All Forum Posts by: Account Closed

Your projections are running expenses at $2,700 a door. That seams a little low but the one thing you have not mentioned is what the last few years of expenses have been. Your lender is going to want to see that and if you get a PCNA done, my guess is that low expenses are due to a lot of deferred maintenance. Additionally, multifamily properties are a hot commodity these days and most sellers do not need to provide seller financing to sell. Not saying that you got a bad deal just I would do a lease audit and walk every unit.

Good luck and many happy returns.

Nicolas Paez

If at all possible, without over burdening yourself, now is the time for LONG TERM DEBT. Rates are at levels that will not be seen again for a very long time. If inflation occurs ( and we all know it will) then having locked in low rates should produce greater cash flow. Keep in mind that rent is a factor of inflation so the more cost you can fix such as interest, the greater you cash flow will be. 

Good luck

Nicolas Paez

[email protected]

The best place for this is typically investment associations. For Apartments you can try the local Apartment associations. As for commercial, check the nation associations such as IREM and BOMA. While tedious, you most appraisal districts have search capacity for commercial type zoning and then you could cross reference with the state LLC registers.

Real Estate Capital Stack

I am often amazed at how many time I use the term “Capital Stack” only to have someone stop me and ask me to explain what I mean, so I thought I would take a few minutes to explain why this is important in analysis of real estate investments.

In its’ simplest form, the "Capital Stack" is the definition of one’s place in an investment. The "Capital Stack" refers to the legal organization of all of the capital placed into an investment. The Capital Stack determines who has legal rights to certain assets and income, who receives priority of payment in the event of an uncured default, and in which order each party may be repaid or given authority to take over or liquidate assets in the event of a bankruptcy.

Another way to look at it is – who has the most to lose? The Capital Stack not only defines legal rights but also is a way of assessing the risk one takes making the investment. Your place in the Capital Stack can make all the difference between a complete loss and full recovery of your investment on those rainy days when things go wrong.

The graph below show a typical Capital Stack formation in a commercial real estate deal.

Equity

Preferred Equity

Mezzanine Financing

2nd Lien Positions

1st Lien Positions

Taxes

Starting from the bottom, Taxes typically have the highest priority and in the event of a total loss, taxes would get any proceeds if any were available. This is one of the reasons that many people like to invest in tax liens because regardless of the debt, the taxes ultimately get paid or you get the asset.

Next up are 1st mortgages. If the 1st mortgage is say 60% of the investment, then the property would need to lose 40% of its value before the 1st Lien holders would sustain a loss (assuming the taxes are current). Since this type of 1st Lien is somewhat protected, the 1st lien investor usually gets the lowest overall return. (i.e. lowest risk)

As you move up the Capital Stack, each investment group is less protected, hence greater risk, hence higher return expectations. At the top, Equity has the greatest risk and hence the highest expectation.

All this seems very basic but far too often investors forget to take into account the level at which they are investing and the appropriate risk. To best highlight this I like to use a Band of Investment Approach to compare investments. Below is a simple Band of Investment analysis for a $1,000,000 property:

Investment A

Investment Class	Amount	% of Investment		Desired Return	Cap. Rate Allocated to Class
Equity	200,000	20%	X	10%	2%
Debt	800,000	80%	X	5%	4%
Indicated Capitalization Rate					6%

Now let’s look at the same investment with much less debt because the 1st Lien lender is not willing to move up to the 80% level in the Capital Stack. The resulting analysis might look like this:

Investment B

Investment Class	Amount	% of Investment		Desired Return	Cap. Rate Allocated to Class
Equity	500,000	50%	X	10%	5%
Debt	500,000	50%	X	4%	2%
Indicated Capitalization Rate					7%

As you can see, this analysis assumes that you are only interested in getting a 10% return to your invested dollars regardless of the risk. The debt has reduced the 1st lien investor’s desired return since they now have moved down the Capital Stack and reduces their risk.

The question is which is the riskier investment? A or B

Capitalization analysis would tell you that since B has a 7% cap. rate, B is the riskier investment.

A better answer might lie in the following:

Investment Class	Amount	% of Investment		Desired Return	Cap.Rate Allocated to Class
Equity	200,000	20%	X	10%	2%
Mezz. Position	300,000	30%	X	7%	2.1%
Debt	500,000	50%	X	4%	2%
Indicated Capitalization Rate					6.1%

Doing a little reverse math, the above analysis would indicate that for Investment B above, as an investor, you should be willing to accept less return for Investment B because part of your investment now is represented by your Mezz. Position.

Application of the Capital Stack in Investment Decision Making require an investor to establish their risk/reward equation first. Many of the investment structures in the middle of the Capital Stack have gradations of higher return with each level of additional risk.

The Capital Stack analysis can be segregated into many different investment classes. It is important that an investor understand how conditions such as recourse debt, environmental risk, property condition, etc… impact their position in the Capital Stack. At one extreme, an investor purchasing a single family rental with full personal recourse debt represents little difference from an all cash buyer since his/her investment represent the entire Capital Stack.

For more information and comments, please feel free to contact me at [email protected]

Nicolas Paez

I agree with Nathan's assessment but not sure that the $1000 per account has any relevance. If the accounts are single family or individual units that might be a fair value.  We are actively looking to purchase a management company and have not seen anything priced like that. For example we are looking at one firm with over 2000 units under management but that only represents 6 accounts. I can tell you that $6,000 would not even get me a lunch invitation.

The biggest concern you should have is the longevity of the accounts after the transition. I would follow the rule of thumb that most professional services firms such as accountant, lawyer, doctors etc have which is 1.5 to 2.5 time net annual earnings. Additionally, I would setup a formula to ensure that the owner and employees are rewarded for contributing to that continuity. ie backend load some of the price including employee loyalty bonuses.

Good Luck

Nicolas  at AHC Capital

Not sure I understand all your question but our partnerships are typically structure as follows:

1. the money partner gets a prefered return to the capital appropriate with the capital stack investment. ie first feeding at the profits.

2. the "working" partner and "money" partner then split the "extra" bases on their level of work contributed to the, deal. In our case usually 50/50.

3. lastly, and this is where I am confused about your question, many of the services you mention such as management, contracting, acquisitions, etc are direct costs. If you are going to ask someone to contribute these activities to your deal, then you are not bringing 100% of the cash. Sweat equity is every bit as valuable as cash and should be accounted for in the investment. for example if your accountant is going to charge you $2000 to help you set up your partnership, then he/she would have $2000 in the deal as a "money" partner and be entitle to a return similar to the cash money partner.

As for the "side" benefits an individual may get from aligning themselves with you, only they can accurately asset if that is appropriate for them and you would be well advised not to get into someone else's business unless you want someone to tell you what a fair return is to your money. Remember that 80 to 95% of the capital stack is getting less than 5% return these days.  

Nicolas at AHC Capital

LLC are a great investment structure to help protect you from certain types of liabilities however, there are several major pitfalls and LLC's do require you to follow certain rules that if you do not render the LLC protection meaningless. These include;

1. Typically if your loan is less than $2M you probably have personal liability to the lender and as such the LLC may do little to protect your assets from financial default. What the phrase? "joint and several"

2. Acts of negligence are many times not protected by a LLC. This is where most novice investors get burned. As an owner, you are expected to be very proactive in safety and risk mitigation. ie BUY LOTS OF INSURANCE.

3. Many investors co-mingle funds and pay many personal expenses out of the LLC. This is a very open invitation to "pierce the corporate shell". Setting up an LLC is more than just an accounting or legal structure. it is and operating platform and as such investors need to follow the rules otherwise the LLC will not do much to protect you.

I am not advocating not using a LLC structure only that if you are doing so to protect yourself from various liabilities, you need to do a lot more that just file an incorporation document.

I am not a lawyer, but have owned and operated over 50,000 units and managed the largest multifamily loan portfolio in the county and can tell you I have been on both sides of potential problems. They are never pretty.

Nicolas at AHC Capital

Thomas, There is no right or wrong way to get into real estate investing. I did a very similar career route and while I never practiced as a CPA, it has been invaluable in both opening opportunities and providing insight into investment options. I highly encourage you to complete your certification after all a large part of real estate investing is about taxes.

Best of luck

Nicolas at AHC Capital