Your top lesson from holding large multis?

Question

Jonathan Twombly · Answer

@Rob Barry and @Jerry Poon

I started with a 102-unit deal and went on to purchase three more in 11 months.  Here's what I would do differently.

1. Start with smaller deals I could do myself without a balance sheet partner, so I could gradually build up my net worth and not have to split profits with so many people.

2. A bit counterintuitive but I'd also trust my gut more.  When the management company I first hired introduced me to the asset manager they were going to use, I was not impressed but I deferred to them.  Then when that asset manager hired a PM with no experience with the property type, I did not speak up about it.  I figured, "this is a big manager company with thousands of units under management; they must know what hat they are doing."  But the wrong people running that deal turned a good deal into the dog of the portfolio.   My gut told me they were putting the wrong people in, but i did not speak up because I still lacked confidence.  The lesson here too is build your confidence with smaller deals first.

3.  I would be less concerned with investor returns and more concerned with property liquidity.  I was afraid of raising too much money and driving down returns, but every property needs a reserve fund to keep it liquid when capital items come up.  On large deals, the lender may require you to escrow repair funds every month.  To get the funds back, you need to pay for the repairs and then seek reimbursements.  And you often need to reach a threshold, like $20K, before you can make a request.  It's like paying for the repairs twice from a cash flow perspective.  So you need to make sure you have a reserve fund set up in advance to use as an internal bank to float the cost of repairs while you wait to get the money back from the bank.  Our deals with reserve funds have out performed the deals where we only raised enough to close by a long shot.

Jonathan Twombly · Answer

I see that my last response did not really answer your question.

1.  Assuming I had the net worth, as described in the last example, I would go for 100+ unit deals.  The issue for me in my response was not the deals - it was having to share profits when I am doing all the work.  Also the effort of pulling teeth to get people to sign on debt along with you, even though that debt carries very low risk.  And fund-raising is a strain.  But if you have the funds set up from other people, you don't have that issue.

2. Partnership is good, if the partner is experienced and you see eye-to-eye.  There are lots of people out there with the experience; finding someone who you share values with is the harder part.  So make sure you find that person if you want it to be a long-term partnership.

There are also mentors out there - free or paid.  Either can be good if it is the right person.  If you can access such a person, a mentor who is willing to mentor you in return for a part of the deal may be the best option, although, again, you are now married to this person, so you want to make sure that the fit is good.  A paid mentor could also be appropriate because your risk is limited to what you paid them.  If you don't like them, you move on.

Even though I learned a lot from my partner, there was lot I had to learn by experience once I got into deals.  There was no substitute for that.  And every deal is different, so even taking two deals up to the point just before closing did not give me any experience in what can happen at closing - not just with sellers but with lenders - as well as what happens once you actually have to manage or asset manage the deal.

Jonathan Twombly · Answer

@Rob Barry

So, here is the thing about commercial real estate that really separates it from residential:  the size of your net worth limits the amount of debt you can take on, regardless of how good the deal is.  So, if you have $1,000,000 liquid and that constitutes the entirety of your net worth, a lender will give you no more than $1,000,000 in a commercial mortgage.

You cannot buy a $4,000,000 property with your $1,000,000 and 75% LTV.  (Though you could buy 4 $1,000,000 properties with $250,000 down and 75% LTV on each one, using the equity in the other deals to satisfy the net worth requirement.  Silly, but that is the way it works.)

If you have a net worth of $3,000,000 (not including your $1,000,000 for the equity down payment), and you have 10% in cash, then you can get a commercial mortgage.

Fortunately, you can also combine with teammates.  So, if you have friends who are willing to contribute their balance sheets to the deal, you can get debt up to the amount of your combined net worths.

This is still true, even if you seek non-recourse debt.  There is actually no such thing as true non-recourse debt in the commercial space (unless you go below certain LTV thresholds, which depend on the lender).  At 75% LTV, all commercial debt is subject to what is variously called "good guy guarantees", "good act guarantees", "bad boy carveouts," etc.  Essentially, these say if you commit fraud or do other bad acts, the debt becomes full recourse.  That is why the lenders still impose the balance sheet requirements - if you're a bad guy, they want to be able to collect from you.  You and your partners will have to sign these personally.  The only way around this is to go below the LTV thresholds or to start a fund that signs on the debt, but in the fund case, the lenders will still require at least one "warm body" (i.e., a person) to sign individually.

Jeff Greenberg · Answer

Although these are important in smaller properties, these can have a larger overall effect when you are dealing with larger properties.

When interviewing the PM, make sure that you have a clear understanding of the payroll burden(health benefits, vacation, workman's comp, etc).  PM's can be very generous with employees benefits that you pay for.  Since they are employees of the PM company, they must get the same benefits as other employees of that company in the same classification.  Even though we budget 1300 per door per year for payroll and burden, I have see it at 1400-1500.

Don't assume that you and the PM are on the same page on optimizing the NOI. Always get references from other owners as to the companies performance.

Make sure that you and the PM are on the same page as to the quality of repairs and make ready's that you expect.  You don't want them spending more time and money than necessary for your class of property, nor do you want them to be lowering the standard you expect.

Rob Barry · Answer

@Jonathan Twombly

Thanks for your reply. I just listened to your BP interview as well. I can commiserate with your having bought one or two smaller properties and then wanting to go right for something quite large. I'm just closing on my second sub $100k SFH and realizing that, at this rate, it'll take quite a long time to generate meaningful income from acquired R.E. assets.

At the moment, I'm liquidating my position in my business to free up capital for investing in multis (and starting a new biz) and trying to determine how large I want to go with the first bigger deal. I'd been thinking to find a partner moreso for the experience/street cred than for getting the largest property possible. So let me put two questions to you.

1) Let's assume you were just starting out in multis again and had, say, $1m liquid and a few well-heeled friends looking to add R.E. positions to their portfolio. What sorts of assets would you go after, and would you seek to own/control one outright, or have leading positions in 2-3?

2) One of the big takeaways from your early experience is "only partner if the partnership is ideal." It makes sense why you'd rather have full control, given the time wasted lessons learned with floundering deals in your first partnership. But how else would you have confidently attacked such intimidating deals as an outsider without a partner who had at least some experience and credibility in the marketplace?

Kind thanks for your sage advice.

Jonathan Twombly · Answer

@Jerry Poon:  @Michael Le  has it exactly right. Syndications are the way to go if you want to grow.  But starting off smaller, so you can get the debt without a balance sheet partner, is what I'd recommend.  Of course others would disagree.  It depends on finding the right partner and finding any balance sheet partner is not easy.  In any rate you're more likely to find one when you're out there doing deals and have demonstrated your expertise.

Michael Le · Answer

@Jerry Poon, I think Jonathan means to still syndicate but go with a deal that doesn't require more than his personal net worth and liquidity. If you bring in a co-sponsor/KP for the purpose of using their net worth and liquidity on the loan, you'll likely have to give up some equity.

Jerry Poon · Answer

@Jonathan Twombly Thank you for your input. In response:

1. What is the advantage of going small versus going with syndicates/partnerships? I am going to guess that the profit is higher, but the paperwork and hours put into organizing those structures outweigh those gains. I am currently on this "smaller deal" track right now. All my investment properties are owned alone (through financing) but I approaching my DTI wall. Right now I am inquiring about private money to try and clear this hurdle. What would you have done after you have hit the wall?

2. That is a painful lesson I've learned not through real estate but through my day job. I have paid for it, and will not be soon forgetting it. I currently do not let anyone on my REI team make decisions without me because of it.

3. That is an interesting reimbursement process. Is that industry standard? May I take a guess and say that it is these type of hurdles that have you wanting to avoid syndicates/partnerships mentioned in Point 1?

Jerry Poon · Answer

I am interested in this as well.

Your top lesson from holding large multis?

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