All Forum Posts by: Giovanni Isaksen

A common structure is to give equity investors a preferred return on the project's cash flows, with the balance divided between LP and GP and then a split of the profits after investors then the sponsor's investments are returned upon disposition or refinance.

The preference (or pref) is the investor's first claim on the cash flow (NOI less debt service), usually stated as a percent of their investment for instance 7-1/2%. So an equity investor with a $1million investment would get the first $75k of cash flow, anything above that would be split at the agreed rate between the sponsor (GP) and the investor (LP).

If there isn't enough cash flow to cover the pref the portion not distributed is added to the investor's investment total to be paid at disposition. Depending on the terms these shortfalls can be compounding too so that the LP gets the first 7.5% on their initial investment plus any shortfalls from the previous year(s). This can get to be quite expensive for the GP who isn't hitting their projections.

At disposition or refinance the LP typically receives their investment plus any pref shortfall back, then the GP gets their investment back and finally the remainder is split. The split can be a fixed ratio, say 60/40 or it can have a waterfall structure where the ratio changes more in favor of the GP the higher the returns are. The waterfall thresholds can be set at certain LP IRR returns or multiples (2X, 3X, etc) and can be quite complicated to model so it is important to lay out clearly with dollar figures who gets what when with waterfall structures.

Note that the split of cash flow above any pref can also have a waterfall structure. These waterfalls can be great but they can also start with very low GP splits that really incentivize you to exceed your projections too.

What the terms including the pref, splits, compounding and thresholds are is subject to what you as the GP negotiate with your LPs. If the LPs are institutional investors such as a pension fund or private equity they'll typically demand better terms than you might negotiate with friends and family and it's really important to correctly model out the waterfalls so both parties know what to expect.

If no institutional equity is involved a simple structure is easier to explain, track and distribute. For instance Cash Flow: 7%pref non-compounding with anything above that split 50/50; Proceeds: LPs get 100% investment plus any pref shortfalls back, the GP gets 100% of their investment back then balance is distributed 60% LP - 40% GP.

Make sure to include enough of a asset management fee in the expenses so that you don't starve during the life of the project, neither you as GP or your LPs want you to go out of business midway.

I would definitely get professional help structuring and modeling your terms to make sure you don't box yourself into a corner where you make nothing or worse get sued by your investors. That's in addition to having an experienced securities attorney making sure you're good with the SEC and any state regulators where you, your investors and the property are located.

Good hunting-

Yep, @Steve Olafson, selling at a 5.5 cap? Congratulations, now you're a buyer at a 5.5 cap. But hey we've got a 200bp spread over our 3 year fixed loan rate! What could go wrong?

That said I believe the Fed really is trapped and that we are turning Japanese which means low interest rates for much longer than most people suspect. Japan's 'lost decade' is old enough to drink and will be graduating from college soon. We're following the same economic plan and shouldn't expect a different result. Net-net the cycle peak will be extended, for an extended period of time.

+1 on @Steve Olafson's comments. We're doing this with one property right now. None of the brokers have a listing agreement but they know if they bring a buyer at price X or above they'll get both sides of the commission. We don't really want to sell it but cap rates have compressed in that market so much over the last six months that testing the market is a prudent thing to do.

@Chris G. is that vinyl plank flooring or sheet goods? The vinyl plank is just about bullet proof (but not completely tenant proof) and you can replace individual planks if needed. It's one of those costs more up front but saves you in the long run items with a 20 year life though. If you're a short term holder it probably won't pencil but a lot of the big institutional apartment operators are going to it so it's becoming pretty common in the industry.

Welcome to BP @Eileigh Bevers. I think the Everett area is probably the best Puget Sound submarket in terms of price/value/potential right now. With the tax deal in hand Boeing will be sticking around for at least a couple decades and the Paine Field area is becoming and industry center for advanced composites. This means skilled jobs and that non-Boeing suppler composite companies will be locating to Everett to take advantage of the growing talent pool. For exactly the same reason that Google opened in Seattle so they could poach from MSFT, Amazon, Adobe, etc. composite companies will want to be in Everett. Net-net more well-paid skilled employees for tenants.

Good hunting-

Great discussion. I've see usage all over the map. Some properties you'd swear that tenants had a side business doing other people's laundry to tumbleweeds in the laundry room. Looking forward to the replies.

One thought about consolidating the 3 laundry rooms; is there some amenity that you can provide in the former laundry rooms? I would think that tenants would appreciate having laundry on their floor and would take more ownership in them but if the rooms are large enough to serve other purposes (yoga room, conference room, lounge, etc.) you could increase the competitiveness of the property.

Great question @Bok O. Was talking about that just last month in a Multifamily Executive piece Cap Rate Limbo: How Low Can They Go?. At least on the coasts and across the sunbelt (the 'smile' markets, visualizing them on a map) multifamily seems to be nearing the peak if not there in some markets but... I believe there are forces at play that will stretch or extend the peak. See my post here for the chart and details: The Multifamily Market Cycle Peak Is Here, It’s Just Not Evenly Distributed Yet

@Douglas Dowell I too am a believer in Glenn Mueller's methodology but not a fan of his Cycle Monitor reports because they are based on where he thinks markets should be in their cycle rather than where his published methods would indicate they actually are. I started noticing back in 2012 that his reports and what was going on in certain markets was diverging and earlier this year published two posts on my research: Widely Followed Apartment Market Cycle Research Misses Widely and 3 Things I Learned Charting Multifamily & CRE Market Cycles

For different ways to visualize the market cycle have a look at the charts here: Market Cycle Charts with a little more detail

Good hunting-

Was just laughing with a client this week about how every long term successful real estate investor we know would have Never Sell! engraved on their tombstone as we traded stories about our respective mentors.

I never liked the term flipper because it was a derogatory label popularized by the media to stir up controversy. I prefer to call it what it is (and what the company I founded and sold did) which is spec remodeling. Just like a spec builder who buys a lot, builds a home then tries to sell it for more than it cost, a spec remodeler does the same thing with an existing house. The principle is the same; create value that hopefully someone will pay for at the end.

That said spec remodeling is a job unless you're in the business of owning a construction company. A business as defined by Michael E. Gerber in The E-Myth Revisited: Why Most Small Businesses Don't Work and What to Do About It  (on Amazon http://amzn.to/1Bs4HEh) is one where you as the owner doesn't work in the business but on the business and they can't take extend periods away from the business and they nor the business not suffer financially. A job on the other hand can be high paying but if you don't show up for work there's no income; think of doctors and lawyers and contractors/spec remodelers who are swinging hammers and running projects day-to-day.

But either as a business or as a job spec remodeling is not an investment. An investment implies that you're putting up money in hopes of a return instead of your labor. Granted there are very few pure plays either way; investments with no work or jobs with no investment but by primarily putting your money instead of yourself up for work you free your time up for other things. One thing could be doing more investment deals. Another thing could be doing spec remodels to build up capital as many have posted about.

In the end though the goal is to accumulate enough wealth to create financial and time freedom. That means building a portfolio of assets that work on their own without you having to run abound spinning plates and keeping the balls in the air everyday. Many people have found that income producing properties professionally managed fit that bill quite nicely.

And it's not just me, Trammell Crow said (and if you don't know he was...)

You can get rich selling [or flipping] real estate, but you can only get wealthy by owning it. 

Good hunting-

Your dad doesn't own apartments as much as he owns a job running apartments @Robert Marek. From what you say he is a storybook example of a tired landlord, something that we as opportunistic value investors are always looking for. Depending on the location, a bit of rehab and upgrading the tenant base driven by bringing in professional management could have the property performing nicely and be a good long term hold, or even a flip.

Not picking on your dad because it's a very common scenario (thankfully for us). It's really the same in any small business, starting out the founder wears all the hats and toils away 24/7 first to launch the business and then make sure it survives those first critical years. But every founder has a limited amount of 24/7 in them especially if the business (an apartment building in this case) is in addition to their day job.

Burnout happens as surely as night follows day and when that point arrives, or hopefully before that point arrives the founder has to decide whether to grow the business enough to support bringing on other people to reduce their workload or allow the business to whither to the point where the founder can still handle the volume of work post-burnout. Unfortunately with an apartment you can't shrink the workload short of selling the building.

Bringing on people doesn't have to mean hiring employees with all the associated overhead that entails because you can outsource certain tasks. In the case of property management (and the related building maintenance) you can hire professional property managers who do nothing but manage properties just like yours. Yes they need to be managed but that's a lot less work than doing it all, every day, all day and night long.

You hear people complain that property managers all suck and that they as the owner can do a better job. If that's truly the case then why aren't these complainers already in property management, if they're as good as they say they'd clean up (Note that as apartment investors grow their portfolios, owning a property management company typically becomes more efficient than hiring outside companies). The other thing is that this is own-a-job thinking and it will limit your success. Especially if this is your second job are you really as good as the pros?

Do you belong to IREM? Do you hold a CPM designation? Do you belong to the NAA and have a Apartment Maintenance Technicians Certificate (CAMT)? Do you network with fellow property managers and regularly attend continuing education classes to stay up to date on the latest techniques, technology and products available?

My dad was one of those DIY guys and it was great for learning as a kid growing up and helping on the weekends. But my aunt and uncle had a similar property with a property manager in place; my cousins got to spend a lot more weekends goofing off and their property did just as well as (if not better) than ours.

What I learned from all that was that a good property manager more than pays for themselves with increased NOI and if that's not possible it's because the property was bought wrong in the first place. Some people restore cars as a hobby but they don't make any money doing it, the returns all come from playing with the cars. You can be a hobby property manager too but you should expect the same financial results as the car hobbyists.

Good hunting-

I do a lot of asset management which is a fancy way of saying I manage the property managers but what it really means is that I get the benefit of their collected wisdom without having to do all the hard work they do.

We also do a lot of what's called 'value add' deals where we take an uderperforming property and bring it up to market or 'stabilize' it. What the property managers have taught me in doing those type deals is that one bad tenant can make your life hell and worse yet can make the other tenants' life hell too... and scare off the good ones. And it can take several sets of tenants to clean out the dead wood if you do it in drips and drabs.

So much of attracting good tenants comes from good word of mouth that it's more expensive (especially if you life span is worth anything to you) to go the cheap way by trying to move the old tenants out one by one. Our property managers and I have learned that it's more often much less costly in the long run to do the clean sweep than die the death of a thousand cuts. Most likely you seller won't do that for you so it will but up to you or your property managers to move out the old tenants. Run the numbers for sure but include all the real costs including stress when you do.

Good hunting-