Planning first 3 commercial investments. Feedback on strategy?

Question

Looking to make 3 commercial real estate investments in the next year, two as primary (sole) owner, one as a limited partner. Just finished 10 years in industry, and just returned to the states after 6 years in Japan where I wasn't comfortable doing real estate. Roughly $0.5M in liquid assets saved up I'm eager to invest in real estate. I understand I missed the optimal timing from the last real estate cycle, but it still looks viable to invest today in cash flow deals with a plan to buy and hold.

I've read 15+ books on real estate investing (analysis, due diligence, financing, etc.) and feel comfortable with the theory, but lack experience. I've been warned commercial real estate is an easy area to get screwed if you're not careful. Appreciate any advice from more seasoned investors.

Investing Strategy:

• Purchase a 15-30 unit apartment complex; self manage for one year to learn the ropes, then hire property management. Criteria: 8-9% cap, 10-15% cash-on-cash.
• Purchase one mobile home park (30-50 lots); convert park owned homes to tenant owned; position for low maintenance long term
• Participate as a limited partner investing $75k-120k as one of 4-5 co-investors in a 40-60 unit apartment complex. Expecting 6% cap, 8% cash-on-cash. The deal will be found and managed by a high school acquaintance with a successful property management company with whom I have moderate trust.

I'm attracted to the last deal (limited partner).  However, I've been warned limited partners can get screwed in a variety of ways (general partners increase operating costs that go into their own pockets; limited partner yield approaches 0-3% and becomes virtually unsellable).

My high school acquaintance explained the last 3-4 deals he's done in the $3M range have included 4-5 wealthy investors who go in together and receive roughly 8% cash-on-cash. I understand one incentive to not screw them is for continued investment on more deals, but wonder how reliable that is.

Questions:

• Anything you'd do differently re: investing strategy?
• Any advice as a limited partner?
• Any advice overall?

Greatly appreciate any feedback or suggestions,

-Michael

Brian Burke · Answer

@Michael Anuzis, yes, @David Thompson is right...investing in a syndication can result in the same tax benefits as owning directly.  However, be aware that the operative word here is "can".  Syndicated real estate offerings are governed by the operating agreement of the partnership and those can be structured in many different ways.  It's possible for the investment sponsor to divert the tax benefits (by structuring the offering documents to specify that the sponsor or someone else receives them instead of the investor) so it's important to carefully read the partnership documents, and have your tax advisor review them as well.

While sponsors can divert the tax benefits, I think it's bad business and it makes it harder for them to raise capital, particularly from sophisticated accredited investors who know better and are watching for these tricks.  This simply underscores the importance of doing due diligence on an investment sponsor and being particularly picky with whom you do business.

The best sponsors will not only pass all tax benefits on to the investors, they'll also take steps to maximize the tax benefits in the first place.  One way of doing so is to perform a cost segregation analysis on the real estate which allows some building components to be depreciated on a shorter schedule than the typical 27.5 or 39 year schedule.  This provides a greater degree of tax shelter, particularly in the earlier years of the investment.  Since most syndicated offerings have a life span of 10 years or less, this works very well in this context.

Of course, tax benefits aren't the only reason to invest in syndicated offerings, and how the sponsor treats tax implications shouldn't be the primary deciding factor when choosing a sponsor to invest with.  Experience, track record, and a history long enough to have seen more than one real estate cycle are very important.  As I often say, a bad sponsor can ruin a great real estate deal, and a great sponsor can produce the best possible outcome when faced with adversity.

Be sure to do your homework before writing any checks.

David Thompson · Answer

To Kaz's question comment, there are several ways to find good sponsors.  There are several on BP and as you review and interact on apt forums especially you will come across several of them.  Keep in mind, a sponsors reputation is critical to the sponsor.  If you have untrustworthy folks out there, that will bubble up pretty quickly.  Bad track records, these folks won't stay around along.  There is a ton of effort in building relationships and investors to fund syndicate deals and good sponsors know that their track record is like gold, it must be cared for, secured and monitored constantly.

To vet sponsors you come across, develop a checklist and your own criteria.  Here's not an exhaustive list but some ideas to consider:

1) Track record of performance - what's good for you 5 deals? 10 deals? 20 deals?  Have they gone full cycle (bought/sold?); have they gone through a REI cycle typically 5-7 years and how has their holding held up in a downturn?  Are they under, meeting or over performing on what they say their targets are?  Consistency is what you are looking for at and preferably above expectations.

2) Ask for Referrals from a few investors who have been in a 2 or more of their deals.  Ask BPs investors if they have been involved w/any of these sponsors and what has been their experience?

3) Do they have a website and review their business model?  Does it align w/your needs and expectations.  Google all the folks on the team under "who we are" and ensure not only the sponsor but their partners if they have them are coming up clean.

4) Are they visible?  I work w/a sponsor who has the world's longest running daily real estate podcast.   Do you think he cares about his reputation, how he does his deals to ensure investors are treated right? If he is not honest, shady, poorly manages his MF investing role and underperforms....he probably loses two businesses.  What's at stake?

5) Do they use conservative assumptions / accounting (on rent, occupancy, costs, etc.)  Ask for a few of their most recent deals including the investment summary, PPM, go through the numbers, go thru the partnership agreement discussing how the GP and LP roles / situations are handled. Check out the fees in the PPM - are they w/n industry standards?  Review the risks in the PPM - there are basic risks in any RE investment but some that catch your attention may need some explaining.

6) Communications - ask for their communications schedule.  How are they communicating w/their investors.  I like to see monthly communications even if its simply an email bulleting project updates.  Quarterly comms should come w/property management financials report (actual vs budget) and Rent Roll for your review.

If I can elaborate on any more of these points let me know.  Again, just a starting point and I'm sure there's other good ones folks would like to add.

David Thompson · Answer

Hi Michael

Welcome back from Japan. Yes, REI landscape has changed quite a bit in 6yrs. Where we are in the cycle is debatable but careful selection, conservative accounting, clear value add strategies in the right growth markets, with experienced partners is more important than ever.

Overall, I do personally like hybrid strategies, diversifying into different markets, with different niches. Some active, some passive $ at work.

I'll comment on your limited partner deal. It's really 3 things: market, deal, and team.

1) market - top 5 in nation in job, pop growth.

2) deal - value add deals only. Is there a clear strategy to force appreciation and drive NOI higher ? Conservative assumptions used in financial model? Exit strategy ?

3) team - track record of success?

Not comfortable, move on. There are syndication groups that check all the boxes and target, achieve 10% CoC and ROIs up to 20%. For passive $, why feel obligated to work w a high school contact. It's your $. Maybe use active capital for these partnerships and select experts for your passive $. I like syndication for the latter.

Aaron Morris · Answer

Just to add to all the other great comments: The way to not get screwed is to build a team: broker, attorney, CPA that can help you navigate the waters. There isn't any amount of research that trumps experience and relationships. Interview three or more brokers who specialize in the asset class you are most interested (looks like multi-family). Interview a couple of attorneys that specialize in real estate. Be careful to take their temperature regarding doing deals. In my experience there are two types of real estate attorneys: those who like to do deals and keep the clients goals in mind and those who are so adverse to risk they'll never advise you to do a deal. Go for the former. Find a CPA that does a lot of work with real estate investors. That shouldn't be too challenging. These people will protect you. The smaller concern is getting screwed. At least here, there are very few who are out to get you. The concern is that without this team you'll never be able to get in to a deal because the listing brokers job is to find a buyer who is ready, willing, and able to purchase the property. New investors usually have one or two, but not all three of these things. You need a broker who can sell your viability as a buyer to a listing broker and get you in to the deal.

Kaz M. · Answer

@David Thompson @Brian Burke

Great points! I will make sure to keep those points in mind when looking a sponsor.

David Thompson · Answer

Yes, Very tax efficient, full benefits like other RE investments (property tax, interest deduction and depreciation to name the big ones).  As a Limited Partner, you will get a K-1 from partnerships in spring of each year based on previous years results.  Its a simple one page summary of income and deductions showing what normally is a paper loss for the first 4 years of a 5 year hold while you are putting the cash in your pocket.

Yes, some sponsors are not taking on new money but I'm sure they'd put you on their newsletter or contact list.  Being accredited investor status is usually the investor's hurdle.  I support Joe Fairless so you can start w/me, Brian Burke, Brian Adams are a few that come to mind.  Again, if you hang out in the apt forums on BP, you'll run across them in their title or profiles.  I would be patient w/your money....easy when you see it just sitting there....review several sponsors and vet like I've mentioned above.  Some may have deals now and some may be hunting.  You should directly talk to them as well and make sure they answer all your questions and be comfortable w/their responses.

I'm more than happy to chat w/you and provide education or depth on what we've shared above or what comes up in your mind.

Michael Anuzis · Answer

@David Thompson & @Kaz Miyazaki, thank you both for the excellent suggestions. I was under the impression syndication deals didn't provide the tax benefits of investing in real estate, but came across an interesting article on BP yesterday explaining that syndication deals often can provide full tax benefits if structured right. (particularly: deductions for depreciation & interest)

• fundrise.com only provides a 1099-DIV (dividends)
• realtyshares.com provides a K1, but captures all deductions through a second LLC that appears to maximize tax benefits for the platform, not investors. (not a tax expert; I may be mistaken)

From your advice and the above article, I gather it's possible to find syndication deals structured to share tax deductions proportionally with investors. I haven't been able to find anything like this. Shared tax deductions was the main reason the deal through an acquaintance looked attractive.

Any suggestions how best to find syndication deals like the ones you've discussed? It sounds like there might be waiting lists to invest with the top sponsors you've described.

Kaz M. · Answer

Hi Michael,

Welcome back. Where in Japan were you staying at?

I will agree with @David Thompson. Passive role in a syndication deal might be a good way start getting insight on a larger deal. But then the question is how you find and vet a great sponsor.

Planning first 3 commercial investments. Feedback on strategy?

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