates above-average returns. If you, like me, have made poor investments in the past, this one is not one of those decisions. Rest assured, I will never abuse my investors for a short-term profit.
This short phone call with me will be a quick data gathering conversation to see if we would be a good fit. Be certain, this is a two-way interview to make sure we are a good match for each other.
Real estate is a methodical process coupled with a long-term relationship.
We need to make sure we are on the same page - let’s get it correct the first time.