All Forum Posts by: Stuart Udis

@Arn Cenedella very informative post. Hope others take the time to review your case study. I find there to be two reasons very few follow your strategy.

1. Most of the "real estate gurus" focus on getting their students into low barrier housing opportunities pushing the narrative that cash flow and number of doors are the standards to strive for.  This is because it's easier to quantify and show immediate results to justify their fees. Sadly, these investments rarely perform as the spreadsheet or appraisal suggests.

2. Many GP's focus on raising money from investors who are interested in short term holds and are singularly focused on rate of return. The best way to appease these investors is through using as much leverage as possible. These LP's are also usually invested in the most risky partnership opportunities, miss out on the most efficient tax treatment and never get to take advantage of the realization events your LP's will experience.

Suspending distributions should not be viewed as a better outcome than a capital call. It's a very short-sighted approach. You can't judge a syndication until you exit the deal and the decision making of your Sponsor and how they navigate this rough patch will be the deciding factor for how the syndication performs. I recognize capital calls are generally disliked but it might be the best way for the Sponsor recapitalize the deal. By way of example, rather than relying on a capital call, the sponsor could theoretically take on additional or more expensive debt through refinances or by creating debt or mezz funds. Furthermore, learning that the sponsor is suspending their fees or reducing management fees could be required because the generated income no longer supports these fees rather than being a decision derived from the sponsors generosity. The decision to not make a capital call could ultimately turn the deal into a loser as the cost alternative capital might be higher.

Investors share various reasons for how they qualify income producing assets, but from my personal interactions and observation, the 1% rule is raised more than any other reason. In fact, I see the 1% rule relied on more than all other reasons combined. It seems to be widely taught and followed but see this as an incredibly flawed underwriting technique that has no bearing on the properties capitalization rate.  I will share my primary reasons but would like to hear other’s take on this underwriting technique as well.

1. Expenses disproportionately impact lower rent collecting properties. Take for instance an “A” located 1 +1 duplex where units rent for $2,000/m and compare the building to an identically designed “C” located 1+1 duplex in the same market where units rent for $1,200/m. Now assume each unit is occupied by 1 person. Common utilities paid by the landlord will be similar if not the same; standard services (extermination, changing filters, snow removal, fire safety inspections etc.) will cost the same.
2. Expenses will vary depending on the market. The cost of doing business varies from municipality to municipality. A $200,000 duplex might have identical rents in municipality “A” and municipality “B” but the property tax rates will vary, local regulations will dictate licensing requirements, labor rates will vary &  the particular location will dictate insurance premiums since insurance carriers will weigh local replacement costs and whether the municipality is viewed as being a “plaintiff friendly” in arriving at insurance premiums.
3. Better situated assets will attract better tenants. While you shouldn’t categorize all tenants and it’s the landlords responsibility to properly screen, the tenants who reside in better situated housing and pay higher rents are more financially responsible meaning lower rate of rent loss and will generally take better care of the property which combined will result in less time allocated towards management functions if self-performed or more favorable management fee structures if 3rd party management companies are utilized (which ties back to #1, as well).

If you are receiving monthly payments this does not sound like its tied to the sale of an asset and thus not LTCG income. Tax treatment has a big impact on the after tax rate of return which is how you should analyze any investment opportunity. I would recommend speaking with an accountant as most operating or partnership agreements contain language that shields the GP/Sponsor when it comes to any type of tax representations. 

Most who implement asset protection start off with the correct intentions. However, very few understand the operational procedures and obligations which diminishes the effectiveness. Merely purchasing real estate well doesn’t guarantee success. The property requires proper management thereafter. The same applies to asset protection. Forming the appropriate entities and obtaining the correct insurance is only the first step and if you want the benefits of the asset protection strategies that are frequently discussed in these forums following through with these actions is equally if not even more important.

1. 1. Once you correctly file your organization documents, follow the procedures of your operating or partnership agreement. If you want the benefits of separating yourself personally from the business, treat the entity like a business. By way of example, if your agreement requires meetings, conduct those meetings. Also, open your bank accounts correctly and do not co-mingle funds. Failure to take these measures will leave you vulnerable to a plaintiff’s attorney interested in piercing the corporate veil. While the standards vary depending on the jurisdiction, the examples I shared tend to be the most common avenues.
2. 2. Make sure you are signing well drafted contracts and you are not only collecting insurance certificates but are also being added as a certificate holder before any 3rd party vendor performs services for you. Your insurance carrier will expect indemnification and these step are critical to ensuring you are satisfying the terms of your insurance policies.
3. 3. Secure responsible debt on your properties. Debt provides many benefits in real estate, and one is asset protection. You are “less marketable” to plaintiff’s attorneys if your properties are encumbered with debt but keep your leverage at responsible levels.

Your initial priority should be identifying markets where short term rentals are permitted AND in my opinion even more important, identifying markets that are both reliant on short term stays to support the local economy and possess barriers that prevent more traditional hotel operations from entering the market. There is a movement across the US with many municipalities either banning or restricting the ability of property owners to lease their properties as short term rentals. This is because most municipalities charge taxes and fees specific to the hotel industry, and when the local hotels lose market share, the difficulty in holding "mom-and-pop" short term rental operators accountable results in municipalities losing considerable tax revenue. It is also helpful to engage a local zoning attorney who can assist with any use permits or licensing that's required. These should be your initial steps. No matter how great of an operator or how good your boots on the ground vendors are, if you lose your ability to operate the property as an STR, the business concept fails.

Both are important. The cash flow helps secure the best financing terms but equity is where you ultimately make your money. The key is to focus on acquiring assets where the equity can actually be realized at the time of sale. A lot of equity is what I refer to as paper equity. It is equity that is shown on an appraisal report (typically relying on income approach valuations) but these reports are tied to assets located in lower or no entry of barrier marketplaces. This is common in the lower income SF space and also see this frequently with warehouse conversions to smaller office/studio spaces. The owners tend to have difficulty selling these assets at the appraised values, thus fail to ever realize the equity shown on paper.

There are both federal and local/state taxes to navigate and given the tax consequences are impacted by the structure I would recommend retaining legal counsel and a tax advisor who have local knowledge in the state where you intend on investing. Are you raising additional equity from passive LP's or are the three partners you mentioned the only participants & will all three be involved in the day to day operation? If it's the second option, it sounds more like a JV than a syndication in which case the partnership agreement should clearly outline each members responsibilities (both financially as well as management related). It is best if each member has strengths that can add value to the partnership as opposed to redundant skill sets. If it's a syndication where you are raising outside equity, the legal process is more costly and complexed.

@Sunny Karen My advice would be to focus on the quality of the real estate rather than the financing for the time being since you are not reliant on the financing to fund your initial acquisitions. Even though rates are beginning to come down, lenders remain conservative and are offering lower leverage on rental assets. I suspect as rates continue to decrease terms will begin to improve and more buyers will re-enter the market/ be able to pull trapped equity out of their recently completed projects. Therefore you likely have a window to be aggressive with your acquisitions with less competition in the marketplace. You will also be able to negotiate better terms without relying on financing contingencies. 

Once you exhaust your capital you can take inventory of opportunities and determine when is most appropriate to add debt to recapitalize yourself.

Are you the sole owner? Perhaps there is someone who can serve as a co-guarantor? However, you will have to show the co-guarantor receives consideration for a lender to accept the additional signer.  In the future, its best to know you have an exit strategy that does not require selling or relying on alternative lenders. If you are new to the business and/or building up your credit and you have difficulty securing well priced financing, it's probably best to partner with someone who can help with the financing. Otherwise its really difficult to get ahead if you are relying on higher priced debt on the refinances.