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Launching Real Estate Syndications – Launchpad – Founder’s Investment Theory

By: Tilden Moschetti, Esq.

What does it take to be a syndicator who has no trouble raising money? Someone who can raise $2 million, $20 million in a matter of days rather than months? Well, the answer is simple. And it actually boils down to just three questions. 

By answering these questions, everything will become easier. You’ll be able to raise money much faster, you’ll be able to market easier, you’ll be able to save costs on your marketing, and you’ll probably be able to find deals to syndicate easier. New people who are trying to syndicate as well as experienced people tend to hit this roadblock all the time by not answering these three questions. 

Let’s start talking about Founder’s Investment Theory with a flashback to my first deal. 

My first deal landed on my desk when a partner said, “Hey, do you think we can syndicate this deal?” The deal was smokin’ hot. It was going to make money. It was very secure. And I had a lot of faith in it. It met all the criteria, and we got the deal. We put it into escrow and started working on putting the syndication together. 

But that syndication process actually ended up taking six months. A good portion of that time was just making sure we were doing things absolutely right and complying with all the laws. But the other challenging part was finding the right investors and getting them matched up with the property. 

The bar for me was pretty high, because I have this friend Mike. And Mike is a very active syndicator. He has no problem raising millions and millions of dollars in a matter of hours. So the bar for me was set high and I did everything that I could to fund the deal and to find the right investors. I tried researching marketing sales. I tried every sort of marketing angle I could take. I experimented with things, spending a lot of money and a lot of time to try and find those investors and get them matched up. My approach was a shotgun or “throw the spaghetti at the wall” tactic. I pitched the deal to everybody. And therefore I never really got very far. 

One day, I was lucky enough to have lunch that I set up with a prominent physician whose name was Dr. S. I had done deals with Dr. S before. He was a great guy, very easy to get along with, very candid. He wasn’t practicing anymore. He was having fun and living the good life of a retired fairly well-to-do person. I went in with the intention to pitch him the deal, because I knew that he could easily come in for at least $300,000 in my deal, which would make a huge difference in getting that deal closed. So I sat down to lunch. I started pitching him the deal. And he looked at me with a furrowed brow. And I told him everything about the deal. He replied, “It’s not for me.” I was taken aback because I thought for sure he would do this deal. He likes me. He knows me. He trusts me. 

When I asked him why not, he turned to me and he said, “Well, I’ve got three different categories of investments. The first is my safe money, in things like bonds. If anything happens, it’s very unlikely that anything is going to happen to that money or that I’ll lose anything. The second category of money is my income money. That’s the money that I live off of. I need to get about a 10% return. And I will still want it to be pretty safe, regular, consistent income, but nothing special. The third category of money that I have is my play money. This money is for me to just have fun. It’s for those deals where I can find somebody who’s got a crazy business idea and be a part of that. Now, I’m probably not going to make this money back in any one particular deal. But the returns are so high, I’ll probably get it back down the road. And if no one hits it out of the park, I’ve made a little bit of money. But really, I’m not looking for my play money to actually make me money. I’m just enjoying it and having fun.” 

I continued to assure Dr. S. that this was a great property. And he said, “Yeah, but it doesn’t fit into any of my categories. It’s not safe money, because it’s real estate. It’s not income money, because you told me that the real value in this property is its appreciation. And it’s not play money, because the IRR you told me about this deal is at 17%, well below where my play money mark is. So it’s just not the deal for me.”

I left that lunch with no check in hand. But I did leave with an education. That night, I was thinking about Dr. S. as I was reading a book about how Warren Buffett would invest. I asked myself, would Dr. S. invest in Berkshire Hathaway? And I came up with the answer of no, I don’t think that he would. Dr. S. wouldn’t see Berkshire Hathaway as being especially safe. Berkshire Hathaway is also not income money in Dr. S’s viewpoint, because the company generally doesn’t pay dividends. And it’s definitely not play money. Berkshire Hathaway isn’t going to be making him that 50% really fun money that he gets to be a piece of the action and have fun with. So Dr. S wouldn’t invest in Warren Buffett, and he wouldn’t invest in my deal. 

This led me to those three questions that turned everything around and became the body of the Founder’s Investment Theory. 

Question One: Strategy

Question number one is: what is the overall strategy? Now obviously, Warren Buffett is known as a value investor. He’s looking at investments whose intrinsic value is way below the sales price of the investment. That’s what Warren Buffett does. So what’s my overall strategy in this? In this case, let’s go to what the different strategies of commercial real estate are, and then we’ll look at where this investment falls in line.

We can look at the strategy kind of along a continuum, including the hold period on the X axis and the complexity on the Y axis. There’s five different common strategies.Where these fall for on this continuum could be completely different for everyone. The first example is development.

Strategy A: Development

For me, development has a longer hold period. Every development I have done, I can drive to, and closeness is important. In California, our entitlement process takes forever, more than two years, in order to even get the entitlements. So for me, that hold period is just longer than a year or two years to get something going. For you, it may be significantly less, and that’s totally fine. And it may be something that’s not complex; it doesn’t matter. The point is that you understand where your strategy falls on the continuum as you see it. So we’ve got development, and we’re looking for raw land or for an underutilized location. 

Strategy B: Value-Add

The second is value-add. When I’m looking for a value-add opportunity, I’m looking for a deferred maintenance, a missed opportunity, below market rents or high vacancy. It’s something I have to put some work into to get anything out of. And so it’s complex, but it won’t take me years in order to do it. So for me value-add tends to be fairly short. 

Compare that to the same idea of stabilized value-add, which is when you’re finding properties that have a normal vacancy, but the leases are expiring, and you want to capitalize on that by either bringing those those rents back up to market, or you’re looking for below market rents in general. And then as leases expire, you’re building those lease rents back up, in order to get more value out of the property. Generally you’re looking at more than one tenant, so a lot of times, it takes longer since you’re on the cycle of whenever leases come due in order to build up that value into the property. But still, because you’re doing leasing and you’re doing renewals, the complexity is a little bit higher.

Strategy C: Under-Valued

Then you’ve got your undervalued properties. These are ones where they are trading significantly below replacement cost, or they’re deals that have a very low price per square foot. Maybe they’ve got a very high cap rate because leases may be renewing but they don’t know whether the tenant is going to renew or not. These are undervalued properties. The strategy typically with these is to basically flip, so you sell them maybe a year afterward to take advantage of the capital gains tax for your investors. So you hold for a year then you sell resell is an undervalued strategy. 

Strategy D: Cash-Flow

And the last strategy is your cash flow strategy. And these are those properties that are in prime locations where you’re either looking for massive appreciation or you’re looking for rent escalation. In order to add that value, and normally this will take place over an extended period of time.

So these are the five basic strategies that make sense. 

My first deal fell into the lower quadrants, bridging the gap between the undervalued and cash flow property. It wasn’t a value-add deal, because it was brand new construction and the tenant was already in place. So that’s why it was undervalued. It was in a good location. And so really, the strategy was to wait until the rent bumped at year five and then sell the property, which is what I did.

Question Two: Niche

The second question we ask ourselves is: what is the niche?

This can either be your property type or your location. So for property type, is it going to be office building, apartment building, industrial building, medical office, retail strip center, mall, self storage, airports? You don’t need to necessarily specialize in just one property type. But just be aware of where you fit and what you generally emphasize. 

The second is this idea of location. So that first property that I did was across the country. It took more than six hours to fly there because you had to change planes in order to do it. So it was not near me. Other properties I developed, I like to be able to drive to regularly so I can monitor its progress. So location is also important. 

If you’re going to be doing deals near you, maybe you’re an expert, and it also kind of brings to how you talk to your investors, for example, some investors in California don’t like to invest outside of California, other investors in California only like to invest in California. Some people like something hyper-local, that they want to visit and go see before they invest. Other times, they don’t care, they just want high returns. 

Question Three: Risk Profile

And the third question that we ask ourselves is: what is the risk profile? The risk profile is where on that continuum does the property stand? We have very high risk, for instance paying something like a 40% IRR. Or very low risk, maybe paying something like a 10% IRR. 

You may be asking yourself, why would somebody do a 10% IRR deal? Well, they may be wanting to do that deal just to get exposure into real estate and don’t really want to be a part of a read or something like that. They don’t like the efficiencies and rates. What about the 40% IRR? Well, who wouldn’t want that money? Somebody who’s generally risk averse. Somebody who doesn’t want a high risk product, who wants to make sure that their money stays safe. 

And somewhere in the middle, you have a medium risk investor. And maybe that’s paying out 15% IRR. 

The people who are attracted to the very high deals are not going to be attracted to the very low deals. They’re not attracted to a 10% IRR. So it’s probably a waste of time to talk to them about medium-risk deals. If the person you’re talking to starts mentioning a 40% deal elsewhere, you’ve probably got a very high risk tolerance person that is looking for just that kind of deal. Whereas if they start to get a little afraid about what you’re saying in terms of returns, and they are asking a lot about how risky it is, they might very well be in this very low risk category.

When you put these three questions together – what is your strategy, what is your niche, and what is your risk profile – you start changing the way that you communicate with your investors. Suddenly, investors are looking at you as specialized in one particular thing. And that builds trust with those people so that they understand what it is that you do and what value you bring to the table, rather than you just choosing good deals and putting them in front of everybody.

Once you have a very specific thing that I look for, based on your Founder’s Investment Theory, you can build a regular set of investors that invest with you. If you present a deal that’s close to what they’ve seen before and they can understand the deal, trust you, and understand your approach, they’re more likely to invest.

 

Are you ready to get started with your own syndication and need a private placement memorandum? Moschetti Law Group is a real estate syndication law firm and we’d be happy to meet with you to put together your Regulation D syndication documents and guide you through the process of launching your own offering.

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