Hey, Tilden Moschetti here, hope you are doing well. Coming to you live from North Carolina. I wanted to welcome you to this webinar today. We’re going to do a lot of very cool things. We’re going to go through underwriting, but we’re going to do it in a manner that you probably haven’t seen before.
Underwriting itself for financial analysis is probably considered one of the most boring things you could do by many syndicators. I actually find it extremely exciting. And you’ll see why once we dive deep into the financial analysis picture. When you look at it from the concept of levers, which is what we’re going to talk about, you’ll see that there are a lot of possibilities in how you can shape deals into ones that not only work really well, but also work very well for your investors.
At the end of the day, what we’re trying to do is build an investment that investors will invest into, but will still make you the most amount of money. So a lot of times how I approach the financial analysis picture is I start with my FIT, right, the Founder Investment Theory, and I’ve got videos on that. And I’m sure you’ve heard me talk about that before.
When you start with the FIT, and you get an idea about what your investors are looking for, not only from a financial picture, but also from what sort of deal in general they’re looking at it from – what sort of lens? Are they looking at it as a cash flow deal? Are they just needing a long term thing? What’s going to get them excited? Those things. Then you can start to build your investment offering in a way that really dials it in specifically for those investors.
Starting in the financial analysis picture, we start with the typical things that you might see in advertising. So what do my investors expect to see in terms of IRR or expect to see in terms of some sort of multiple or something like that? The problem with that is that we see, and you see this on advertisements all the time on Facebook, is that all that syndicators are talking about is those measures. “Hey, we’ve got a great 15% IRR. We’ve got a 15% IRR.”
I mean, if you scroll through my entire feed on Facebook, because I click on every single ad that syndicators put out, it’s just full of these and it’s just IRR after IRR after multiple after multiple after IRR after preferred return preferred return IRR. And there’s nothing at all interesting, which puts syndicators in the role of just a commodity where you’re competing on IRR, multiples, preferred returns, things like that.
And what that does at the end of the day is it puts you in a spot where now you’re competing as a commodity. You’re trying to give investors the highest possible return possible, even at sacrificing yourself. There are a lot of ads right now that are competing, saying, “Well, our splits aren’t 80% like everybody else, our splits are 95% to the investor and only 5% to us.”
But what that ultimately means for the syndicators is, unless they’re really padding their fees, which they are – but unless they’re actually, you know, if they were doing it correctly, and not padding their fees, and just doing those 5% splits to them, they’d be out of business. They would be doing way too much work for not enough reward.
So let’s go through sort of a high level in terms of how we do financial analysis and how we break things down. Of course, you can ask questions, there’s a Q&A in there in the bottom, feel free to use that. I’m not going to be checking it too much, because I want to go through in detail a lot of these. But certainly towards the end, I’m hoping to have enough time. But there’s a lot of information I want to go through.
So let’s go ahead and get started with that. Let’s open up a whiteboard. You’ve seen my webinars before, you know I love the whiteboard. It gives me a good chance to put everything down in a nice place.
So when it comes to financial analysis, and when it comes to writing a pro forma, so even your real estate agents when they’re building a pro forma, there’s two sets of things that are going on at any given time, right? They’re looking at facts and they’re looking at assumptions. This is how every analysis starts with those two items.
So what are the facts? We’ve got simple things like size of the property. And by the way, I’m going to use an apartment building as a sort of a template here. Most of my clients are syndicating multifamily properties. It’s just a starting place, it doesn’t matter if this is real estate that’s multifamily real estate, if it’s an office building, which hopefully it’s not right now, if it’s a multi-tenant retail building, which hopefully is a great asset class right now, or if it’s something else entirely. This is the same sort of thought process – everything starts with facts and assumptions.
So we’ve got the size of the property, we’ve got the lot size, you might have the FAR, you’ve got the existing tenants. And you’ve got other factors, too, right? It’s located somewhere, and that somewhere has demographics, you’ve got the operating expenses of today, you’ve got property taxes, you’ve got, if you don’t own this asset yet, you’ve got the fair market value, which is the price you’re paying for it, right? You’re buying this property for something. And so you’ve got this set of facts. There are other facts too, and we’ll get into some of those in just a second.
But let’s talk about some of the assumptions that are going on. Well, we’ve got existing tenants. So what is the likelihood of renewal? Right? They’re on a lease, what’s the likelihood they’re going to stay or renew? That may change everything, right. So in some places, where there’s rent control, you may not be able to move tenants out. If they’re planning to renew, you’re not going to be able to increase the value or redo the inside in order to charge them more rent if they’re there.
You’ve got what’s the likelihood of default. Right? How likely are those sorts of tenants going to be to just up and leave? Now if they’re on Section 8, the likelihood of default is very, very, very small. But the likelihood of renewal is probably also small, but the rents are being kept down. Right. But if you’ve got a very huge luxury building, with all sorts of upgrades already done, the likelihood of default may not be very big depending on the credit of your tenant. But it could be very high. And so these are all pieces that are going into your financial analysis, and we’ll talk about where those fit in in just a minute.
We’ve got the demographics of the city, or the location. Those evolve over time. We talked about urbanization, and now gentrification and things like that, as they continue to expand. But what about demographics like the job base? You know, you can have the luxury apart… A good example of this is Flint, Michigan, right? So right before GM left Flint, Michigan was a booming town, huge opportunity. Great place. If you owned an apartment building in Flint, Michigan, your tenants had an extremely low likelihood of default, and extremely high likelihood of renewal, great demographics, great job growth. And then GM decided to leave. What about the demographics of where that property is located now? Are the demographics going to be good? Or are they going to be bad? What are we seeing for the future? That could change a lot, right?
If we’re telling our investors, “Well, we have fantastic demographics, we’ve got all this job growth,” what happens if that job growth doesn’t occur? And then we’ve got other things like the assessed value. Depending on where your property is located, property taxes can change on the assessed value, right? So that may be a big wallop that could happen where it could change everything. And so what are those components that really make up what the future holds for this property?
Well, a lot of times we care a lot about rents, right? Rent growth means higher values of the property. So in terms of rents, what are the facts as it relates to rents? Well, we’ve got historical facts, right. So we have your historical terms that have been successful, you have historical vacancies. You have historical rents. And you have your historical turnovers. You have your historical time to lease.
But what about the future? What are the assumptions that we make? Well, when we’re talking about rents, those future rents, almost everything about it is an assumption that we’re making. And those can radically shift things. And we’ll see how that’s just an enormous lever. All these things are enormous levers that can move everything for how things are portrayed.
So we’ve got things like your future terms. You know, what terms are you going to be able to offer? What vacancy is it? So let’s talk about vacancy real quick. So in Houston right now, which is where Applesway took place, right. So Applesway is sort of the basis that I’ve been communicating about this webinar to you. Applesway had basically bought a huge number of doors, something like 2000 doors, in Houston on multiple properties. And they made a set of assumptions.
And I happen to have found a video, if you look up Applesway on their Facebook page, you’ll be able to see the video that they’ve left on. And he’s talking about the deal that they’re doing, and what he’s predicting and projecting to do. And he’s saying, “Well, we’ve got a tremendous, great vacancy rate.” It’s one of the anchors that he’s been talking about. The vacancy has been always historically low in Houston.
But actually, that’s not true. There was an article in CoStar today that came out exactly on this topic. And the article said that vacancy in Houston is actually going up, and it’s going up pretty dramatically. Now, why is that? Why is Houston vacancy going up so much? Because they have a good job area, right? So it’s a good state, it’s got low taxes. Why is their vacancy going up? It’s because all the developers have been coming in and building all this product. And so there’s now all this brand new product that’s great to do.
And that’s exactly what Applesway didn’t count on. Right. So they were projecting that they were going to buy this building, they were going to buy these sets of buildings. And they were going to be just like the shining gold star. And they thought rents were going to be driven up. They were going to drive rents by improving properties by adding about $3,000 of improvements inside each property. And they were going to be able to charge between $200-$300 more per month for those properties.
So immediately, in 10 months they were going to make the turn and it was going to make all this increase in value, right? So there was this hidden value that was there. But then, so they were saying, “Well, rents are gonna go sky high.” And that’s how we’re going to be able to get you, I think it was a 24.7% IRR. And we’ll go into that in a little bit more detail.
All right. So they were predicting that, but what really was going on at the same time, is it wasn’t rents that were going up, it was vacancy that was going up. And what happens when the supply goes up? Demand goes down, right, and so rents go down. So rents were actually being depressed because there was a lot of new product out there. And these regular apartment buildings that there was really nothing special at all about, and they weren’t very attractive, meaning they weren’t these luxury apartments that they were trying to build them out as.
So there’s no way there are people that are going to say, “Well, gee, I’m gonna pay more rent in these places, rather than go across the street to the brand new building with the well-known operator who makes everything fantastic for me, at the same rent that I was paying before Applesway raised their rents.” So vacancy has been going up.
Other future terms we talked about – what are those future rents going to be able to do? Are we going to be able to charge those additional $200 or $300 a month in rent? That’s a lot of the problem that we’re seeing. Turnover – now, I don’t know specifically what the turnover rules are in Texas, but let’s assume that it was okay that they were able to move tenants out and improve property, improve the occupancy, improve the level of improvements so they can demand more rent. But what happens when those tenants want to stay? Right?
So you either have a choice between improving their property, but they’re going to be wanting and demanding less rent, or if they’re going to be having that problem anyway, where people are going to be improving their own space, why wouldn’t they just move across the street into the nicer building? And then time to lease – when you’ve got a huge glut of properties that are vacant, right, and that are lowering rents in order to induce people to come in, it causes a huge existing problem.
And then also, what they were trying to do is capital improvements. Not only to the interior but to the exterior. Now, capital improvements might get some people to go and stay in those places, but unless it’s something like that’s really improving the look, like refacing a building, it’s not the kind of thing that people are gonna say, “Wow, they have brand new air conditioners.” Most people looking for rents are just expecting an air conditioner that works.
So we have an expectation as a fact of the existing capital condition, right. So we know what the working condition is, basically, of those. But if I’m planning to do a future capital improvement, I’m guessing on a few things. I’m guessing not only on what the cost is going to be at the end of the day, right? I might get bids, but that doesn’t mean that’s actually the cost. Anybody who’s done improvements knows that the cost that you get at first isn’t the cost you’re gonna get at the end.
Time is extremely not the same thing, right? You’re… it’s always going to be done in a week, but it never is. And then you also have the actual value or the intrinsic value, let’s call it, that was being added to the property by that work. You’re guessing that the improvements you’re going to make are going to induce people to stay more.
And so that’s sort of the background as it relates to how the facts and assumptions are playing off each other. Right. So the facts, you’ve got a purely existing thing. You know, this is it as it is today. This is the building as it is today. But then as we factor in time, this is why this is a pro forma. Right, because we’re making guesses, we’re making assumptions about what’s going to happen in the future.
So let’s talk about the four-step method of financial analysis. This is something that I came up with as a way to look at it when I was coaching people. So I used to coach people on how to do real estate syndication. And so I wanted a method to be able to show people the steps that I think about things when I’m putting together a financial forecast and being able to talk about it with investors.
And as I did that, I discovered along the way that actually it’s more than just a series of blocks. There are actually little levers inside every single piece of it, which moves the dial in order for the investor return that they’ll ultimately get and the amount of money that you get. So let’s go through it.
So we start with basic facts and assumptions. So your inputs here are obviously the facts, those assumptions that we’re making, market data. Right, those all go feed into what our basic facts and assumptions are. We can’t even come up with anything until we’ve got that, until we know what the property is. I mean, it’s got to be located somewhere, we need to know the square feet, we need to know those things in order to even begin to do a financial analysis. So first, we need to gather up all those.
The next step that we have to do is we calculate our NOI and our potential value. So NOI in and of itself is and should be considered to be an objective measure. So NOI is an objective measure, because we should have a very set amount of what the rents are today that we have. This isn’t a pro forma, this is the NOI of today.
So I know that my rents for last month were X number of dollars. I know that I’ve got operating expenses every year of X number of dollars. It’s very set in stone, right? So I know what those things are. My income minus my operating expenses is my net operating income. Those are things that are non-negotiable, they’re things that aren’t up for assumption. They’re there in every property analysis, which is nice, because that makes NOI a very objective measure as it relates to that.
And then we can figure out the potential value by using this market data to come up with a capitalization rate. And I’ve come up with the potential value, right. So if properties in the exact similar condition in the exact same kind of situation, with the exact same kind of income structures with our costs in line, all those things, we can kind of work with those together and make it as objective as possible.
Now, granted, potential value isn’t 100% across the board objective, but it can be pretty darn objective if you’re using market data and using it in a very objective manner. If you’re looking at it that way. And that’s the way appraisers work. I mean, that’s how they come up with an objective potential value of the property.
So our inputs here are our rent roll. Our income, maybe it’s other income. You know, if it’s an apartment building, we’ve got laundry, maybe there’s some parking that we charge additionally for, things like that. Interestingly enough, this was also one of the levers that Applesway fell prey to. They made an assumption that, “Okay, well, our rent roll, our rents are actually at, I think it was like 85%. But we’re going to say that the property is undervalued, because surely we could get this property immediately up to what the market vacancy was at the time, which I think is 92%.” And I could be totally off. That’s just from memory. So they’re saying, “Okay, there’s automatically a 7% bump.”
Well, there may be other factors, subjective factors on why those properties just didn’t have the kind of tenancy that all the other buildings did. Because they were older buildings that were not as attractive, and were still charging relatively high rents. That’s probably one factor they should have taken into account. But it wasn’t, and they were also saying, “And on top of that, we’re going to have this other income amount. And we’re going to just say, immediately, we can charge $30 for parking space a month.”
Well, I don’t know the Houston market, but in a lot of markets, you can’t just automatically charge for parking. It doesn’t happen there, they’re not going to take it. You go to a market like San Francisco or New York, or probably even like downtown Dallas, or probably downtown Houston, and maybe you could charge. These weren’t downtown luxury apartments where you could just automatically charge. This was middle income, regular, not very attractive garden style apartments.
And then we’ve got our operating expenses. So they said that they also weren’t going to be counting their operating expenses really at the same level either, because they were going to be saving water. And that was going to be saving 30% off of what – that’s the example that he used in the video – they’re going to be saving 30% off their water bill because they were going to be saving water. Well, even still, that puts in a lot of tenant improvements, or a lot of improvements that need to happen. A lot of capital improvements, even to save some water. And 30% is a pretty high number for savings on water.
But these are the factors that feed into NOI. So the next piece of it in the four steps is an analysis of cash flow. And now cash flow comes after the point-in-time event NOI. And why is that? Well, suddenly now we have a mortgage on the property, right? We may have debt. And if there’s debt then suddenly now we also have – debt isn’t an objective measure, right? Some people can get very, very cheap debt. Some people get very expensive debt. Some people don’t do debt at all. Some people lever it as much as they can. So it’s not objective.
And so debt plays a huge role in that. There’s also other factors that affect it. And so you’ll see that these things start to get more and more assumptive the higher up the chain we go. Because we also have fees, right? We’ve got your fees starting to come into play as a syndicator. Your money comes from two sources: it comes from fees, and it comes from that split of equity, right? So that equity gain is part of it. But what happens before that piece is fees. So the amount that you’re being paid as an asset management fee, that comes before the cash flow number.
We also have capital improvements. Right, they’re not a part of NOI, so they’re part of cash flow. We also have the amount that’s being held back in reserves. Every dollar that’s held in reserve is considered cash drag, right? Because you’ve got this dollar that’s basically sitting in the bank, should you need it, and it’s not able to act as a machine and make money for you. Right, it’s not an invested piece. I suppose you could put it in a CD, but it’s not going to be making the same kind of returns.
So those are the inputs into cash flow. And then the last step is performance. And now here, this is where you in your financial analysis – so this isn’t a linear thing that takes place, I should remark. This isn’t a piece of this happens, then this happens, and this happens. They sort of go together in that same general direction. But they’re taking place at very different levels and very different thought processes, which is why I write it like this because it kind of gets higher level, higher level, higher level thinking as you go rather than into the weeds, right?
Our basic facts is about as into the weeds as we can get, because that’s the piece right there. The square footage is 10,968 square feet. That’s it, right? It’s not changing at all. But when we get to cash flow, it’s like, well, we might take debt, we might not. Or I might charge a 1% asset management fee. And I might charge a 1.5% asset management fee. So that becomes a lot more loose and it becomes a lot more manipulable, like we’re manipulating those levers in order to see where we can drive value.
So what happens up here, as our inputs, we’ve got our purchase price. And we’ve got our sale price, our estimated sale price. We’ve got prefs. If that’s how you’re doing it, we’re gonna assume that you are just because it’s easier to talk about it in this context here. These are all inputs into performance. So here, this is the big picture as it relates to, you know, what that overall piece looks like. Right?
So it’s got, we’ve got a set of facts that feeds into the calculating NOI that feeds into the calculating of cash flow, which feeds into the calculating of performance. So, let me go just quickly back through. I was writing down the size of the property, the facts, things like that. And then this shows that plan, so we go from that basic facts and assumptions here. We go up to the NOI and potential value here, cash flow here, performance here.
So let’s keep going. So now there’s different – as I was saying before, there’s different levers and how we can change all this. And we’re going to talk about this in terms of not only what you can do in order to shape your things and how you can talk to your investors and things like that, but also want to backstop it with things like what some of the gurus are doing when they put together a syndication or some of the things certainly that Applesway did. So we’ll go through that.
Okay. So what are levers in NOI? Right? So we’ve got – and this is important, because when we’re coming up with the potential value, we’ve obviously got NOI divided by cap rate equals value, right? So that’s the calculation of value. So the higher my NOI is, the more valuable potentially I’m going to have. And the lower the cap rate is, the better I’m going to have that.
Well, so on this top line, the things that move NOI are obviously your income. The higher the income, the more valuable it is. Right? So I’m incentivized to make sure that I’m projecting my income fairly and making sure that it’s as high as possible, but accurate, right. So I don’t want to leave things out in terms of my income. I don’t want to leave out other income, for example. But I also don’t want to create a situation where, like what Applesway did, I’m making up income that didn’t exist. I wasn’t saying income that might exist as part of my value. And that’s why the value was so incredibly under market.
So income minus expenses, right? My expenses are another piece of it. So as my expenses are down, so is my total NOI going up, right? The higher I can make that number. I also have to figure in other things. If I’m going to mark things to market, then I also need to take into consideration my vacancy. Is that a stable number? Right? If my vacancy – if I’m saying my vacancy is at 5%, can I say that that is the vacancy that it is today?
Now, is it fair to say that, well, we know that it can go to 95%? Well, certainly, if you had a tenant already signed the lease, you probably would, right? And you’d probably use that as a big factor. And then you’ve got the other one that, as it relates to your fees, is property management. Property management fees are available for you to take if you decide to do the property management, and a lot of our syndicators do, right?
A lot of syndicators are property management companies that decide to syndicate and basically what they’re doing is they’re building out more business for themselves, because they’re going to be the property management company. Totally legit. They should do it. They’re doing great. That’s a great idea. But it’s also a lever, right? Because how much are we charging for property management?
Occasionally, when I’m talking to new syndicators, and we’re talking about what the property management will be, I hear things like, “Well, it’s a triple net property, but we’re going to charge 8% on property management.” And 8% is not the property management fee of a triple net. No, it should be on a single tenant triple net, it should be like 2%, if that. And on a retail building, maybe 4.5%, maybe as much as 5%. There’s complex things going on. And this is not in a mall context. I’m talking about smaller triple nets.
So then the other thing that’s driving up value is your cap rate. And this is obviously a little bit more assumptions, right? So I’m looking at, okay, well, what are the other properties in there? You know, one of my mentors, many years ago, what he told me to do is you have to walk every comp, right? So you have to get out, you have to get out of your car, go to search for stuff, drive there, walk every single comp to get a feel for them. And it does, it makes a huge difference.
And when you lay it out and you start looking at all the comps in comparison to yours and build a matrix, then you start seeing, “Oh, okay, this is how my property really sets. And this is why that building is much better in this respect, but maybe it’s not as good in this respect.” And that’s how cap rate kind of changes. Again, it’s exactly the same thing that an appraiser does in order to come up with what cap rate to use in order to come up with value when they’re using the income approach.
So those are the levers as it relates to NOI. Right? As it relates to cash flow. Now we’ve got NOI itself is a lever, right? Cash flow levers. NOI is a lever right? Because the higher the NOI that we’re using, the more cash flow we have at the end of the day.
Debt and how that’s going to function is a major lever. Right? If I have an interest-only loan, that’s going to automatically give me more cash flow than one at the exact same interest rate that’s paying off the principal. I may have some other things happen because the interest-only period may only be for a short period, but it’s going to change that cash picture. It’s going to change the tax picture of how it happens and how things get passed on to my investors. Right?
If I’m taking the value of paying down my principal, well, that principal payment amount isn’t going to be tax deductible by my investors on their taxes. The capex that I plan on doing, then here’s the big one – fees. We’ve got your asset management fees. Right. So I have a huge range of clients who do all sorts of different asset management fees, and all of them are legit. We go through them all, we make sure that they’re in line.
And when they choose a higher number, and they know what they’re doing, they’re choosing a higher number because it’s well supported. Like if I was doing a development piece, I would choose a higher asset management fee myself, because it’s going to take more work, it’s going to take more communication about that asset piece itself.
On top of that, and speaking of development, we have construction fees, right? Your construction fees can be as high as 10% of soft and hard costs, sometimes even more. And that’s not counting the developer fees themselves.
The amount that we hold back in reserves. If I don’t hold anything back in reserves, I buy the property for a million dollars and I decide we’re going to have zero reserves, well, that’s going to be a very different cash picture than me saying, “Well, I’m also going to hold 20% back in reserves in the cash flow in order to put them into reserves.” That’s just going to have a 20% effect on what the cash flow looks like.
And then cash flow is a forward-looking thing. Where do I see growth happening? You know, do I have – do I see that happening, and how’s that going to play out? When it comes to a syndication, we’ve got distributions. Now this also plays into performance, we’ll talk about that in a minute. But distributions make a huge difference when it relates to cash flow. Because if I make a distribution – if I’m making monthly distributions, right, and these are my months, and then per unit, I decide to distribute in month one, I decide to distribute $2. In month two, I decide to distribute $1. Month three, I decide to distribute $3. And then month four, again, I decide to distribute $2.
It’s gonna make a different cash flow situation. That’s certainly going to make a different impression on my investors than if I just did really the exact same amount of $2 every single month. But growth has a play in this as well, because if I make this decision that, well, here in month one where I’m making a $2 distribution, I’m banking on that I’m not going to have another period of month two and month three and month four where suddenly I’m only going to be able to distribute $1 again. So it has a long-term effect on how cash flow works.
And then of course, your performance measures. And this is ultimately what your investors see. So this has, you know, as your cash flow as a lever, which your NOI is a lever because it was before. The price that you bought the property for is a lever in the overall performance, right? Because it’s how much money is it going to cost? How much money do you need to raise in order to put together the syndication? And how much money ultimately is that value? Right?
So if the property costs a million dollars versus 500,000, but it’s sort of the same amount of cash flow? Well, certainly better choose the 500,000 than the million just for performance sakes alone. Then you’ve got your projected sales price. You know how assumptive can that get? I mean, we have no idea what the sales price is ultimately going to be. We make guesses based on our assumptions.
And if you make your assumptions fairly clear early on that there, you know, this is what it’s going to look like, then you can start to build these levers. If your levers are all in line with pretty much normal, you can come up with a reasonable sales price. But what Applesway projected it was going to do was, it said, “Well, our sales price is going to double your money in two to three years. And most of all of the properties I’ve ever done before, I did it in two years.” That’s what he said. Well, that’s a huge jump in sales price. And so in order to necessitate that sales price, they have to, you know, radically drive up NOI. I mean, it better go through the roof. And we better be crushing that cap rate. All right, it better be just demolishing, crushed, but to do it to double it. And in that shorter period of time. Now you have the cash flow threatens beforehand, but so it wasn’t in full, you know, that kind of appreciation, it wasn’t full double your money in two years. But still, you know, it’s probably 40% per year. So that’s, that’s a lot.
So you’ve got your sales price, then, of course, you’ve got your splits. Prefs, etc, right. So you know, if I’m, if I’m paying out a big pref, that’s a large amount of money that’s going to my investors right off the bat. You know, if I have a preferred return of 12%, that’s a pretty big preferred return. I don’t really see 12% preferred returns outside of like fundraising for debt. But a preferred return of 12% and like an 80/20 split? Wow, you’re giving a lot of money to the investor. So their performance is going to look good.
So at the end of the day, maybe you can advertise that. But could you also advertise a lot better? What if you did, you know, what if you did an 8% preferred return, which is fairly common and not unusual, and you decided to do, you know, maybe keep the 80/20 split, whatever. And it translated to still a 15% IRR.
So it’s all that series of levers that leads to this deal. And that’s the problem that I’m talking about, is because you’re leading to this number, but the assumption that is being made here is not only how we get here. Right? It’s not only how we get there, but it’s also that that’s what the investors care about.
At the end of the day, an investor – if Bernie Madoff went to an investor and said, “Hi, my name is Bernie Madoff, I’ve got this great deal for you. I’m gonna give you a 12% preferred return, I’m gonna give you a 90/10 split, and it’s gonna give you an IRR of 40%.” Are they gonna do it? No, not gonna do it. And that’s, that’s the key difference. Is that – and that’s what’s forgotten in every single Facebook ad I’ve ever seen for an investment. Is it’s making the assumption that this is all that investors care about. And it’s not. It’s not at all what investors care about. It’s you. They want to know why they should invest with you. Not why are you going to get me this number at the end of the day. They want to know why you. And so that makes all the difference.
So you know, I have a lot of clients who will put together very complicated pitch decks. And I’ve got one of my great clients, he sent me a pitch deck long after I’d been working with him. And it’s like 20 pages of solid text. Well, nobody’s going to read it. And now it was very well backed, and everything was very scientific. But that doesn’t – why he was so successful, I mean, there’s no way that that’s what investors care about. At the end of the day, they knew who he was, he had a very good reputation in the community or does have a very good reputation in the community. He has a track record that’s unbelievable. He has, you know, he has many, many, many, many millions under management. So he knows what he’s doing. That’s why people were investing with him, not because his pitch deck from the beginning was very short.
By the end they grew to this monstrosity because they thought it needed to answer every question in every pitch deck, and it’s just not the case. At the end of the day, the investor invested in the person and in the idea that you’re selling them.
I have companies I represent – we raised, we put together PPMs and all those things for businesses as well. And the businesses that do terrific, they do terrific because of one or two things. They do terrific either because the management team is phenomenal and they have a great reputation. Right? So these are people who it’s like, “Oh, I know who that person is.” So they can raise money with that, then they’re hanging their hat on that. And so the product itself may not be very interesting. Some of the products that they’re raising money for are kind of dull, not the kind of things that you’d be like, “Wow, that’s great.” But the people who are running it, there are people I’ve heard of, they’re people who are interesting, they’re people you see on the media, right? Those are the people, they don’t have trouble raising money.
The other businesses that do very well raising money, they come up with a really cool idea. So we have cool – we have companies that are very, very small, that don’t have a huge track record. But the idea is really cool, right? It’s something that, you know, if it was on Shark Tank, every one of the sharks would be fighting over, because it’s such a great idea. So those people don’t have any problem raising money either.
But this doesn’t mean it’s not the same exact case for real estate as well. Because real estate, I mean, if you’re buying and building in the middle of town that doesn’t, you know, and it’s got this boring return, and there’s nothing interesting at all about it, well, you better make something interesting, because you’re not going to have a very easy time finding investors. If you make something and really explain why this is a good deal beyond all of this, then maybe you’re going to have something that’s good.
And so that’s the piece that’s kind of missing – is that these, most investors, most of the syndicators are relying on these sets of numbers here. But what they stand in – they see the gurus who are putting together packages. And what’s the problem with a lot of the gurus? So aside from Applesway, so excuse me, what some of the more famous syndicators are maybe putting out numbers that are the same as this, but if you want to get their PPM – and I have – and you start seeing what they’re doing, they’re not getting that. The investors aren’t getting that. They’re counting on their persuasive ability in order to get that.
There’s buyback rights that are very onerous to the investor. If you look up some of these people, and you look on some of the forums of, you know, other investors and you read about what people are talking about them, you know, they’re getting returns of maybe 2%, maybe 3%. What’s even worse, though, is they probably could get returns that were negative, because of buyback rights. So some of them have buyback rights that say, “Well, we can buy it – we have, we reserve the right to buy back your property at 70% of the value put into it.” And they’re getting it and they’ll fill up very, very quickly.
Or they’ll put it into product types that are, you know, office. Midtown office products that, you know, wow. Right now you’re gonna do an office project. Great. Good luck. So that’s kind of the spiel on underwriting. So I hope that helped. Let me take a chance to look at some of the questions.
Great. “If I invest as preferred loan Class B share, is investment on personal name or company better?”
The investment itself is – when investors are coming in and they’re making a – investing into debt, they’re investing not only – they’re making a debt, a bet that you are going to deliver, be able to deliver that kind of return. Because at the end of the day, they don’t really have equity to bank on. Right. So they have to believe in you most first and foremost, because they don’t really have anything at the end of the day. So they need to make sure that you are going to be able to deliver on it. Now yes, the company itself has backing behind it too. But really they’re counting on you or the management team in order to do that.
The legal structure for investing in properties in different states is exactly the same. So our legal structure is always – you know, we’re dealing with the federal system. So our structure is always going to be under Reg D 506(b) or 506(c). It’s going to be – you’ve got your sponsor entity here. And you’ve got your investment entity here, which actually I’ll draw as a building. We’ll say it’s just a one property thing. And your investors all invest here and the sponsor manages that, in exchange for management fees. That’s the very basic structure about how these are put together.
All right, good. There’s a question about whether or not this whole structure – you know, how do you apply it in terms of, you know, putting together a syndication. So when you’re putting together – when you’re deciding on whether or not to move forward on a property, that’s ultimately at the end of the day, you want to be able to give a number, right? Because your investors are expecting this. They still need to know, you know, what sort of returns they’re getting. But then to use these other measures here – it’s ultimately how do I move those levers?
This is how I start every single time. So if you were next to me when I was doing an analysis for the next project I’m working on, you would see, basically, I’ve got a series of options available to me in my spreadsheet. And then I’m building out – first I build out a cash flow statement of just complete cash flow, like I bought this cash. Ultimately, I want to get to NOI, and I want to look at what the basic facts and assumptions are, you know, where are those in my middle of the road? I always steer it to the middle of the road. So that’s where I start.
And then if I just assume put together a simple structure, what kind of returns am I talking about? So if I come up with, okay, at the end of the day, with just all cash, I’m getting a preferred return, I’m getting a return of, you know, maybe 15% IRR with an 8% pref and a 70/30 split to my investors with no debt. Okay, well, then I know automatically, and depending on the property type, based on debt cost now – so this used to be very easy, when debt costs were much lower. So before it was – you automatically would just put on debt, and then your returns would go up. That doesn’t happen nowadays.
So if I’m doing 15%, though, I would guess if I could get debt below, below 10 or at you know, somewhere in that ballpark, I’m going to be able to make more money for my investors. And so I’d start to, you know, put that on. The more money I make for my investors, the more money I can make for myself. So I’m always trying to balance that, right? I want to make – I want to be able to over-deliver a little bit to the investors and make the most amount of money I can as a syndicator.
This is another question. “The sponsor has an ownership interest in both entities. Correct?” Yes, yeah, absolutely. However, many times it doesn’t have to be that way. So a lot of times – so this is you here as the person. So this entity here, this sponsorship entity that exists, its whole purpose is in order to protect you from investors, ultimately, or from the deal going south and getting sued. So it’s an asset protection vehicle. It’s also easier in order to manage the investment. But the main purpose really is that protection.
Now most of the time, if you wanted to invest as well, I would put you all the way here as an LP personally investing into that investment entity. And that would be the way we do it.
Great, looks like right on time. Are there any other questions? I got time for one more probably. I know it’s a lot to digest. And I talk fast. So I will be making this recording available. But what I mostly wanted to do was be able to share with you sort of how I think about underwriting because we’re entering into a whole new phase of economics, you know, in this country, right? We’ve got higher interest rates. So the old days of very low interest rates are gone.
We’ve got majorly shifting dynamics not only in economics. I mean, we have, you know, some areas of the country are growing rapidly. Other areas are not growing at all. Other places are leaving, you know, traditional good places, but there are people leaving. So there’s major shifts that are happening not only in that sector, but also in terms of what the general interest is, right.
So no longer is it going to be – office used to be terrific. Office is a great example. Because I’ve done few office projects. Office was wonderful. It was great, it was stable, it was easy. It’s a great product type. But now office, I wouldn’t touch at all unless I had a great alternative exit. If I had an opportunity to buy an office building at a huge discount, and I knew I could turn that into a profitable conversion into multifamily, something like that, I’d do it.
But the estimate right now that we’re seeing, you know, from the industry, people who make those sort of estimates, is probably at most 20% of those could be converted into multifamily. So that’s an – and I don’t know that world enough to be able to tell which is going to be 20%, which is going to be 80%. But like I said, we have a lot of changing demographics.
But right now, this is the time to start syndicating. There are tons of opportunities that are opening up. And there are tons of opportunities when you’re competing, not on numbers, when you’re competing at the level of – when you’re competing just for prefs, splits and IRRs, it’s a scramble. You’re a commodity and you know some of there going to be winners and losers. But when you’re competing based on you and you’re making it your brand, it’s a whole different ballgame.
I mean, that’s why some of the gurus are able to raise so much money so quickly. But it’s not just the gurus. You know, one of my earliest clients, he owns many, many billions under management. It takes him less than 24 hours – in the last project, he raised $200 million in like three hours. So he hit go on suddenly email and raised $200 million in like three hours. It was insane. And that’s the kind of thing that people can compete for, while other people are struggling to raise $2 million. Because they’re competing on, you know, “I’ve got an 8% preferred return with an 80/20 split and giving a 15% IRR.” You know, that’s not how you’ll ultimately be successful at competing. Now, if you’ve already got that network, that’s great, because that’s automatically giving you the leg up, and people are investing in you.
So thanks for taking the time to meet with me today. Again, I’m Tilden Moschetti, Moschetti Syndication Law Group. You know that by now. And if you’re looking to start your syndication, you know, we’re a law firm that does more than just help put together – we don’t just put together a private placement memorandum and all those documents for you. But we’re also here to – you know, I want you to be successful. I want to help you reach your goals and be, you know, think long term and really grow that company into something big. And if I can be a part of that, and helping you grow that – you know, not with equity, but we’re helping you grow that by, you know, offering a little something in terms of advice or something like that. That would be great. That’ll make me sleep even better at night.
So thanks again for taking the time and I hope you enjoyed this webinar.