Syndication Attorneys Podcast
Financial Analysis and underwriting is a absolutely critical skill for syndicators and fund managers to know like the back of their hand, I used to coach people on how to syndicate real estate in a program that I used to have. Today, we’re going to take a look back, and we’re gonna go back to one of what I would call a rapid implementation call, it was taking that information that I have that background and experience I have, and putting it to use and making it available to the people who I was coaching through the process. So this is an excerpt out of one of those calls, it’s a deep dive into the machinery itself, how the gears fit together as primarily also a between the facts and assumptions and how they all work as part of this big machine in order to generate money to pay for investors, I hope you find it useful.
Financial Analysis is the process of evaluating business businesses, projects, budgets and other finance related transactions to determine their performance and suitability. And obviously, that’s what we’re mostly concerned about right now. So this is the you know, making see it’s that evaluating piece that really is what we’re trying to do, trying to identify if this is something we want to do it this something that makes sense. So it’s the that evaluation that we’re doing. But at the same time as syndicators, I would say, We also do this underwriting piece as well, because underwriting is to, to finance or otherwise support or guarantee something. So I would argue that as syndicators, we are basically supporting that the overall thing, when we come up with our projections that we’re putting in our PPM, we are actually saying, you know, this is what we are putting our name behind and putting our reputation on. So to me, that is underwriting. I think it’s just important just to set a framework that we that we talked about them in the same thing, and I probably will keep saying them synonymously as well anyway, because it’s habit, they aren’t actually the same thing. So you may want to call it out to when you’re when you’re talking to investors, it’s probably better to say financial analysis, because that does kind of cover your underwriting as well. Because if somebody is a stickler for those definitions, they may call you on it. And I fortunately haven’t been yet, but I could be. So what are we doing when we are doing financial analysis? There’s two phases to this. So the first oops, the first phase is we are taking a snapshot in time. As of now, what does that property look like? So what are its characteristics? So if we looked at all the things as let’s put it this way, if we look at all of the things that go into the bucket of the financial analysis, we’ve got the most important thing for the the now analysis is fact. We’re trying to say these are the facts about the property right now. Now we’re gonna go into those in a little bit more detail. But that’s the the main thing that we’re trying to do today. And then much smaller than that, that impacts how we look at that. And that changes this picture that we’re taking with this camera is our assumptions.
Right, it’s small because it’s just, they’re not as big or important at this now stage. But what are we trying to do when we’re trying to do an analysis and build projections or a performer which I really considered to be the same thing? We’re trying to set up something for the future. That’s supposed to be a clock in case you can’t tell. And that other one’s supposed to be a cam And so we’re trying to say what is it going to be in the future? Now, oops. Cloud Backup, when we’re looking to the future of what this looks like, the facts that we have, aren’t very become much less important. Because time erodes all those things, leases start expiring, and maybe they’ll renew and maybe they weren’t, taxes may go up, or they may come down, they don’t really go down, but they taxes may go up, or they may go up a lot. And it’s our assumptions that start ruling the debt. And I’m gonna run out of room assumption start ruling the day. So we go from big fact to little fact and little assumption to big assumptions. And these are what’s changes. Now, the further you go out, the bigger this effect is, because, you know, you’re going to have to make more and more assumptions. And the more and more things change, the more and more those assumptions that you made, in the very beginning, will do it. And so this process is building your pro forma. The reason we are even talking about this right now is because it’s important to have in your head that the either the proof, certainly the performance that you get from other people, but even the performance that you get from yourself, that you’re doing yourself for your own investments, there’s there’s two ways of looking at, at that pro forma, and how and how you’re going to use those assumptions. You have a a way that is I would call it let’s call it optimistic and then we’ll call it I don’t really want to use pessimistic I’ll say conservative. So they’re either optimistic or conservative. So because that’s generally the terms that we use in the industry, we don’t generally say pessimist, so we can use assumptions that are very optimistic, and they’re still true and based in have a foundation for choosing them. But they’re not, they’re not the most necessarily the most likely to happen. Because when you’re predicting the future, I mean, there’s obviously a huge range between, you know, from something like, you know, very unlikely to happy happen to unlikely to happen. And they probably go on some sort of bell curve and to how they actually play out. And so if this is our bell curve, our optimistic is probably at this end of the spectrum. And our, our conservative is probably at the center of the spectrum. So they’re just they are like, they’re within that bounds of like, but not, they’re not, they’re on opposite ends of each other. You wouldn’t want to go all the way to this end and be so optimistic that you’re predicting that you know, you’re going to 10x or 10x the the rents every year for the next 50 years, because that’s never gonna happen. But you also don’t want to predict that the moon is going to fly into the building and destroy it and melt it all down and it won’t be an insured loss both of them I suppose could happen in some in some world just not very likely hours. So let’s go through kind of how this range happens between fact and assumption and amateurs this he is and we start with the facts on this side. We start with the assumptions on this because that’s really what they come out they come out of each other facts for the for any property, somebody want to name a fact go for it. What’s what’s a fact Size. Size Great. Yeah, it’s gonna be a certain size. Absolutely. Maybe you have plans on growing it, but that’s an assumption whether that’s gonna get what else? Fry price I think a lot size. I think well, yeah, certainly lot sizes. I don’t think price is a is a is a I don’t think price is a is a is a fact, which it’s not done yet. You know what they’re asking, but you don’t know what they’re actually going to get or what it’s going to be at the end of the day. So I think it’s still a little bit gray. Sar sure stands for floor area ratio. So there’s sighs I’m gonna put location here because it’s kind of a big topic, right? So we have existing tenants, right? They they exist, they’re in your building. And that it’s not going to change that they are in the building at the moment that you’re taking that snapshot. What you don’t know is whether Well, let’s start with what the rental amount. So we don’t know what their their rent, let’s say you don’t necessarily know what their rent is going to be rent next year, if they are on CPI. And oops, if so, and we’ll talk about that more, probably not in this call, but another comp. But if their rental increases are, are pegged as something like the consumer price index, you don’t know what Consumer Price Index is going to be, you probably are using a figure like 2% or something different figure it out. But it’s an assumption that you’re making. You don’t know what the default rate is going to be. You don’t know if those tenants are going to default on the on their lease or not? Or if they’re what kind of credit risk they are. They you know that they are in existence, but you don’t know the likelihood of that actually happening. So there is a chance that’s going to happen. And that percentage that you apply is a question mark, you don’t know the likelihood of renewal to guess that you’re gonna make. So other facts that you know demographics demographics at the given time, is, is absolutely there. But you don’t know in the next 10 years? If you know, is it growing? Is it shrinking? Something can happen? Is it gentrifying or not? So I’m going to put it over here too. Because the demographics in the future, you’re gonna, you’re gonna make, you’re gonna make some guesses. And those all have an impact on ultimately, your your market. And maybe it’s gonna be your it might be how your your market sees it in the community. So maybe it would change your cap rate, or maybe it’s going to change your rents. But certainly demographics and the how they change is going to have a pretty profound impact on what your property’s going to do. You’ve got operating expenses, now, you’ve got operating expenses that are historical, but you don’t know what they’re going to necessarily be in the future. Let’s take property tax. So we in California, we have a more set set system, but we’re very much in the minority in the way we do things most of the country has, has what the assessed value is going to be and then it can that assessed value can change it can go up or it can go down. And similar in California, you know there’s there is still ambiguity here prop 13 could go away. Whereas was on the last election was to move prop 13 To eliminate prop 13 Four for commercial buildings, it didn’t pass but it could have made it so that was also assessed value for commercial buildings. So it’s not a It’s, it’s an assumption that you’re going to make whether it’s going to stay or not. Now, you probably are going to assume it. But it’s still in that realm. You have a management company. But you don’t know if they’re going to continue or raise rates. You don’t know whether I mean, if you’re doing it yourself, you don’t know whether your costs of doing the management are going to go up. So that make it so that you’re going to need to change your your management fee or not. Utilities is a huge one. So, so I’m going to put these together actually, utilities, contract labor. And by this, I mean things like your garden, Port Portage, pest control, etc, etc, etc, anyone that you’re hiring, that isn’t part of your regular workforce, is contract labor, and then we’ll put repairs and maintenance. So all three of these you are gonna guess on what the growth rate is going to be. Most of the time, I’m guessing it’s gonna be 2%. But that’s probably a little bit on the optimistic side, because I want that expense to be less, where 3% would probably be more conservative. Certainly on utilities in California, guessing on a low growth rate of 2% is probably very optimistic. Then we’ve got a whole nother category of your market leasing.
And your market leasing is something is a fact that what does exist is your, your market and historical terms your market and historical rents the how long it takes to to turn it. And commission mounts, things like that. So I mean, all of these things can change, because you have no idea what the future terms are going to be. You have no idea what future rents are gonna be. You have no idea how long it’s going to sit on the market.
You don’t know if Commission’s if those greedy brokers are going to start demanding more Commission’s or not. And, and if you’re doing your own commission, I mean, if you’re doing the leasing on the property yourself, you still don’t necessarily know what you’re going to charge. Because you may want to charge the other side it. And it’s we’re looking at at all of this through the lens of really the whole investment itself, not just you know, your pocket, obviously, but But building out projections for your investors. So each one of these things put as has an impact. And then capital expenses, obviously. Who knows, right? Who knows what’s going to happen on that a track system may explode, and suddenly you need to replace it. The roof may suddenly cave in and you need to replace it. Something can happen. You’re making an assumption on Well, I think this is going to need to be replaced or be repaired at this point in time, but you don’t know. And so those all go into your Proform. So again, the reason that we’re talking about it here and in this context is because all of these things are part of your that snapshot that you’re taking right now. But to build that a pro forma. Those are all assumptions that become the overriding thing. To that drive, your your number at the end of the day. They’re very it’s very easy to make a property look stellar, and it’s very easy for a property to look horrible. All in how you’re painting the picture. revenue. And it’s really up to you to decide, you know, it’s a terrible drawing, it’s up for you to decide where on the bell curve, you are going to put those assumptions. I mean, if you’re gonna put them here, or here, or here, or here, whatever, it’s up to you to make that decision. And when you do make that decision, just know that you’re making that decision. This is the same reason that a, you know, a sophisticated read doesn’t just won’t take a broker’s pro forma, because they know that it’s always going to be over here that the broker is going to be painting their assumptions, and they’re being much more conservative on what their projections. So they don’t want to see it, it’s not even worth their time. Does they want they’ve got their own assumptions that they’ve decided are, are what they’re going to base everything off. And it would also be who viewed to act in a similar manner, start figuring out what your assumptions are going to be about what things you do, I mean, likelihood of renewal is how we’ll see how do I do this. So CPI always set at 2%. It’s in general around there over the past 20 years. default rate, somewhere between 5% 10% If we are talking in a generally normally affluent area, likelihood of renewal is really up to the tenant, it’s more of a feel thing. It’s somewhere between 50% to 90%, maybe 95. If you’re really, really comparable. Demographics, I mean, you’re probably paying attention to demographics as it went in. And whether you thought it was, you know, an area that’s gentrifying, you’re probably more likely to be interested in it. Whereas if it’s an area that you think is going to go downhill, and you think it’s going to, to tank, I don’t think you’re going to be putting investor money there. Your property taxes you’re going to be doing based on either kind of figuring out where you were historical for assessed value, or if you’re in California, you’re using 2%, because that’s what prop 13 says the maximum rate is. For management, you’re probably going to keep it consistent. For the growth rate, I tend to use 2%. For for these, if I’m making a projection for what I’m going to tell investors 2% is a reasonable rate. But it is probably a little bit optimistic. Certainly when it comes to things like utilities, market leasing assumptions. Now, here’s where you probably are going to base things mostly on on history. So unless you’ve got a great deal of familiarity in the market, and kind of have a feel for where everything should go, you’ll probably pull a bunch of lease comps or ask other agents for lease comps, and base everything around that. And then your capital expenses, you’re gonna be relying on your, your inspectors, your property managers, you know, people who have that industry knowledge who can say, well, you’ve probably got another seven years left in this roof. And then you’ll you’ll you’ll figure that out. So I’m going to pause here. Are there any questions on this part? So far? Is that okay, good. Was this was this this was this too fast? Was it a good pace? It was too slow. I think I’ve pretty much got that part. Okay, good. Alejandro Anthony. Good to go. Okay, good. Was it a good pace? Was it a good pace? Anthony tech. Yeah. Okay. Good luck. Yeah. Okay. Perfect. All right. So. All right. Now, the next part I want to talk about and this probably is going to be kind of review but I want it to B. It all kind of builds on itself. So this is the way that I see.
This, see, we’ve even got a little diagram built in and ready to go. This is the way that I see it. The very basic calculation of, of how cap rate works. So, and I’m going through my vision of it, because I think the way I see it kind of sets up how IRR works better and isn’t exactly the same way that they teach in, in the real estate courses, etc. So, at some point in time, you buy this machine, call it machine, which is the property and you paid cash for this machine. And so that is your cost. So, we’ve got, we’ve got a series of gears that are all kind of going to get now this gears turning around this is your this can be thought of as your income to nice big gear. They go in opposite directions because their gears this gear is your expenses. Actually, I would let’s just call it expenses, because I don’t want to get to compete. And then out of that comes your and we’ll have a go all the way out, that comes out your cash flow. Or in this case, let’s actually that will be a little bit like. So let’s say that this is your so this will be operating expenses just because we’re going to call this their outcomes your noi. So now automatically in our machine, we’ve got everything we need in order to calculate our, you know, where what our cap rate is. And the cap rate is just all it is it’s just a performance metric.
It’s just a performance metric of how that machine runs. And so it’s just simply the the NOI over your cost is your, you know, going in cap rate for the building. And it’s but all it really does, it doesn’t mean anything more than just a simple performance metric to give you an idea of of how this thing works. So as things change over time, you know, as it as income goes up. So hopefully expenses come down. Your NOI is going up. And then for that same cost, your cap rates going up.
Now if it costs you more obviously then it’s going to be be degraded. So I put it in that context just to set the frame for how how the cap rate works. Hope you found that blast from the past useful. My name is Tilden Moschetti. I am a syndication attorney with the Moschetti Syndication Law Group. Now if we can help you put together a Regulation D Rule 506 B or 506 C offering don’t hesitate to give us a call, whether you’re doing a business that you’re raising capital for buying real estate by putting together a real estate fund or a private equity fund, or you’re a developer and developing real estate need extra capital were the people to call
So you want to start a business or buy a business or buy real estate with other people. And you decide that you want to do this with friends and family. So how do you do that legally?
Raising money from friends and family happens every day, it’s very common that people get their start by going to those friends, going to those family members and getting that Headstart. Now, whether it is because they are buying a business, or starting a business and just need seed capital, or they’re buying real estate, or they’re doing something else, they’re starting a fund or their, whatever it is that they’re doing. If they’re raising money, the question then immediately needs to become well, how can they do that legally, a lot of people think that they can simply raise money from friends and family by basically taking a loan from them. But that’s not really true, they can get the loan. But what it also requires is that it is a security that they’ve that they’ve made, and so they need to raise that money, offer those terms successfully, they need to do it in a manner that is compliant with the rules. Now in general, there’s two kinds of categories that people mostly use in order to raise that money. First off, they come up with some sort of debt. So they say, Okay, I’m gonna borrow $1 million, from my friends and family. And I’m gonna pay that back in five years, and I’m gonna give them 10% interest. And I’m not going to pay them interest, though, until the very end, because we have to get our feet off the ground. That’s a very common kind of term that maybe may have existed. But that actually is a security because what you’re doing is you’re raising money. So you’re accepting money from people who are expecting a profit, they’re expecting to get that 10%, back at 10% over what they invested back. And it’s relying on on you, right, you or your business is the one that’s actually doing the work. So their role is passive. At that point, it immediately as a security, well, let’s take the interest of well, they are investing in the equity in, in the business. So they get a 10% stake in your business by giving you a million dollars. So you’re obviously valuing business at $10 million numbers notwithstanding, you’ve got a $10 million business, you’re borrowing that $1 million, by giving them that equity, right. So they’re selling, you’re selling equity to them, they’re again to it is a security because what’s happening is they’re investing money, relying on you to do all the work. Now, if it’s the case, where your brother in law is going to give you that million dollars, but you too are going to work side by side and work make this business big. That’s not a security, that’s a basically a joint venture, or it’s just the company itself. It’s that passive role that suddenly makes it a security. The challenge when you’re raising money for this when you’re raising money, especially for businesses, or for probably more businesses than real estate, is that the amount of money that you’re raising, may not meet the actual contractual, the deals that you have to do the kind of returns that you have to do in order to pay all the other fees that go with it. I am an attorney. I’m a syndication and private equity fund attorney, I charge money, my costs, I don’t work for free, and neither does any other Security attorney that I know, we charge a good amount of money for. So at some point, if you’re raising, say $50 Well, my fees are a lot more than $50. So obviously you’re not going to pay me for to raise that $50. Unfortunately, also, the odds of getting in trouble over $50 are practically non existent. So there is that but really, that tipping point five comes when you’re raising 500 $600,000 It stops making sense to kind of try and do it on your own and try and make it all work. And really another as an attorney is is your best bet. Now it does cost money, but you’ve been set it up properly on the right footwork so that you can continue to grow your business and not worry about something bad happening. That something bad happening is a securities violation. Something like that happens you’re never going to be raising money again, you’re going to be cut out from the whole private equity system, because you’ll be considered a bad actor. So you don’t want to go down the road of vite Bev committing a securities violation. Now, I understand that it costs a good amount of money to hire someone like me, someone who’s best in their game and can really set things up. But you also know at the end of the day, it’s setup, right? You also know that it’s set up in by somebody who knows, we’ve seen this happen many, many, many, many, many times, we do about 100 deals a year. So I see a lot of deals get put together, I know how every business is structured, in terms of those. So we have a very good foundation on that. So bottom line is this, you want to raise money from friends and family, if they’re gonna be passive. It’s a security. And so figure out a way either to make it work without their money, or find another avenue, or do the right thing and hire an attorney like myself, in order to get it done. The question that also comes up, I should put in that well, how does venture capital work? And why are angel investors? Why are they a security? And why don’t I have to do this for them? Well, actually, most of the time, you don’t need to do this for them, because they’re never taking a passive role. An angel investor or a venture capital company is not coming into your account is not investing in your business, passively. They’re going to be taking board seats, they are looking at not only just giving you money, but they are looking at their investment. They want to protect it and they want to give you advice at the same time. So therefore, it’s not a security, they’re just investing in your business, but they are going to be very active within it. When it’s not active. And when it’s passive, then it’s a security. And when you’re raising money from friends and family, that’s what’s going to happen. It is a security. It’s either got to be registered with the SEC or fall under an exemption. I hope that helps. My name is Tilden Moschetti. I am a syndication attorney with the Moschetti Syndication Law Group. If we can help you don’t hesitate to give us a call.
The story we’re going to go through today goes to the heart of whether what you’re working on right now is a security and something that needs to be registered with the SEC, or come under an exemption or be part of a blue sky law. Or if it’s something else just to contract. Today, we’re going to talk about the case of SEC versus how.
As a syndication attorney and attorney that works on private equity funds, my favorite case of all time has to be SEC vs. Howey. This is the fundamental case that talks about whether something is a security or is not. So I thought it would be helpful for you to go through that case, what happened and what that decision is. And then out of that, you can extract what you’re working on and apply it and see, does this make sense? And does what I’m working on right now? Is that a security or not? So let’s go through it. So, a long, long time ago, in the 1930s and early 1940s, there was a company named Howie, and how he corporation did one thing and it did it very well. They would buy 500 acres of land. And out of that 500 acres of land, they would cut it up into strips but not all the way. So they would cut about half of it into strips, and then the other half they would they would leave for themselves. Now these strips had on them 48 orange trees. So there’ll be these 48 or an orange trees. And what they would do is they would or they also owned a resort. Now I wish I could draw a resort, but my drawing skills are not that good. So let’s just pretend this looks exactly like a nice, beautiful resort with a big bay window. In this resort, guests would come from around the country, not only from Florida, but most of their guests would come from other states. So the guests would come and they would see pamphlets as part of the thing saying come visit the beautiful orange trees. These orange trees are just happened to be the ones located on these strips. So they’d come and visit and then they would begin the sales pitch. The sales pitch when something like this Dear Mr. investor, you see how beautiful this place is we’ve got orange trees, and you know how much money we make from those orange trees, we make a lot of money. That’s how we can afford to have a beautiful resort like the one you’re staying in. Do you like your steak? Sure you do. Now as part of your stay, you also get to see this. But you know, we have a special right now that we would like you to be part of our business. You see, we’ve got these, these orange trees that we’ve divided up into special slit special things. And as part of that we’re offering to sell you have a beautiful piece of that tract of land that 48 trees you can buy. Now most of our people buy about five, five of these strips, but you could buy more, you can buy as many as you like. But right now we’re selling these wonderful. And what you’ll get is full title. We’re not going to own anything to do with this land. This is your land where you can make just as much money as we make selling oranges. Now I understand you’re from out of state. But as the deal goes, we just so happened to be experts at farming oranges. As you can see, the orange trees are all in bloom, everything’s going very nicely. So what we’re willing to do is this is we will take a lease on your property. This is supposed to be a lease. We’ll take a lease on that property for 10 years. And as part of that lease, we’re going to pay you money in because you own the land, right? And so we’re going to pay you for the ticket to use your land but we’re also going to pay you part of the profits. Does that sound like a good deal now what kind of returns you Talking about I’m sure you’ve seen many other hotels, on Facebook and things like that offering similar packages. Well, right now we’re not offering a preferred return, but we are offering an IRR of 20%. Sounds pretty good and slick how safe it is you own title to the land, all you need to do is buy the land. And we’re going to enter into this contract in order to do the servicing of that land. So that’s the sales pitch that these investors would hear. And they would get people to invest in this. And people would come from around state. And so as this became more and more successful for how they also decided that the resort was only doing so well, that maybe they should also just send regular mail out. And so they’d send regular mail and they’d either invite them to the resort, or they’d invite them to this and they tell people about this great investment opportunity. Now that all sounds well and good, right? Sounds like a simple transaction. Well, the SEC didn’t agree the SEC said, Hey, hold on a minute, you guys, Howie, you’re this is a security what you’re doing here. And that as a security, it’s just not going to work. You need to either registered, stir it or you need to come under some exemption. Now Rule five Reg D did not exist at this point. But there were other exemptions that were occasionally used. So how you need to get your act together? How we said no, this isn’t a security at all. We don’t need to do that. And so it went to court. And ultimately it found its way up to the Court of Appeals the Circuit Court of Appeals. So that’s the second level. So when federal court first and then I went up to the to the Court of Appeals, and the Court of Appeals looked at this closely, and they said you know what? We think how he’s right. We don’t think that this is a securities contract, that this is an investment contract. See the law is this. Let me drag this over. This is what a investment contract is. I may delete these an investment contract is a security are I mean, it’s a security is something that is an investment contract. But we don’t think this is an investment contract. Why? Well, for two reasons. We don’t think this is an investment contract, first of all, is that it’s not speculative. The investors are buying the land. Right. So that’s not speculative. They’re getting that land. It’s there’s nothing speculative about it. And the second problem with it being a security is this, oops, can’t see this under the picture. There we go. And the second problem being a security is this is that the sale itself had value. So it was the sale of the land that how he was selling. And certainly the sales of land isn’t a security. Right? Well, so this case went all the way up to the Supreme Court. And the Supreme Court took a look at it, and they saw where it said investment contract. And that’s what that was really the question, what exactly is an investment contract. Now also, as a side note, I put some other of the of what is a security here, just because I think it’s interesting of promissory notes, stock, treasury stock bonds, certificates of interest, participation and the profit sharing agreement. And we’ll talk about those in just a minute. But let’s go back to what the Supreme Court was saying. And the Supreme Court looked at this and said, You know what, let’s put that aside, I think there should be a four part test. And that four part test should look like this, that any time that there is an investment of money in a common enterprise, with the expectation of profit, which is based on the third on the on the effort of others, that’s an investment contract, and that is a security by the Securities Act of 1933. So was there an investment of money? Yes, there was an investment of money in the land, because they didn’t people who bought this land didn’t have a choice on how it would actually be practical to service that land. Right. So they bought the land. And they actually they bought it from Howie number two. Was there a common enterprise? Absolutely. This was orange farming. I mean, you know, these people were all coming together in order to farm oranges to make money, which is number three, the expectation of profit. Now if nobody goes and just buys a strip of land in the middle of Florida without there being some expectation of profit, because why would you buy a strip of Orange Grove in the middle of nowhere, just say you own one, right? You’re expecting to make money. And number four, it’s based on the effort of others hear how he was doing all the work, they were leasing it, and then they would do all the work on the actual farming, and then they share in the profits. So this was the core element of why it became why the way the Supreme Court said Hunter, Howie, this is an investment contract, how he you did wrong, the you this is a security. Now let’s go back to what to this note one more time. So when we take a look at what you are working on, you have to ask yourself, does it fit into those categories? So does it meet? Is it an investment contract? Was there a contribution of money and investment of money in a common enterprise for the with the expectation of profit based on the work of another meaning you the syndicator, probably is that person or the fund manager is that are those elements there? Because there’s other things too, that also constitute a security such as notes, a promissory note, as long as there’s an investment going in with the expectation, it may be a security. Now, not all notes are securities, but the ones that I hear about all the time, are securities, and that’s where they get a bunch of people together, they say, Hey, we’re gonna borrow $5,000 or $5 million, in order to get our business off the ground, and we’re gonna raise it from friends and family. So that doesn’t qualify does it? We’re just gonna pay them simple interest, we just are taking loans from everybody. Well, the only loans that are exempt from this are really loans from banks alone from from other people is a security as long as it meets those tests, as long as it’s an investment of money. So I’m giving you this money in order to for your business, within a common enterprise, your business with the expectation, with the expectation of profit, I’m expecting to get that money back plus interest, and relying on the work of another meaning you I’m expecting you to do your business so that you can afford to pay me back. Right, that is a security. Likewise, this participation in any profit sharing agreement, as long as that profit sharing agreement is relying on the investor taking a passive role. That is a security which must either be registered with the SEC, or fall under an exemption like Regulation D. And it doesn’t matter whether it’s written down or not. As I’ve said in other videos, what matters is what’s in the investors head. Does the investor believe that they have a passive role? Or do they actually have a passive role, either one of those is fine to make it automatically US security. So I hope that helps. This is the big test in all of securities, the Howey Test, super famous, because it outlines those four elements that are present in any security. It’s the it’s the very clear rule, which helps us to find it. Now, of course, there’s been new case law, but the new case law has just helped help let us know what the boundaries are. Those are the still the main four pillars in any test to see whether or not it is a security. My name is Tilden Moschetti. I am a syndication securities attorney with the Moschetti Syndication Law Group. Now if we can help you in your offering and your security offering, please don’t hesitate to give us a call. We can go through whatever you’re working on and determine with you whether or not it’s a security, we can talk about whether it makes sense that it is or in some cases it doesn’t. Because sometimes I’ve had people call me and at the end of the day, I don’t think it’s a security and neither should they. So if we can be of help to you and in doing that exploration, we’d be happy to do it.
We’re gonna take a deeper dive into a deal deconstructed on a syndication deal is a real deals, just slightly modified so that we can hide exactly what the property was for privacy reasons. Now, this will also talk about the fees that you can make and money making in there. It is a blast from the past, it was recorded about two years ago. And I thought it would be helpful to put out here today, I’m going to be doing that continuously now for for some of the videos that I have before, because they’re useful, there’s great content there. And I want to make that available and help y’all. If you liked this content, please feel free to subscribe, it would really help me out a lot. And you’ll also get notified when new videos come online. Here’s what we’re going to be doing today is we’re going to be going back through everything that we talked about last week. And just a quick high level overview. And then we’re going to go deeper into details such as, how do we underwrite that property? And then once we’ve closed that escrow, how do we make money on it and ultimately sell the property where our money comes from, and we’ll go from there. Alright. So here’s my screen. This is what we talked about yesterday, basically, we, and I’m going to do this very, very quick. So we, we looked at three different properties from a very high level, we looked at them through the lens of our founder investment theory, the underwriting and then survey the investors. We’re gonna go deeper into that underwriting in just a moment. And then ultimately, we came out and at the end of the day, we said, yes, the Wilson building is a property that we would like to syndicate. So we make that commitment, we put our 3% down. And then this begins this process of where are we We’re in escrow, we’ve got 90 days to close it, and we’ve got to race truck cars going at the same time. So we’ve got the, the race car of the transaction going, that we need to get this closed, and the race car, syndicating it, finding investors and making sure that everything is working there. On the syndicating side, we are we formed the entity, we make a choice as to which one of the SEC exceptions we do, we’ll put our PPM together operating agreement, subscription agreement, start marketing it, build that list, walk our investors, and ultimately, they latch on and give us the money and we close. Meanwhile, we’ve done our financing and our due diligence on that side to make sure we get the money on the loan, in order to get to close. And then we’ll go through the money part of that in just a minute. So let’s go ahead and switch over to my other screen. So let’s go ahead and switch over to the my screen, my Excel spreadsheet. So this is a underwriting template that I have. And this is I’m gonna give, I’m gonna be sending this out, there’s I’m gonna send it out to as a tab in a more templated form. So if there’s any comments you have about what you don’t like about it, you know, I’d actually be very interested to hear it. Because I want this to be especially useful. When I’ll type kind of talk as I’m going about the changes that are coming to this template. So that way, you kind of can see the direction that it’s going, that this should be out, I will send out this spreadsheet itself, I’ll send it out as part of the notes for this call. And then the template itself will be coming out in the next week or two because I kind of want to pretty it up and make it a little bit better than it is. All right. So let’s go ahead and let me make it a little bit bigger for people. So this is a underwriting spreadsheet. It starts with some assumptions, and I’ve got a lot of things in it. And not all of these things are filled out. Because this can be really thought of as sort of a back of the envelope calculation. And when I first get a property, these are the kinds of things that I’m thinking about doing. And I am doing some some perspectives and there’s even some other property information in this in terms of friends and things like that in just just to give you a quick rundown. So it makes assumptions about your income and expense. Your acquisition costs, financing. Ultimately, what the costs of insurance are how property taxes work, I will say we’re in California. So I’ve been using the property taxes really add, I’m using it at a little bit of a conservative number of 1.25%, which is how we work in California, other jurisdictions are different, I would just estimate what the property taxes are going to be. And then you can use this the exact same way by filling in that what the exit looks like. And here, we’re really looking at growth factors and vacancy factors, what lease commissions look like, what capex looks like, et cetera. Now, I, for this spreadsheet, I use this spreadsheet as a very, very quick way of underwriting a property. It’s not the only way I do it, I also use another program, which I will probably if there’s time, I’ll get to it. That is a lot more detailed. It’s property called our DCF. It’s similar to Argus, I think it’s a lot easier than Argus if you’ve heard of that. And it it basically lets you get into much more detail and much more creative solutions. But this is going to give you the basic idea of whether it’s an it’s even worth trying to syndicate this property or not. So we have an input screen. And basically what we’re doing is we’re out we’re, we’re spitting out three reports. So we’re going to be spitting out a syndicator summary, an investor summary, a property summary, and then a bunch of other things which are useful as attachments into your PPM I would not give these indicators summary that’s more internal to see if it’s worth doing. So the we’ve got different inputs here, I don’t use a lot of these be except the purchase price, down payments, things like that are useful, and then this other income we are going to use here. So the best place, I think to start with everything is what my mentor taught me. And what he taught me was that the everything is, is the comes from the lease. So the lease is the key of the deal. So let’s go ahead and put here is the just a quick rent roll that comes from the LM on this property. So this was an older property, I’ve updated the dates and everything. So you’ll notice that on the dates, and he basically is showing you everything that we need to know. So I take all of this data here, a my lease abstract, or and I start just applying it into my into my spreadsheet. So you’ll see I’ve basically done that here, I’ve put down the different types of tenants because I want to understand the tenant mix. Well, I put the size down. For base rent I’m used, I decided to go with the convention of dollars per square foot per year, because most of the people in accepting California use that convention. So we’re going to use that convention as well. But feel free to change this to whatever your purposes are. This is base rent per month. And then other income is for camps. Now I don’t have per unit cam charges here. So what I’ve done is I’ve actually applied that into the the NOI and we’ll get to that in a minute. But basically, I wanted to basically verify that I’ve got you know, the same number of square feet that are that’s being advertised, which is the 1499 I wanted to make sure see what my what my average rent was, what my average monthly rent was. And ultimately I could see what what those are as well. Now, I can also use this vacancy if I had a vacancy, you know, here, I could change my equation to basically create my my vacancy factor. So out of this, I’ve got a base rent that is then I’ve got my base rent. And this goes into our NOI and this is why this property is why this spreadsheet is not quite as flexible, as say a property that we would be syndicating, and if I would say it’s less strategic, let me put it that way. For example, I may see that, in this particular deal, I remember that there was something specific that was happening with the sandwich shop with when its lease was expiring that they were way under market rent for what they had, especially given the fact they put in a lot of T eyes and they put in a hood, this, this dollar amount was just low, so they were due for a substantial increase. And then there’s also some other sub market rents, I mean, $15, a square foot for that space is is not not appropriate for a print shop. So there was going to be a considerable amount of rent boosts, there was also going to be changes. And what we do with the cell tower, maybe or the Billboard, and we’ll talk about that in a little bit as once the property is going, but this is the going in just Is this worth that idea. And it’s always, this is always a game of bouncing back and forth between what is what you can do, how you can get the numbers to be the way that you want them to, without, you know, without lying, but ways of saying what are those levers that I need to pull in order to change the investment. So ultimately, we’re coming up with a pro forma of operating the investment. And we’ll do a much much deeper dive in a just in a recorded session on building out performance and underwriting as well. We’ll do a multifamily we’ll do retail, we’ll do a development piece. And maybe something else if somebody else has any, anything that they want us to do, about how to basically build out this pro forma and, and get the most out of it. So let’s go through the numbers real quick here to kind of understand what we’re doing. All we’ve done, because what we’re trying to do is get that back of the that that napkin bar napkin overview is we’re just taking the potential rental income of this place fully occupied for the rent roll, so it’s the same dollar amount, times 12. And then taking the other income that’s coming from here. So that’s coming from the cell tower and the billboard. And then we get at the end of the day, we get our gross retail, or rental income. Now, we always apply a vacancy cost and a credit cost. Now if you’re doing a very detailed underwriting, you’re it’s gonna be kind of baked in, but you to the extent of vacancy, but you’re, you’ll have maybe still some sort of number for credit loss. And so right here, we’re just using 10% to be conservative, maybe vacancy in the areas 5%. So you decided 10% was a reasonable number to do it. And don’t worry, again, if I’m going too fast, we’re gonna have a much much deeper dive on underwriting in general. So once you’ve subtracted out the vacancy and credit loss, we get the effective rental income. And then we add in that other income, other income is not included, because it is not part of the potential rental income. That’s, that’s affected by vacancy. So that’s why it’s separate down here. And then we get our gross operating income. So all we’ve done for that is calculate the growth of our, our rents in our rent roll. So we’ve just in this scenario, we’ve just said everybody’s on a 3% rental increase. And then same thing with the other with the billboard and the cell tower that these are on 3%. So those are right here. The Bat growth, and then other groups, what we’re doing is just seeing as if everybody stayed and if everybody had 3% rent increases, what does this look like? So then we come to our operating expenses. I again, this is in a particular order that I like I do have a we have one recording that’s in the Knowledge Library either now or it will be very, very shortly like in a day or two on on how to do this portion of it, how to go through the property details. sell property, taxes, insurance management, I have a ticular order I like to do these things and electric and gas water. Now, this is a triple net property. And so we’ve we’ve also included that number in the answer. So I included that number here under other rental income. So these are the cam charges that we got from the, from the OM that was provided to us that we were looking at. So basically, we take these at the end of the day, we’ve got $81,000, which is 24% margin, which is really quite healthy. And then we at the end of the day have a net operating income of 262 924. And now, I actually did massage these numbers down a little bit, not the operating expenses, I I massaged down the the operating incomes, from what they were in reality just to make it a little bit simpler. And so that’s where we’re at. So now we’ve got that operating income. And now we really need to figure out okay, so we’ve got all that now, what is how much money is actually coming in. So as a very quick refresher, we have, we always have two kinds of things we have everything that takes place above the line, and everything that takes place below the line. Everything that takes place above the line are these things that ultimately come to noi. And we say that they are above the line, because everybody is going to incur these costs, any reasonable real estate owner is going to incur this. Now things that are below the line are considered discretionary. And so things that are below the line are ultimately gets us our cash flow after taxes, which we’ll show. But for the most part, I don’t actually use cash flow after taxes as a syndicator. Because my investors may have different tax positions than than I do, or that I’m forecasting. I do put it here just as because it’s easy to calculate, and why not. But really, what I actually am concerned with is getting to this cash flow before taxes. So to get there, we take our net operating income, we subtract out our annual debt payment. And that is because, you know, debt service is not something that everybody has to do, I have owned properties with that I’ve owned properties. Without that. It is not a mandatory thing. So that’s why it is a below the line cost. Participation payments are pretty rare, we’ll leave that out. Lease commissions. Here, again, is an example about how this is a quick estimate. Because all we’re doing here is we’re saying, look, it’s going to be we’re going to take that vacancy factor of 10%. And we’re going to just apply the 6% leasing commission across there, it just setting a very normal level playing field on what it would be for just to get a quick calculation at the end of the day. Same thing with capex, we did it down here, I just put in $20 a square foot you may agree or disagree. It’s whatever you think it is, you can put in your own number there. Likewise, you can stage this out over different years, I’d like to just use a quick calculation on this to give me an idea. Funded reserves. We started this with a if you remember in the very in the yes in last week’s call with a $50,000 reserve account that we were funding. And it’s a good idea to keep adding to funded reserves just as a piggy bank, and that you can come up with whatever calculation you think makes sense here 1% of and a Y is pretty normal 2% is normal, I wouldn’t do substantially more unless until it gets up to unless you need it to get up to a certain dollar amount. 50,000 for this property is reasonable. And there’s different metrics you can do in order to get determined what you think is the best amount of your fund reserves. Your asset management fee is 1%. And 1% is a very normal amount for an asset management fee. So that’s why we Use that. And I also forgot to mention that this property management fee, I decided to mark it three and a half percent. And on this building, it was marked to two and a half percent, I wanted to mark it up a little bit, because two and a half percent is awfully low and the lease is actually would have supported even going up before. But there was no particular need to add that additional cost. So at the end of the day, when you subtract out all these things out of your net operating income, you get your cash flow before taxes. And then what I like to do is then take my cash flow before the the my cash flow before taxes per share. So this comes from the investor summary. And we looked at it just a different different presentation of this last week, it’s not substantially different. So let’s go through this and we’ll circle back to where everything plugs in. So ultimately, you’ve got a property, I like to start at acquisition, you’ve got a property that you’re buying, you know, you can buy it at 3.3. You’ve decided that a reserve account of $50,000 is appropriate for this property in order to do it, it’s there all triple net leases, it shouldn’t be too expensive, it’s a pretty high demand area. So you’re not expecting a huge amount in terms of T eyes or additional costs. 50,000 should be appropriate. Cost of startup is your costs that include your filing fees, your SEC fees, things like that. Your cost of financing, this is your points that you’re paying on as part of the deal. I like to leave this in here, even though it actually comes in at the loan cost, I think it actually helps explain it a little bit better. Because you actually do have significant costs just to in order to obtain that, and then it still gets baked in. So your cost of financing may include things like your cost to either for referral fees, if you’re using a broker dealer that will cover some of those costs, your costs of of like loan acquisition, your appraisals, things like that, that are going to be necessary in order to do that. Your acquisition fee is this In this scenario, this is just your brokerage fee. So this is $66,000. It’s just a 2% fee on one side, and I have not baked that into there could be an additional acquisition fee. So these are the numbers that you’re playing around with in order to get this internal rate of return ultimately, or this average rate of return kind of balancing out. Because as you move these numbers around, so as you move around your your total cost to fund it, you’ll see that that this self sell and four and 25 and 45 is not included. So it’s just money that you’re assuming is going to go into your pocket, which you could invest as an investor, if you will. But for this sheet, I didn’t do it that way. And so this cost of fund is this projected return. So you’re offering this this 1237 shares, I almost always encourage people to do the dollars per share at $1,000 a share. It’s an easy number to work with. As long if you’re doing a simple things like not a blind pool $1,000 that share works, you’re doing a blind pool, probably $100 a share. But most of you are going to not be doing blind pools appears. So the number of offered shares is 1237. And that’s just the number of shares that you’re putting out on the market that you’re looking for investors for because ultimately you’re looking to raise this 1237 That’s not the number of shares that you’re actually that are actually in the investment. So in this scenario, we’re doing roughly 10% We’re doing so we’re actually doing 11% More, this number could be as high as 20. But when I was calculating it with 20% it made the return for the investment for the syndicator terrific. It just mushed the internal rate of return down to a point where I didn’t think it was that great. And my feel was it just should have been a little bit better for this property. I wanted it somewhere around 15 1617 into this. So ultimately I was trying to drive there. This is your an estimate. Then annual distribution. And this is we have it both in total and cost per share. And that comes from that this cash flow before taxes. So this I like to say it’s at year one, because it increases each year, right, because cash flow before taxes hopefully is increasing every year with rent increases, which ultimately gives us a return that does not include disposition. So all we’re doing here is we’re taking the average of our cash flow before taxes. And then we are dividing that by the share by the amount of dollars that they put in, which is the cost per share. So that is, is six 6.29%. Your internal rate of return then is the Well, first we need to use to our disposition before we get to internal rate of return. And again, we’ll go through these in a lot more detail. But I don’t want to be boring people with with internal rate of return calculations, for the people who already have, have already got it, the people who don’t, that’s great, we can certainly go through it, we’ll go through it in great detail. And there’ll be in video, so don’t worry, we will cover everything you need to know. And if there’s something that’s not being covered, just ask. So our disposition sales price, where we just are calculating that based on we were buying this at an eight cap, based on how the property positions itself and what we know we are capable of doing, we know that we could get a we could get probably get this down to a seven and a half cap. If you look at it different ways. And we’ll also build this spreadsheet out. So you can like alternate between which scenario you’re going to use because this has a substantial impact on your on your bridge rate of return. But let’s say we can get it at a seven and a half cap with those regular rent increases, that basically brings it down to almost $4.1 million. So the sales price, obviously, there’s a cost to sell it this is that this is using a 6% cost of sale, which means nine sides broker fee that will be offered on both ends. There, we have to pay off the loan, which leaves us at the end of the day of proceeds of $1.944 million. There’s also this funded reserve account Oops, that’s not correct. So that needs to be fixed. So this, this is also a good example, as you go through where you will see that there is there’s something that’s not right. Because either you went through it and put things in that or and this is going to change your internal rate of return as well. So funded reserves is this $50,000 Plus, we’ve been making contributions. Here Okay, much more reasonable number and see that dropped our internal rate of return down to 13%. I’m glad that I made that mistake, because that highlights exactly part the process itself is you may have decided I want really I want to get 15% of this. And so I need to find a way in order to get that improved. So how can we do that? So there are a few levers in order to do that we need to either increase income, you know, or increase cash flow at the end of the day. Or we need to decrease the cost per share. And in this case, that probably means just less shares that are out there in the world. So how I would do that would be I would first look at my NOI and I would say okay, well how can I do that? Since since the current management fees are kind of a set cost. You know, that I’m getting we could reduce this to 2%. Say we reduced this to 3%. Now we’re not going to see a major difference, because it’s broken out amongst all the tenants and old similarly, we’ve got, you know, a $2,000 month drop, but let’s see the impact. So we got a 1% impact there, I would want to get at least a little bit more. And so I probably would do that by reducing the costs of my I would do it by, say, pumping back. My, well, I think the first thing I would look at is what would happen if I pump back in my part of my feet here. So let’s remember what I’m doing here I’m doing, I’m cutting my feet in half. And what I’m going to do is I’m going to put that into the property itself. In order to do that, and what that’s going to do is, it’s it’s going to reduce the costs that this is plus, add that to now I’m reducing that total cost. Now, it’s not going to reduce everything yet, because we need this will be now equal to. 1204 And then this, remember, I wanted that really just 10% higher to give me a rough ballpark, now probably brought my return down just a little bit. Let’s see what was our actual number, I can do it this way. increase, so I’m still at 14 and a half percent. All right, I probably can accept that. I would like 15, ideally, but I probably I know that I’ve got some things I’m gonna be doing with all of these tenants, that’s gonna bump that up. And so for a very quick summary, what I would do is I would first say, okay, that’s what it’s going to be for right now. And then this is just my go forward analysis. And I probably would use this for to start marketing and just say, look, I there’s a lot of juice left in this property, this is being exceptionally conservative, we’re gonna get that number up to 60 and 70%, I think through some different value added techniques that will drive that that return. So that’s how we would do it. So I’m glad we found this error because that is going to highlight exactly what we need to do here. And so this is our property. Now this screws everything up because that’s now so let’s say I kept I don’t need a negative but let’s say I kept a missile is pulling from the wrong field. So now we’ve got this, we’ve got the projected returns here. This is what we’re promising investors. Now this is part of our profit. This is our money here. So we got the brokerage fee that we’ve decided we’re not going to put back into the property and that’s the $33,000. So the the total of 66, half of its going in half, half of its going into our pocket or you could choose to buy up shares, whatever. In this calculation, we’re not buying up shares. We decided we’re going to be doing distributions every 12 months. We’ve got the asset management fee, which is calculated on that over here asset management fee and then we’ve got our property management fees still and then our ownership distributions and this is based entirely on the spreadsheet in investors. So Based on this spread of how many shares are owned, so when we do this deal, so we can expect every month we’re going to basically be getting, this is only in the wrong number because of that this is wrong. So every 12 months, we are going to be getting this money, and it’s going to be increasing, this is really only for year one, we’re going to be getting $3,300 Pretty good. At the time of sale, we also have money coming in, right, we’ve got the sales price that we’ve already determined. Now we’ve got a brokerage fee of 3% that we’ve already baked in, which is a commission of 123 630. So this has our this has the amount of money that we’re making every quarter or every term, this is incorrect. This is to calculate essentially our net present value. And I’ll fix that calculation here. Now why do we do net present value, and why is this calculation is off, we do net present value to see if it’s worth our time to to basically do this in do this investment. Here, we’re going to be three to $3,000. Down, I’m just calculating based on very quick numbers. To get what the value is, and all I’m getting here is not that I need to get calculate my disposition share cost as well. But we’ll see that if my net present value is approaching zero, I need to really think long and hard. If it’s worth it for me to send a kid, every dollar that’s over it is is is being is discounting the money that I’m getting at 10% return which is great for my time that I’ve put in. So that that might be a little confusing right now. And we’ll go over that in more detail in in the underwriting section. Because it kind of goes, we need to have a long talk about IRR. And when then we can talk about it net present value. Basically, though, this is a property that you’re going to make a lot of money on, your investors you think is like are likely to be able to get up to 15% 16% 17% made definitely below 20. But you know, you’re certainly going to be able to pop it up. And we’ll go into some more details on on how we add value in just a minute. But first, are there any specific questions about this underwriting portion? Knowing that we went very fast? And that will cover it in much, much more detail? Not all at once. Well, I mean, we’re gonna be able to get a copy of the file, right? Absolutely. Yeah, it’ll be on the show notes on workplace by the today. I mean, it’s here it is. Okay. And certainly, if you have any questions on that, or how did you calculate that this or anything like that your questions are more than welcome. Just post a blog post on workplace is probably the easiest place because then I can answer it a little bit quicker. Alright, so let’s go ahead and talk about another portion of this. So let’s stop the share. And I’ll share something else. So back to my whiteboard. Okay. All right. So here we are, we’ve closed the property. And now we’ve got a basic, we’ve got some underwriting. So what do we need to do now? We’ve promised investors a few things. So, promise. So we’ve promised them monthly distributions. Now you can distribute monthly, you can distribute annually, you could distribute quarterly, you can do whatever you want. Monthly, is kind of a pain. But it’s, in a sense, it makes more sense than quarterly. If there’s a lot of things going on and your cash flow make make more sense if it’s monthly as well, because I think it’s generally easier to do everything at once. Especially if you’re the property manager from all expenses of the property and all of the expenses and distributions of the InVEST So, expenses of the investment is your if you have taxes that accounting fees, your bank and your asset management fees. So I think it makes most sense to do it monthly, it does not make any sense. And it is horrifically awful to have everybody on a different schedule. I’ve done it in it’s horrible. So get them all on the same schedule. Most people are good with monthly The only people who may have a problem with monthly as people using their SEP IRA. We can go into that detail when we have we’ll have another vendor call about SEP IRAs. So let’s go through this. So how what do we do first, every month now we are making a distribution and you are sending them a report I have a template for reports. There is also a very detailed walkthrough of the reports in the Knowledge Library if it’s not there today, it’ll be there this week on exactly how we do these updates. Basically, I’ll give you a very very high level view of what we are of what we go through what we’re really looking for is we’re looking for your to give them a helps first I like to give them pics you know couple pictures of the property and date the date the pictures, so that way they know that you are keeping an eye on July one then I like to have sort of a cash flow summary a notable expenses then there’s detail under here. Then there is your occupancy summary there is a discussion of any rent delinquencies. We talked about the reserves, because that’s their money. They won’t forget it. So that talks about how much is in reserves and then a investment overview. And here I’m giving just some more metrics about the investment as a whole. And then I break it down into even more specific key investor math tricks. This is basically how well their investment is performing different yields and then a summer so what I’m trying to do is I’m sending them this email every month. And it’s very simple once you’ve built basically a template for yourself to just plug all these numbers in and if you’re doing your own property management or their or you’re having it done for you, most of this number is going to come directly from them anyway. And so it’s very, very quick to to plug it in, and your investors will always know what’s going on nobody’s going to object to seeing this every month so this will make them feel much more comfortable. So these things are going on all the time, right so every month we’re doing this now at the same time we’re looking we’re doing a few different things and there are other things that are in the core that are that we are continuously looking at. We’re always looking at what I call the three options which are you know, hold refinance or sell we are always looking for value add opportunities and in this in the case of Wilson we know we’ve got a a cell tower and a billboard. Those may be value add opportunities for us so those would probably Believe bear a stronger look at now it isn’t necessarily that a value add isn’t now always going to be, you know, re tenanting or restriping, what you’re doing with a value add, really the goal is to get the cash in your investors hand quicker as part as quickly as possible. Now, if you think that you can sell your cell tower or your billboard or both, to a good buyer, and they do exist, they pollute just by those, then maybe you want to sell that at the very beginning and return a huge amount of money back into your investors hands in order to in order to give them that money sooner, which means your IRR is going to go up. Because as you go down this T bar of IRR, you know you’ve got your negative 1000 You know, you’ve got dollars amount here. And then ultimately, here you have your dollar amount plus your disposition. The larger you make this money sooner, the sooner you give them this money, the the larger your internal rate of return is going to be which means your your performance is generally going to be better. You if you can say look investors, we may do a 25% return it’s true, you did you made them a 25% return annualized over the course of the investment by giving them that money sooner. So that is another portion on this particular deal that I would think is a value add opportunity. There were also others such as changing the way tenants work, upping rents and things like that. And I know we’re not going to have time to go in detail on like how to do that in this particular call. But we can go over that in I’ll show you the tool that I like to use, maybe on the next call if people want to see that. And then ultimately, we are so we’re looking for, you know, our options do we hold do we sell do we refi or managing that property, this is their asset management piece. And this is our asset management piece. These are the two biggest parts of asset management besides that communication. So that is what’s taking place under all this, all of these is we are managing the asset. Ultimately, you’re going to decide, Okay, it’s time to sell. Most of you will put that final decision in voter hands. And there is a video also in the Knowledge Library about how you actually do a vote. It’s right now it is located in within the operations of the core section and in the it’s in the communication subsection of operations. But there will also be an additional one that’s under the exit because ultimately we need to make a decision on selling. And there’s a template that we have also for you on how you gather the votes and starts off first, do you have 51? Do you need 51% of the votes? Do you need 75% of the vote? Whatever that number is, you make a case for how you would make that determination. And then you’d put it out there to vote. If enough people vote to sell, then you sell the property you circling back on the question that we often get is yes, you can take brokerage fees on this. And that is you can take your brokerage fee if you want for the sale of the property, regardless of if you have, I believe regardless if if you have a license in that state because you are acting in the interest of an asset manager, not a broker in that context. And you can tell escrow to pay you accordingly. And so as long as it’s been disclosed that you’ll be doing that in your PPM you will be fine. And then we go to you’ll go to sell and you will run the transaction just like you do any other transaction. You will market it you know ultimately your choose a buyer. I would give yourself when you’re voting some leeway on how you would make a decision for it and have a rational basis for that you can explain on why you would choose this particular buyer. We talked about that in the in the core as well, and that is, you know, on a part of the exit and market section. So choose a buyer, and then you’re just making sure that all your due diligence and disclosures are done. And then it closes. One, once it closes, you’re now in this interim period where you need to finalize everything. So this is the finalized section of the exit part of the core. And under finalize, what we’re really looking at doing, from the assets point of view, is we’re looking at taking that distributor or paying off any extra costs. And this oftentimes is paying off a you know, your final accountant, your final tax bill, making sure that’s done making sure everybody’s up on their taxes, so that everything can just take place seamlessly. And then you distribute, you give a final report to your investors. And and then you close the entity when you’re doing this final report, you’re of course, you know, doing your your investor relations as well to try and encourage them to invest in other things with you. And that is the basic property process of what we do. And so, I will also include the quick spreadsheets that I have for calculating the existence this share I will distribute this one as well. But the that basically has, you know, a quick way of calculating what, who your investors are, what the distributions look like things like that. So that way you can see, you know how you can keep track of your monthly distributions or your monthly distribution amounts. And ultimately, you can use that same sheet to calculate what your final dispositions look like.
So how does a waterfall work in a syndication or a fund? What are the steps? What are the different kinds of things that can go on, that’s what we’re gonna talk about.
Thought it’d be helpful to have a visual representation of what exactly happens in a waterfall and how to think about it. That makes it real clear, because it really isn’t very complicated. And but seeing it on paper sometimes can make all the difference in the world. So let’s go to the handy whiteboard. So let’s talk first about a direct investment deal where we know what it is, let’s say it’s a piece of real estate. Most of my clients are real estate, but we have a number of private equity firms, hedge funds, businesses, all sorts of other people that raise capital, but most are in real estate. So let’s stick with that. So we’ve got a piece of real estate
we have a piece of real estate, and let’s say let’s talk about a capital event first. So capital event is when the property sells. Yay, capital event. All right, so capital event occurs. So money comes down. And it hits this pool, right? So there’s a big pool of money here. pool money pool. Alright, so there’s big money pool. And now out of this pool, first what has to happen? So before you give any money back to your investors, the next step that happens is expenses. These are expenses that happened before so that we can end up with net profits at the end, and that those net funds, so expenses, I mean, the big one obviously would be something if it was real estate is to pay back the loans, oh, my goodness. The other one, the one that’s matters most to you is payment of fees.
To you, Manager. Now, important side, note the payment of fees, most of the time these fees portion is going to be treated as income on your taxes. So keep that in mind when you’re doing your tax planning. So this happens first, right, so we pay off those, we pay out all the expenses, the loan, the whatever there is left, sometimes there’s taxes, I’ve got other videos on that. But most of the time, it’s you know, you got to pay your loans, you got to pay your fees, whatever else is owing, which ends you up at the end of the day with your net proceeds.
So you’ve got your net proceeds that’s supposed to look like $ sign, there you go. So you end up with your net proceeds now from the net proceeds. This is where we really start thinking about waterfalls. The most common first step out of the out of a waterfall is a return of capital. This goes to your investors. Right so that that money goes to your investors, it’s returning the amount of money that they have. So you’re probably paying out all those Class A units, that amount of their initial capital contribution 99% of the time, this is what what is in the operating agreement and the PPM and it’s described accordingly. So after Return of the capital, what happens next? So a lot of times there’ll be a step here, that is the preferred return. So the preferred return let’s say it’s 6%. That goes to the investors. Okay, this return of capital here as long as it is a return of capital to your investors is not taxed
as long as it’s not at tax to the point of which is this their basis, of course, cost segregation, other things like that can adjust that but I just giving you that brief like idea just so that you know. So your preferred return is coming to your investors. Now the preferred return probably is taxed, and it would be taxed as long as you’ve held the asset for more than one The year it’s going to be taxed your investors as a capital gain after the payment of the preferred return, sometimes and this isn’t very common, especially in a real estate deal, but it certainly does happen and maybe 20 to 30% of the of the formations that are right the structures that are right. And that is what’s called a catch up. And that catch up will be normally it will be to the whatever that percentage is of the preferred return. And this gets paid to manager. So that catch up to the manager is a amount of money that is to bring them to this 6%. So what you’re basically saying is, okay, investor, here’s all your money back, I’m also going to give you a preferred return, which means I’m going to make sure that you get 6% of your money back before anybody else gets any money. And so we give you 6% of the money back. But what that actually has done is it’s decreased the size of this pool here. It’s decreased that size of the pool such that now it’s not in line with whatever buddy wouldn’t necessarily think it is. So you can do the preferred return as a pure catch up of 6%, to the manager to make everybody fair, but that alone would essentially be a 50/50 split, right? So that first 12% of profits would basically be okay, we’re going to split that 12% 50/51, we’re going to pay the investor, then we’re going to pay the manager. But that’s probably not what your investors are normally thinking that a catch up should be. Because if you’re doing, for example, an 80/20 split, maybe it should be something different. Let’s use a different, different math here so that I don’t have to do the math. But let’s say we do a catch up, up to an additional say, say we’re doing a split of 75. So that would be to the manager, we do a catch up of hey, manager, we’re gonna catch you up a little bit because you didn’t get to participate in that first 6%. And so we’re gonna give it make sure that you get some profits, as you would expect from that next pool. After this now we’re in splitsville. So here, we might say something like, okay, split, we’re gonna give 80% Actually, since we were doing 75, let’s do, we’re gonna give 75% to the investor. And we’re gonna give 25% to the manager. After, let’s say that we want to do a more complex waterfall than then would be normal. So we’re going to say, we’re going to split that pool of money, but we’re not going to split all that money, we’re going to say, let’s split the profits that way for just the next up to 20% of profit. And then after that, we’re going to say, we’re going to split the remaining profit 5050. And that’s it. Right? So let’s put some actual numbers to it. I think that might be useful as well. So let’s say at the end of the day, our net proceeds equals $5 million. Right? And for that 5 million, let’s say our investors invested two and a half million, so two and a half million goes into this category, right? So that leaves us with an additional now we’ve got here we’ll write it here. So now we’ve got 2.5 million left to divide. Right. Okay, so now we’ve got to make a division of other preferred return. Typically, you’ll do that preferred return of 6% on the amount that they invested, which works out fine here. So the next 150,000 goes to your investors, which leaves us with 2 million 350. Right. Now we’ve got this catch up piece here. And so that is equal to just an additional 35.25k. That leaves us with With 2,000,003 852 50. Okay, so now we’re going to divide that pool up, just up to 20%. And because of my math, it’s much easier to do this in Excel. I’m not going to do that here. And let’s just say, we’re going to do this simple waterfall here, because you’ll get the point. So, so we’ve got that admission additional to $2,385,250. So of that, now, we give to the investor we’re giving 1,000,007 88 937. And the remaining there we go. The manager gets $596,313. Not bad, right? So the manager on this deal alone, just from the capital transaction is made that 596313 plus the 35 to 50. Plus plus whatever amount that they made to in the in the fees, which means that outside of fees, they’ve made a good $631,000 So this is the way that a that a waterfall works. Now if my name is Tilden Moschetti, I am a syndication attorney with the Moschetti syndication Law Group. If we can help you put a syndication or fund together, we’d be happy to talk about it. We work exclusively under Regulation D Rule 506b or Rule 506c. That’s what we do every day and make sure we can help you be successful.