All Forum Posts by: Michael Worley

@Annie Bliss I realized that I missed a part of your question. You asked about Value Add.

When a property is described you usually have a property that is either Stabilized (meaning up and running efficiently, fully leased or close to, basically retail ready condition), you have Value Add (minimal deferred maintenance, operational inefficiencies or capitalization problems or other issues which allow the property to be run sufficiently better) and finally Rehabilitation Condition (needs a lot of repairs, not currently rentable, etc).

Value Add Condition properties are more about the new operator coming in and turning it around from a management standpoint and much less about taking a run-down structure and repairing it.

No, I'm not misinformed at all. **EDIT I should expound on what I mean by 'disqualifes' in my above statement. I mean it is disqualified from the tax treatment** You can borrow money and use it to buy things inside of an IRA, but it makes the income derived from said activities subject to immediate taxation at your ordinary income tax rate. It's called UBTI (unrelated business taxable income) and is taxable in the year in which the income occurs (i.e. immediately). Publication 598 from the IRS outlines this clearly.

Here is an excerpt relating to the EXCLUSIONS (i.e. the instances where it doesn't count):

Other exceptions. This exclusion does not apply to unrelated debt-financed income (discussed under Income From Debt-Financed Property, later), or to certain rents, royalties, interest or annuities received from a controlled corporation (discussed under Income From Controlled Organizations, later).

Here is the portion inside of the same publication referring to Debt Financed Property:

Investment income that would otherwise be excluded from an exempt organization's unrelated business taxable income (see Exclusions under Income, earlier) must be included to the extent it is derived from debt-financed property. The amount of income included is proportionate to the debt on the property.

In general, the term “debt-financed property” means any property held to produce income (including gain from its disposition) for which there is an acquisition indebtedness at any time during the tax year (or during the 12-month period before the date of the property's disposal, if it was disposed of during the tax year). It includes rental real estate, tangible personal property, and corporate stock.

Non-recourse or Recourse loans are irrelevant to whether the income is immediately taxable or not.

I hope you guys realize that borrowing money to buy property inside of a qualified retirement account is against IRS rules and invalidates the tax qualified status right? The IRS is very clear on using leverage (i.e. Borrowing money to buy something) being a disqualifying activity in ALL tax tax qualified accounts.

CPA's are licensed in the state they reside. Most states offer mobility privileges so that they can service clients who have out of state operations. State dependent though.

Late to the party...

I think you have to separate the discussion into what level of investor you want to be. By level, I'm referring to the level of professionalism, the 'pro status' of the investor. It's not a derogatory term to not be the highest level of professionalism the most 'pro' status. Just like it's not a derogatory term to call someone a college basketball player versus an NBA player.

I think the rule of thumb argument is there to act as insurance from making an obviously bad deal. Much like bumpers on a bowling alley, they keep you in your lane even when you're just starting out.

Where the rule of thumb fails is when you want to get to that next level of real estate investing. At that level knowing the market for the area you are investing is more important than any rule of thumb. I don't mean just knowing the average rents in an area, the GRM, the average expenses or any other such measure. What matters most when you are trying to step up your professionalism is knowing the market in a deep meaningful way, like the traffic patterns, the movements of employers, the local political landscape, demographic shifts, etc. That level of knowledge allow the real professionals to buy properties that on paper look terrible by most any metric, but profit handsomely. It allows those pros to pass on a deal that looks fantastic but burns investors in a couple of years.

The point is, you can start with rules of thumb and you can only use them and you can have a nice real estate investing career / portfolio. But you are trying to be a world beater (which from Ben's posts I suspect that's what he's talking about) then rules of thumb go out the window.

This is also why I think, as a rule of thumb, you should only invest in areas you are intimately familiar with. (you see what I just did there.....)

 It's pretty typical to provide the private money investor with a set rate of return of something like 8% until the deal sells and/or refinances their money out at which point the private money investor gets their money plus some percentage of the equity (most commonly 50% of the equity).

Peter, one thing to consider, if you're a 20% owner or greater in the LLC most recourse loans will REQUIRE you to guarantee the deal. If that's a problem from a credit stand point, perhaps 19% owner ship with a salary (to be budget into the deal structure just like a property management fee) would make sense.

Another way to do it if you want 'equity' instead of salary, is to loan the LLC money with an interest rate and a balloon payment such that you'll capture 'equity' when the property sells or refinances due to them paying off your note at that time.

I just finished listening to the Jeff Greenberg Podcast on Multi Family and wanted to comment on that podcast.

First and foremost I'd like to say that I thoroughly enjoy the BP podcasts. I also enjoyed Jeff Greenberg's insight on his experiences with Multi Family investing. I agree in principle with just about everything he said on that podcast but wanted to approach a couple of the topics from a different angle.

As I mentioned on a different thread, I am a commercial banker for a community bank. Most of the time when I'm viewing a deal or reading a book or listening to a podcast I'm doing so from the point of view of a bank. So my comments will come from my banker's point of view.

Jeff commented on having done a deal where he was an investor in a large MF project of around 700 units. He said that presenting that as part of his 'resume' impressed the bank. That is 100% true. When we have a deal we're trying to get approved, we go through a process called loan committee. That process is where the commercial lender/banker puts the entire package together to 'sell the deal' to the powers that be (usually the board of directors, CEO, Chief Lending Officer at my bank). **it bears mentioning that the commercial banker has a huge incentive to not present bad deals (or present potentially good deals in a poor manner) because no one wants to look foolish in front of the board of directors and CEO** Part of selling that deal to the committee is showing the history of this borrower/operator to make projects work. One of the first questions I get in a committee when presenting a deal is 'how many other units does this borrower own'. It's far more difficult to get a borrower approved on a deal, even if it makes sense numbers wise, if it's their first time doing a property this large.

Next Jeff commented on the 30 ammortization versus a shorter 15,20,25 year ammortization. He also commented on using the same bank as the 'mom and pop' who own a property he's buying. I think this part of the capital structuring plan gets glossed over too much by investors. You have a much faster turn time, and a much higher success rate of financing if you have a capital structure plan in place. By that I mean, the 4% 10 year loan maturity based on a 30 year ammortization schedule is the FINAL stage of financing for a fully stabilized property. You should not aim for that financing at aquisition. Basically if you are buying a value add or distressed property, you should look for financing that is to get you through the stabilization time period plus a year or two THEN do a take out loan with the final terms. You will not only have better terms and cash flow in the end, but you will be able to properly leverage the final value of the property and take out the equity from the work you've done to go on to the next deal effectively.

Which then leads to a final comment from the podcast on using private funding. Private funding is THE MOST EXPENSIVE funding you can have in a deal. It can make a ton of sense to do it, but you should try to get out of the private funding game as fast as you can. What I mean by this is (and this all goes to the capital structure of any deal) private funding deals usually have some guaranteed preferred interest rate (let's say 8% is the current going rate) and they typically participate in the upside of the equity capture. So where a bank might lend you money at 6% on a rehab deal, the lender does not participate in equity capture. The total rate of return on the deal is lower than if you used your own equity. Private funding CAN increase your cash on cash return, but if the deal you're purchasing has a good amount of upside, you're losing a ton of money on the back end. I only mention this because private placements are quite popular on various sites / podcasts. In an ideal situation you'd rather have more leverage from a lender, than use mezzanine financing (which is what private placements really are) which participate in the equity capture.

Sorry for the TL:DR post, I could probably fill a whole podcast with just this subject.

Welcome to BP. I work for a bank here in the DFW metroplex on the commercial lending side. If you have any questions and want a lender's POV feel free to ask.