Syndication Attorneys Podcast
LLCs, partnerships, corporations, sole proprietors, what’s the rights that type of entity for your syndication, or fund? Today we’re gonna do a video that’s a blast from the past, it’s a couple years old, but it’s still very relevant and very valid and up to date information. So it is a discussion about how you would choose your entity type. And that entity type that would fit for your syndication or fun, I hope you find it useful.
We are going through the course specifically, we’re talking about company and even more specifically, we are going through foundation. So today segment we are discussing entity type, and what type of entity should you be forming? So you’ve heard lots of different things about corporations LLCs, everybody’s got an opinion DBS. So we’re going to go through what each of those look like. And then we’re going to talk about how exactly you choose what makes the most sense for you. Give me a little bit of advice and feedback on what the next steps are and who you’d want to talk to, to really firm up that decision. And then and then you’re going to have a pretty good guidance on how to do it. And then ultimately, you’ll make a decision on on what it’s going to look like. Now, these types feed back into your structure. So each of those entity types, that management entity that you’re going to form, it might be an LLC, it might be a corporation, the the buildings themselves, they might be LLCs, they might be corporations, you might even want to do them as DBAs, though I doubt that that you would actually want that. So let’s talk about those different types that there are. So start us off, we’ve got kind of the simplest, we’ve got DBAs. So the DBA stands for doing business as these are normally filed in your local city, or your local municipality. Basically, it just lets them know that there’s a fictitious name that you’re going to be using, and associated with business. This is everything from your sole proprietor, it could be a partnership, but DBAs are or this type. The other type is, is partnerships themselves. Again, that gets filed, typically it gets filed at the local level to get a name associated. But this really depends on your particular state. So in California, if you’re going to have a general general partnership, you actually don’t need to file anything with the state. Not all states follow that sort of methods, some do require that you file partnership agreements with them. So you need to check on what your local rules are, if you decide ultimately that a partnership oops, makes the most sense for what you’re going to be doing. The next type is an LLC, LLC stands for limited liability corporation. These have been around since the 1970s. It was an alternative that came out of smaller companies not happy with all the requirements in order to act as that corporations were being held to. So they are a little bit simpler. And they have some different nuances with those as well. Lastly, we have corporations. So you a corporation is its own entity as well. It gets filed with your state. And it is a it’s a very common mechanism. You’ve I’m sure you’ve heard of them. So you may be asking yourself, Well, why didn’t I write S corp or C Corp here. So S corp and C Corp are actually PACs, ways of filing taxes, they have tax implications. They don’t have actual implications as it relates to an actual property itself. So you may be surprised to learn that an LLC can be an S corp, or it can be treated as a partnership. It’s really up to you and how you choose to do that basically whether or not you make an S corp election with the IRS. So that’s why we didn’t do those. We will be talking a little bit about tax strategy, but not a lot in this because really the best one to answer that. It gets really specific for what your own particular needs are. And so for that probably you’ll want to talk with the accountant that you’ve already identified or will identify as part of your team. We’ll be talking about teams in a later on segment as well. So these are the four main types of entities that we’re going to go through. So the first question that we ask ourselves is, how many owners can there be. So this will kind of rule some things out for you, sometimes it won’t. So DBA is one person. So it’s always one person, that’s who it is, it’s a sole proprietor acting as one person, a partnership always requires two or more people in order to be a partnership, you can’t be a partner alone. So it’s two or more. And you actually can be, have one person as an LLC, or as a corporation. So so if you have more than one person, that kind of rules out DBAs, but all the others are on the table. So now let’s talk about asset protection.
So asset protection is very important. So there are there are two kinds of asset protection that we like to talk about, we have what’s called inside out and outside in. So let’s write that down. Inside Out.
So inside out asset protection is the is the protection that you would have, as an individual, as the manager, or the main executive, inside of the company, to protect you from outside from the outside. So it would be, you’d need to make changes to the outside. So say you have a huge amount of debt, whether or not you’d be able to be relieved that liability is what we would considered outside, inside out asset protection. And outside in is the opposite of that. So it is say there’s a lawsuit taking place, and somebody is suing the LLC, or the corporation or whoever, whether or not that protects you from liability against them. So as far as DBAs, there is no asset protection whatsoever. It doesn’t exist. In terms of partnerships, this is where it gets a little bit more tricky. So we have two kinds of partners. We have general partners, and we have limited partners, the general partner is the one who makes all the decisions, who does all the work. And the limited partner is the person who mostly just invested the money and just sits back and lets the general partner do the work. So as far as asset protection goes for the the limited partner, it is good asset protection, but there is no asset protection for general partners at all. Now for the LLC, we have an LLC is good. For Inside Out. It’s good for protecting against that. And it’s probably less good. But it’s not as well tested, but it’s probably somewhat less good. About for outside in. And we can get into much more detail about this in a consultation, then we’re starting to talk about charging orders and things like that, and different kinds of LLCs in different states and how those affect for this purpose. It’s pretty good. And I wouldn’t rule out asset protection for an LLC, I wouldn’t base asset protection, like getting rid of an LLC, just because of that. For corporations, corporations are good for Inside Out liability. It’s very easy to just file just basic BK or bankruptcy a corporation and the debts of that corporation go away. It is bad for outside in as long as it is a closely held corporation. So if if you are the only person in the corporation or it’s extremely small, but really you’re doing all the work, you really aren’t going to have very great outside in protection. So you probably are going to get the most amount of asset protection from the LLC. In terms of governance and management And, you know, this is what we’re talking about here is how easy is it to get through all the paperwork and, and comply with all the legal formalities. For DBA, it’s easy, there’s very, very, very little, maybe you need to update something every year or every few years, with your local municipality. And that’s it. With a partnership, it’s also pretty easy, it varies state by state exactly what needs to be done. So we’ll just put pretty easy. And then in terms of an LLC, it can be easy to complex. This is where it comes down to whether the LLC is member managed, or, or, or managed or managed. So a manager managed LLC is where the manager makes all of the decisions. So if you or your entity is the manager of the managed LLC, you’re the one making all the decisions and you just take to your investors as to a vote as necessary, as required by your operating agreement. In general, the it’s pretty easy to keep them up to date, keep them things going, it really becomes down to what your your operating agreement says. And unless there’s some sort of specific rules of your state in order to comply, so many states, they don’t require a board of directors, they don’t even necessarily require any executive officers. And so that can be pretty simple. Whereas a corporation is almost always complex, you typically need a board of directors and officers. Now in terms of maintenance costs, that’s going to be very specific on your individual states. So you really, you could draw out and find out through your local state, what the costs are going to be for each of these. And then you’ve got your multi state issues like say you have, you know, everybody thinks, Well, you file a corporation in Delaware, that isn’t always the case. If I file a corporation in Delaware, and I’m doing business here in California, I still have to file with the state of California, I still have to pay my taxes with the state of California. And, and I have to let the California know that this foreign corporation this Delaware corporation is doing business in its state. And it’s because of that rule, we’re not going to go into choosing jurisdictions beyond the easiest way to choose a jurisdiction is to just put it wherever your company is, there is nuance in there. And there may be reasons why choosing a different jurisdiction would be better. But that’s outside of the bounds of this discussion. So once you’ve got the your, your kind of this matrix in mind, the next thing to think about is how to make the decision on what to file us. So here, I would really start thinking about the entity that you’re going to be doing. So let’s start with the managers entity right now. So what’s most important out of this to your to your actually, one more, let’s put one more topic here, because this can be important too. So let’s put record keeping as well. Record keeping for DBA is extremely easy. I would say most of the time, it’s easy to do a partnership, it’s pretty darn easy to do a LLC, but we’ll put moderate just to differentiate it from easy. And by that I mean, you’re going to have to file a Statement of Information probably every year with with the state. But it’s very simple. It’s a one page form almost everywhere. So it’s pretty simple to do. Now for a corporation, it’s much more complex. You need to file you need to have minutes of regular scheduled board meetings. To make and spell. You still need to do the statement oops, the Statement of Information. And you need to have records of any sort of decision make decisions that take place. Now if you don’t do that your corporation could very easily be determined by court as not being a legitimate Corporation, and you’d get get rid of any sort of asset protection that you had from the very beginning anyway, that’s why it’s very important to comply with the record keeping rules. Now, when it comes time to make a decision about what you want to what kind of entity you think you need to form. I don’t think there’s, I don’t think there any attorney would ever recommend anybody do something as a sole proprietor, or even as a partnership for something like this. A, perhaps there are good times for sole proprietor for a partnership, especially when you need extremely low overhead, you need to be very easy, and you want taxes to be very easy. That’s pretty much how we’d make the decision here. But this is just generally not going to be the best choice for you to do a DBA or partnership. Now an LLC versus a corporation, it really comes down to a few things. And what I think most way I would think about it is how easy do I want my governance? And how easy do I want my record keeping, I’m getting about the same amount of assets, about the same amount of asset protection a little bit more with an LLC. So it’s actually got a really great structure for me. And last.
The only exception would be if I really am going to be using this kind of structure anyway, for a board and for officers. Or maybe it’s, it’s something that your investors would rather see because they’re more familiar with corporations as well. So almost always for the property itself. You’re going to use a an LLC, because there’s so much easier to put together. And the paperwork is so much less that it’s it’s just generally easier. In terms of a corporation. In less if, again, my my thoughts would be well, if you wanted to do put together a C Corp, because that’s what your investors were used to. And that’s what they were requiring. Now, C Corp is a type of taxable entity. So it would be a corporation but filed with the IRS that you would be taxed as a C Corp. And it has different tax rates, it has different opportunities for deductions. LLCs and s corpse have an opportunity for 199 A deduction. And your accountant can walk you through that if that’s appropriate for you. They also can walk you through whether or not it makes sense because corporations in general are not subject to self employment tax most of the time. So it really would be come down to what do I if I need to file a C Corp as a C Corp, I’m going to have to do it as a corporation, I’m not going to have that availability in an LLC. And really, what kind of level am I putting it into? And is this something that I want to really make something easy for me to do and be able to trade and move people in and out of, for real longevity, I’m probably going to choose a corporation, because it’s just better set up for that sort of thing. But if this is something where I’m going to just manage it, I’m not quite sure the long term future of it, whether it’s just going to be five years or whatnot, I might very well choose an LLC. So this, so I would go through and rank those and just kind of decide, well, this is important to me, this is important to me, this is important to me make that decision, and that’s your decision, you’re gonna have it’s quite easy to do different entity types for different types of entities. So your properties will will almost always be LLCs. But perhaps your your management company will be a corporation, and that’s totally okay. So go through that, think about that make a decision. And the next step then really is to get that filed. And so I would file that your management entity sooner rather than later. That’s what you’re going to be building your name and reputation under. So that’s really the first decision you’ve got to make. And when you do that you have a limited time to make an S corp election. So talk to your accountant, either as you’re doing it or very close in time to when you’re doing it, to see to get their input on whether it makes more sense for you to be taxed as a partnership or taxed as a escort. I hope that has been helpful make those decisions, write it down, and we will see you in the next session. I hope you found have video helpful while LLCs are probably the most likely candidate for what syndication structure or fund structure you’re going to use. As you can see, it’s not the only choice. If we can help you choose a break kind of entity for you and make your syndication or fund journey better, please give us a call. My name is Tilden Moschetti. I am a syndication attorney with the Moschetti Syndication Law Group.
If you’re putting together a syndication or fund, you may be worried or maybe you already have this situation where you have an investor who wants to get their money out before the end of the fund or the syndication itself. It could either be part of a redemption, or they just have some sort of life event and need to get out and want to get their money back. How do we deal with that? What does a syndication attorney think about it? Well, let’s talk about it.
When I have a client come to me and we start putting together their package of their operating agreement and subscription agreement and private placement memorandum, one of the items we always discuss is whether or not there should be an included what we call redemption. So a mechanism for the investor to be able to get their money back is just a normal part of the transaction in the fund. If that works in the context of their fund, typically, it’s happens in a fund and not in a syndication, then we’ll build that in. But many times it doesn’t work within there. And so there is this general concern about what happens. Certainly, it’s a question that investors may ask. Now, I should do an aside here, and that aside is this. So as part of Regulation D, there is a prohibition on resale. So first, let’s talk about what exactly that means. What the SEC is trying to prevent is it’s trying to prevent investors being able to create a market themselves. So they don’t want to make it so that I’m buying a part of your syndication, in order to basically create a market and start selling these out as it appreciates the value. So that probably behavior is prohibited, but behavior of selling your own shares, or your own units or whatever it whatever denomination is, in your end is typical, and it happens very frequently.
Now, as I said, this is part of a redemption, or it may be something that’s something else. So if there is no redemption itself, normally, we’ll look at the operating agreement itself and determine whether or not there’s a what’s called a right of first refusal. If there’s a right of first refusal, what typically will happen is the investor will say, I found my friend Joe Smith, they would like to be able to buy my units for $1,000 a unit, before Joe Smith can go ahead and buy those before the manager could approve them. The manager needs to take those and then look at the language of the right of first refusal. So it might be that the company has the right of first refusal. Or it might be that the managers habit, or it might be that all the investors have it, or it might be some combination of the three. If there is that right, it needs to follow the rules that are dictated in the operating agreement to give that right to whoever is identified, so that they can purchase them for that negotiated price that the investor who wants to get out we’ll do. Now if there isn’t a right of first refusal not to worry, the investor still has the right to sell. But most of the time, probably all of the time, the manager has the right to approve or disapprove whether or not the new person is able to come into the fund itself. Now if they have that, then we there should be a some discussion in order to do it. Now, it’s definitely a best practice to for managers and sponsors to work with their investors when they want to sell their units. Not only because they give better service to bad investor, and prohibit any sort of complaints, any sort of complaints are much less likely in that situation. But also because your investors may want more shares, if you’ve been doing a good job, they probably do want more of the deal that you’re working on. So that just makes you more valuable in their eyes as well. So if if this happens, you should do a lot of coordination with that investor, to make sure that everything’s happening in a manner not only that’s compliant with the operating agreement, but with really the best interest of all of the investors. When it happens. If it happens with some third party, it’ll typically look like an agreement is written between those two people. And then you will as manager will basically sign off on it and say I’ve approved this transaction. So I hope that helps. Again, when you look at this when this happens to you, and it happens in the year Every syndication at some point, don’t fret. There are solutions to it. There is solutions for your investor. They don’t need to be freaking out and torn in terms of how it’s going to happen. You can help them and best thing to do really is give your syndication attorney a call. If that’s me, we’re always happy to help.
I have a four step financial analysis workflow that I do for every real estate syndication that I look at. Now, having an actual formal process is critical. And understanding financial analysis is the backbone, it’s the only thing that’s going to make you truly successful in as a real estate syndicator, or a real estate fund manager. So I hope you find this useful. I used to have a training program about two or three years ago, it was called altitude and altitude. That’s why it’s called the altitude four step financial analysis, this is still the same analysis that I use today on every deal that I look at. So it all starts with, as we talked about last week, it starts with these basic facts and assumptions. We talked about last week, how there is a range and how, in the very beginning of your analysis, it starts very, very fact based with a little bit of assumptions based. And then it changes though, from there, it starts getting as time goes on. And as we go from just needing an A Y to getting in a pro forma or a five year cash flow, we start getting more and more assumptions. And so there are some assumptions that we make along the whole process. And we’ll see that go on. But we also have assumptions that are that we determined at the very beginning. So after we determine what our basic facts and our assumptions are, we then go through and figure out what our NOI is, and our potential value. And I say potential value, because there is a big assumption there in determining value, we’re applying a cap rate of a market cap rate, this property hasn’t been appraised, it’s just what we think it would go for. And so there we go. So after our, we’ve determined our NOI and our potential value, let me get this out of the way. After we’ve determined our NOI and our potential value, we then are looking at at cash flow. And so here again, is getting a lot more assumption based. And then finally, after we’ve determined what the cash flow looks like, we have performance. So these are the four steps. Under performance, I consider that not only how is the property potentially doing what are those projections about return, but I also look at it as well how would it perform as a syndication? How did those measures line up? So performance is really tied into not only just the regular, what’s the IRR potential potentiality of the property, but also those measures on is this even a good investment for us to look at. So under these, each of these has matures, a different pen color actually I need to do this again. Do that again. So we’re gonna do this in blue. So now in each of these are different what we call different pieces of the puzzle that go underneath them all. So under here obviously, if we’re talking about basic facts and assumptions, we’ve got facts Oh, that’s we’ve got facts. We’ve got assumptions we have market data. Under and so those are the key things instead go into that main step. Now under the next step, the NOI and potential value, here, we’ve got rent roll which also feeds into income. And we have operating expenses. Now, that’s not surprising, because these are what comes up in our noi calculation. Under cash flow, we have things like debt. We have capital expenses. Actually, I like to think I’m gonna call them other expenses we have reserves. And interestingly, we have a we have taxes, the taxes isn’t really something we consider very much on. On the one we’re doing a syndication, but it is important to know what the the after tax cash flow is, as well, just because you may still need it for whatever your other purposes are, if you have somebody who’s actually going to be buying it for you clears, things like that, it’s useful to know it fits in just fine on our cash flow, because all of those same things also feed into our discussion of you know, all the things that are taxed also feed into our our discussion on whether or not it is a good how the performances. And so in performance that we consider a few other things we consider the purchase. And the sale, we consider the equity. And then we consider measures. And so these parts all go to our four step program now, there are at almost every level of this again could just erase that. All right, there are at almost every level, actually. There are at almost every level. And the most important thing out of this, that I’m trying to get across is there are different levers that move each of the main functions. So there are a series of levers that come from noi that change our NOI and our potential value. So these are the NY lovers. We have our income amounts, and that’s rent roll, things like that. And a lot of those things start off as facts right. So the whatever that let the income is, is the income or so you think but we also have some things that just income like whether or not we’re choosing to do pass throughs and whether or not we’d be able to pass through everything that we’re thinking, what we’re using for a vacancy factor what we’re using for a credit factor things like that. So I put it as a broad idea just to start thinking about income is certainly a big lever and expenses is of Asli a big lever and on expenses, I am specifically not saying that it is that it is that we can change what we consider an operating expenses. Because operating expenses are a parody objective. It’s pretty standard on what we consider an operating expense. But what we choose to use as our measure for it has some assumptions built into it. There is other income there is your vacancy, as I said, your credit risk we’ve got your your pass throughs. Got management and certainly if you are doing me Management yourself, how much you charge for the management is certainly a lever that you could change the entire noi with, which flows all the way down to basically what your your the return that your investors would be getting. So there are also coming out of this same box, there’s also levers for your potential value, right? I’m there, I mean, we’ve got our Analy. We’ve got our price. And we’ve got our cap rates. I mean, we’ve got I mean that because price equals noi over cap rate. So any of those things can adjust, obviously, what that potential value is, out of cash flow, there are also major levers. And what you’ll notice here, so our first our first big one is noi noi changes our cash flow. So these things feed up into themselves. So every single one of the levers that is within NOI is within cash flow. And you’ll see as we go on every one of the ledger levers that’s in cash flow also has an effect on performance. But some of the measures in cash flow do not have a downward effect. They’re not affecting things within and why. So under this, we’ve got, for example, debt. Whether or not we change our change debt has absolutely no difference on noi, it doesn’t change it one bit. And so it is not a lever of noi, but it sure is a lever on the amount of cash flow. We also have our CapEx, we’ve got our asset management fees comes out of cash flow, it’s a discretionary spend, but it’s coming out of that cash flow. So it is a lever that can change and it can change everything else it changes our cash flow and it ultimately changes the return for investors. We’ve got our how much we are going to keep in reserves or how we’re going to build up reserves, what assumptions we use for growth, and what is our hold period. Actually, let’s use let’s change hold period up the level. So these are the main main Levers as it relates to up there we go as it relates to cash flow. Now performance has its own levers obviously. So here we’ve got just like we talked about, we got our we have our cash flow, you know, it comes up. And because it comes up we also have NOI is is also a lever, we have the price we’re willing to pay and then the projected sales price we have sales fees. We have our purchase and syndication fees we have waterfalls we have hold periods and to some extent we have what our discount rate is. Alright, so here is why we’re talking about this now. When we’re doing financial analysis and ultimately underwriting we’re putting together a package that we can show potential investors of what we’re expecting it to how we’re expecting it to perform, by understanding the different levers that take place within that process, financial analysis and or underwriting. The more we understand those levers the more we can tune it to being a an asset that will work in order for investors to be in listed at all, it’s also important to kind of get how it all goes together like this. Because when you’re having those conversations, and if you’re dealing with a more sophisticated investor, it’s much easier when you’ve got the framework in your head about what this looks like to switch gears, switch gear, switch gear and know what they’re talking about, and be able to get it back to really addressing what their question is, or if they have a particular issue, or they just want to know why you’re doing something, the way you’re doing it. If you have the model in your head, it really makes sense. And that’s also why we’re talking about underwriting and financial analysis at all in this program. Because theoretically, you could just take, you know, the simple thing off of off of a sales brochure that you’re getting then and use that for your underwriting and figure out okay, well, we’re going to, we’re going to be making this much money and just kind of hope that everything works out. But if you have all these things in mind, you’ve got now you can have real conversations with investors about how everything works. And then you can also fine tune it as it’s going and it make determinations. Maybe you’ve decided, well, I don’t think our reserves is high enough. But that how is that going to affect everything else? Well, it’s going to if I need to increase my reserves, that means I have less cash flow, which means that my ultimately the timing of get my distributions is going to get thrown off, which means that I will need to let my investors know, hey, look, the overall return for this period isn’t going to be what we thought it would be because we really want to build up those reserves. So you can be having those kinds of conversations when you get the model and you can make changes on the fly. So let’s go to let me ask her those questions. Yeah. Hello, Andrew, do you have a question? Any questions so far? Okay, perfect. Let me know if you do. Alright, so let’s switch to this spreadsheet. Alright, so here and this might look a little familiar. This is the CCIM. Underwriting workbook. And I chose to start here, rather than using what we were using two videos ago, or one video, goat as well, because a lot of people will be more familiar with these sheets, I’ve actually added some stuff into these sheets, to make it a little bit more useful. And I think it will give a little bit of a basis of why of where everything goes and how it fits together when you see a different model. And then you can see how how what I’m talking about feeds into that. So let’s go ahead and get started. And I put these in order as well. So, of the four steps. So let me so this is step one. Right, this is facts and assumptions. So these are the assumptions that are taking place within the within the in their five year analysis workbook. These and the facts are actually more built on the NOI page than anywhere else. But I think it makes a little bit more sense to separate them out. So you’ll see when we, when we look at the the four step tool that we use the spreadsheet, it actually breaks it apart into all the different parts just to make it a little bit more clear. And so here’s our assumptions. So Inc ordinary income tax rate, capital gains tax rates straight line on recapture. Is it 25 This is actually a 20 As of today, and these are here because they’re part of CCI M’s analysis CCI M really focuses on invest on the investor side and helping investors make make good decisions. Where as well we talk about really is more on the syndication side. We will go through the taxes probably next week, just because it is something that you do need to know. And why not? We’re using it in the same sheets because it we can and it doesn’t take much more work. So here’s the other assumptions, what is the vacancy rate going to be of your property? How does rent escalate? So year one, year two, year three, year four. So right now we have it in 3%, annual bumps, income is other income is escalating at 3% a year in what we’re going to be using today, we’re not going to be using another income. Actually, no, we will be using another other income. So it escalates at 3% a year, and expenses escalates at 3% a year. So and what we’re talking about actually, the other income that we’re talking about is going to be passed through. So it’s good that those match cap rate used in the sale, I think those are little bit too broad. So let’s bring them a little bit down. Let’s say our alternative is six, 6.5 and seven, and are expensive sale, I would say let’s keep it at 6%. That means 3% preside actually six and a quarter. Now we’ll cover our escrow and title fees as well. Alright, so here is that, okay, so lease analysis now is the next topic that we’re talking about. And I decided rather than just go right to the rent roll, this is a good time to actually talk about lease analysis. So let’s go ahead and, and put it in the right step category that we have. So this here, we are talking about the NOI and potential value, step. So let’s say this is the name of the building is 123 main. Our first tenant is Joe’s store. They are in suite 101. And then this is I like to have at least at least abstracts for every single property, I do every tenant. And so this really has everything that you would need. Now it has some of the things like right at the top, you need to know obviously a tenant is very important to know, right at the top, because when you’re sorting through them, that’s how you’re going to sort through them. Alright, date of lease is the date the lease was signed, the term is how many how many years it is, the rent is whatever that rent is. The expiration date is that. So let’s say this is June 120 21. So a five year term, we’ll deal with rent later. And then this would be May 31 2026. Let’s say it is a 2500 square foot building. And we are you know how many parking spaces they’ve been allocated. I’m assuming this is going to be just a two unit building. And so we’ll just leave that blank term and months 60 You can put the security deposit the renewal options you want to fill this out completely when you’re doing your full analysis anyway because then you’ve at least got it in one very nice easy to see area. And this section over here where we’ve got the paragraph number now that is for exactly where it is in the lease. So premises is often in paragraph 1.1 permitted use is oftentimes in paragraph 4.1. Square footage is often in 1.1. Parking is like in 1.4 I think term is in normally it’s in to and this is just from you know from having done this security deposit I think isn’t Three, but I don’t remember. And renewal options is oftentimes like in maybe 4.5 or so. And now we’ve got a rental period. So let’s say we’ve got in year one, so let’s say it’s six slash, one slash 2021. And then it is, say, through five slash 31, slash 2022. So dollars per month, let’s say that they are at $5,000 per month, which means that they are also in $60,000 per year $2 a square foot. And then we can figure out what escalations are going to be. But I just wanted to quickly go, you know how we do this. And you’ll see why in a minute. It has a lot of other great ideas for you know, putting in who pays for what and operating expenses, these are things that are very, very valuable to know where the different parts of a lease are. I looked like I left in some of from a previous use. So you can see like the suburb subordination clauses in paragraph 20, the estoppel letters and paragraph 21, those are all where they normally apply anyway. So there’s, there’s our first one, we’ve got Joe’s store. So let’s do one more quick one. We’ve already filled that in. So let’s say this is Bob’s restaurant. And so let’s say just for fun that they started at the same time, and they’re both on five year leases. So premises is in suite 102. Square footage is let’s put him at 3500 square feet, so fairly good sized restaurant. And so if he’s starting in there, we’ll put him at six. And let’s put him at ads put him at a very different dollar amount. Let’s say he starts at 8000 per month. And now we’ve got him paying 96,000 per year. Now this all feeds into our rent roll, which is also still part of the NOI and potential value, right. So we’ve got this, this is the the monthly rent. This is the annual rent, we’ve got Joe’s store, Bob store, obviously we’ve got a 6000 square foot building. So we’ve we’ve now identified the main parts of our rent roll for the purposes of NOI and potential value. Now this will change as we have escalations built in, and it’ll have what pass throughs are really coming in. But let’s say that that are passed through amount is that we get let’s say it is $1 a square foot, we’ll say it’s $12 a square foot and cams times 5000 I mean times 25. And then that he is paying $12 a square foot also. Alright, so now we have other income as 36. So now let’s look at the NOI sheet. Now this is the full sheet that is coming from CCM and I’ve just referred to a few things in here. So what we’ve got is how we look at income. So the way that we start looking at income is that all that money that’s contracted for is rent that is contractual, it’s likely to occur. And so we are basically counting on it. So that’s the potential rent that you can get in this period. Right now. Now we also count vacancies that we think are going to have going as well. But you want to make sure to, to then reduce the amount for vacancies back out in this vacancy and credit losses. So don’t make it less than what the actual dollar amount is, you want it to be higher. So here we’re using just a rough. So our total potential rent income is that 156,000, we are using a 7% figure, because that came from here, I came from this assumption, we change that they are vacancy and credits risk to say 5%, because we don’t really have any vacancy. And then suddenly, now we’re using 5%. That’s a much lower figure. So that leaves us with an effective rental income. Now here is a big lever, right? So this is a lever. Because how we change that obviously changes this dollar. Now if I let’s, let’s put it back, it’s seven. Okay, so let’s put it back at seven just for fun. And then we’ll see that now. You know, it’s 145 Oh, AD, versus where we just changed it to swung sheep to 148 200. So obviously, it’s going to change that amount of your income and cents and a Why is your opera is your income minus your operating expenses. It’s levering the entire equation, it’s changing all those numbers. And so it’s clearly just delivered to keep in mind. So let’s go ahead and come up with a few other made racist. Oops. My clear, oops, nope, I would rather that. Okay, got a nice room. All right. So let’s go ahead and finish out the discussion of, of our noi calculation. Because the purpose here is now we’ve got that first snapshot that we’re talking about, all we’re trying to do is really get that big, that big facts, and then little assumptions, and that this part right here, that’s your little assumption, that’s going to be changing. So we’ve now got our income. Now we need to reduce our property, our taxes. And so we can put these in man, by there. But I’ve already said that we’ve got a that we’ve got a large amount of, say we’ve got 12,000, or we’ve got $12 A square foot, times 6000. So we’ve already gotten 72,000. Oops, this didn’t add back in, let me put that in, because this is our other income amount. So our other income is the pass throughs in this in these two leases, that is there. And then it also is and I actually would have would rather put it in, in so it gets reduced by vacancy and credit loss. For whatever reason, cci M didn’t do it that way. The our spreadsheet will does have it so it reduces that amount. Because there’s really two types of income, you’ve got your pass through income, which should be counted, and you’ve got your other other income which doesn’t. So let’s just put in hard code in that $72,000 of operating expenses, and now we’ve got left with $148,200. Interestingly, that is the same amount as our effective gross rental income. So let’s say we find this property at a six cap. This is a property that we actually already know we think that the purchase price is going to be that two to eight oh, so this is a sorry, a six and a half cap. So now we’ve got our purchase price. And now we’ve got not all laid this the noi, but we’ve gotten the potential value. Now this is I’m sure review. But the main point of why we’re going through it right now is to see that here is a lever. So this is what changes everything in there. Also a lever in here is this other income, what our pastures are. Because even though we’ve got a, a, an area in our lease that has these, the operating expenses and who pays for what, a lot of times, probably, I don’t know, you’ve, you’ve all seen it 20% of the time, 25% of the time, you’ll have a landlord who’s not really passing through expenses the way they can. Some of your bigger operators definitely will. But your small time operators tend to get lazy don’t do increases and don’t do pass throughs really the way they’re supposed to. And so that has a direct effect on ultimately what though what you collect, so your income changes. And then, but we make assumptions when we’re purchasing the property on whether or not the landlord’s going to throw a tizzy when we try and collect those. And they do and it become it can become a problem. But it’s so it’s an assumption that you’re making, that ultimately is a lever on the whole thing. So under the CCM sheets, we have proposed it under this. So let’s say we’ll just leave that like that. Now, they also use different measures for here. So let’s say our so we’ll talk a little bit about cash flow, because here, we’re at a new a whole new level. Alright, so this is the third step. And this is the cash flow step. So now we’re at the third step of the four step analysis. I think it’s a little bit confusing the way that that CCM is decided to build it out just for other people. And for really kind of seeing where those where those levers are. Whoops, back. So let’s put in the first huge lever that we come to here is we are looking at the amount of our loan. So let’s say we lever it at 65% loan, just 140 or 11482000. Say our interest rate is 4%. Our amortization period is 25 years. Our loan term is it doesn’t really matter for this purpose. But we’ll just say it’s 10. And our payments per year is 12. So that’s all normal. Now we’ve got our normal debt service built into here. And so now and hope we have a good positive cash flow. Okay, good we do. So now we’ve got a nice positive cash flow. We’ve got a nice positive cash flow. Now we’ve got built into our cash flow, we’ve still got these levers. And there isn’t a considerable amount of work to do in there in the way they underwrite the sheet. But let’s look at the levers specifically. So we’ve got we’ve got the debt portion, right? I mean, here’s a big lever. So how we’re going to be doing debt is a big, big lever. And that becomes a whole different topic of conversation. So we’ll talk about that more next week, about about debt and how that works on here. Because ultimately, it’s such a big lever and it’s it will change everything about how you how your underwriting goes to buy that property and to really fund it with syndication. It becomes it becomes very critical. Not that there’s others. So and everything comes forward. Right. So, like we talked about before, we’ve got our net operating income is a major lever. So that changes and then everything else changes in the cash flow. And so part of one of those levers to was somehow I lost my thing is what are, this was a lever that we had from noi, as was vacancy and credit loss. So those are levers, now we’ve got our interest is our lever, we’re not going to go through participation payments or cost recovery. It’s just it’s not important for what we’re doing. And so our amortization are the other things our leasing Commission’s right, if you’re going to need to lease the property out, that’s a below the line cost that’s going to be affecting you. We also have our capital expenses now here, up up, up up up above ups, because we are we’re still in the textbook calculation. Oops, and then that throws everything off that I’ve just learned. Alright. So we have our leasing Commission’s is one, our funded reserves is one, remember, we talked about that? We’ve got our I would have put capital expenses here as as an actual thing. So let’s just change this that’s a lever, there’s a lot of levers that go into into this part into the cash flow statement. And each of them changes everything that we’re doing in terms of where we get. All right. Does that make sense? Are you getting the topic of levers? Give me a nice Yes. Or no? Alonzo Christian, yes. Yes. Okay, good. So ultimately, then that leads us to, to the topic of our sales. And for those who came in late, the reason that we’re going through this, we’ll go back over it again, in the beginning, just to finish up. But we’re going through the fourth step financial analysis, the last step is the performance step. And this is what your investors actually care about. More than anything else. So we’ve got our our cash flows, what it would look like what a potential sale looks like. Nothing, nothing new or extremely interesting. Again, taxes isn’t really relevant to what the conversation of syndication, it will be part, it is part of your your sheets as well, just because it should be. And just so that you have that information. And so you can use it on just investment property sales, or you could do it, you use it, so you can use it in brokerage, or you can use it in syndication. And now here, you’ve got ultimately your IRR, returns. So you sell it at your nice middle, your before tax is a 15% return, which is pretty good. So for this sample property, we’ve got a nice reasonable return for our investors over a five year hold period. Now, again, we have levers in here. So all of those things that that took place here in cash flow in the here, but but so are our debt, because this was part of cash flow is a lever, right, we change that it automatically is a major level, our sales price is a lever. And a lot of these I mean, you you don’t know what it’s going to sell for in five years. But we have to make assumptions. So this is one of the bigger assumptions that we have to make. So it should be a reasonable assumption and supported by evidence. But then we have our cost of our cost of sale. And this is your broker fees, right. So this is the amount of money that you maybe are taking as a brokerage commission for half of the deal. So in this simple transaction, you’re making, you know, over $80,000 in a for the sale of the property. I say 80 because that’s half of 165 Splitting out both you it’s a very bad idea to double end a deal when you are acting as the seller. So that’s why it’s half of that. So and then ultimately we’ve got you know, the whole period is five years. And so we have a a nice reasonable return as our result. And all of it was affected by all of those levers. So let me switch back to, to what we where we started. So all of these levers are now have all added up to giving us, you know, a, an IRR of 15%. But if you change any one of these things, you’re suddenly going to have a change in that 15%. I mean, not really the potential value this is there more for more for brokerage than for then specifically for what we’re underwriting for here, but nevertheless. So, but if we had changed the vacancy credit risk, our IRR would change, we make the credit risk or vacancy percentage we’re using much higher, we’re suddenly going to have that that 15.0 to fall down below 40, below 15. If you change the how you are going to be getting that your pass throughs recovered, that’s going to also if you think Well, I’m not going to be able to recover at all, then you’re going to need to drop that down. You’re in your cash flow, if you decide to do an asset management fee, which these sheets don’t use, that’s going to reduce the amount. If you decide, okay, I need to put more to reserves, that’s going to reduce the amount. So all of those things change, ultimately, this return that your investor is looking for. So when you come to the end of end of your analysis, what you want to have is to have a nice sheet that’s well supported by by a really well done financial analysis that says, Okay, this is what we’re projecting. And this is why and you’ve balanced out to optimize it as much as possible. You’ve tweaked the amount of asset management versus property management, versus how much debt we’re gonna take versus all those things to hit that target. There’s 15% That you are striving for. So that 15% is, is the goal, because you’ve already identified through your fit that the risk tolerance level for your investors is 15%. Now actually, I made up the numbers completely as we were going, and it just worked out perfectly to be 15%. So that was great. But that was purely by accident. It was I know, I know, I definitely deserve a lot of kudos for that. I hope you found the four step financial analysis process to be useful to you. Feel free to give me a call if you need help setting up real estate syndication or real estate fund where you’re looking to raise money for your business or you’re looking to you’re a developer and you need additional capital. We’re the people that call when you’re doing a Regulation D Rule 506b or 506c offering
Probably the worst thing that could happen in your career as a syndicator, or a fund manager is having to make a bad capital call, having to call up investors who and say, you know, we just need a little bit more money or you’re going to lose money. It’s a terrible situation, we’re going to talk about two different ways that we deal with capital calls. And we put it into a operating agreement and let investors know in a PPM, it’s what I look at as a rate as a syndication attorney, and you should know what your options are.
Now, having to make a capital call is awful. Fortunately, I’ve never needed to make one in any deal that I’ve done. But it certainly does happen quite frequently, that there will be a point where you’re going to need to call your investors and let them know, you need more money, or the the bad things are gonna happen. Now, I’ve almost had this happen once as money ran dry as a lawsuit started up in a deal that I had going. And the lawsuit itself was eating up a lot of lawyer fees. At the same time, it was diminishing the account that we had in reserve. So fortunately, that didn’t happen. We made it out just in the nick of time. And I was able to recover that syndication without doing a capital call. So yeah, that was good. Because making it just as feels icky, right, you’ve made all these promises to your investors about what you’re going to do, and to not be able to deliver just feels bad, it’s just feels wrong. But there are things you have to do, right? Sometimes you got to get that extra money, it could be something like a lawsuit or deferred maintenance, or it’s maybe it’s something that that happened, you know, a freak of nature happen. And it’s just not covered by insurance. And in order to make everything work, still make your tax payments, you’re gonna need to take do what needs to be done, or service the loan, of course. Now, in order to do this, there’s really three ways we handle it. The worst way probably is to just not include it at all. Now, if depending on the deal, that’s pretty safe in order to do, you can always go back to your investors and ask for more money, it just may not be spelled out in the operating agreement. So it’s not uncommon to leave it out. Because it’s kind of uncomfortable and uncomfortable conversation. Now I get it, I would still encourage investors, syndicators and fund managers to think about it and include it as part of the operating agreement. But if you’ve got the right kind of structure and enough reserves, I guess it’s probably okay to leave it out. Now, the most common way to deal with with capital calls, where it is included, is to do it as treatment as a loan. So you put a call out to your investors and say, okay, investors Listen up, we’ve got to raise an additional $500,000, we need to do it because of XYZ. And as part of that, we’re going to offer this low, you can that you can invest in a loan in us make that loan of $500,000, we’re going to pay you off, as quickly as we can’t, we’re not going to be making any, any distributions until though until the loan is paid off. And then the we’re going to do it at an interest rate of 10%, or whatever percentage you determine, would make the most sense. So that’s one way to do it. The second way to do it is a mandatory capital call. So a mandatory capital call looks like this. Investors, we need $500,000 Each own 10%. So I’m gonna need to get $50,000 from each of you. Now, if you don’t give that to me, it’s going to work like this. That day, that 50,000 That you don’t contribute, is going to come off of the amount of equity that you own already. And it’s going to go on one of the other investors ledger, but it’s also going to go more than that. So we’re going to actually decrease your equity more than the $50,000 worth. We’re going to decrease it say $75,000 Worth and give that $75,000 worth of equity to the investors who pick up the slack. That’s the more more confrontational approach, but it’s the much more effective approach sometimes and alone environment just doesn’t work and you aren’t going to be able to do it and somebody’s gonna have to be able to step up and if nobody steps up, then where are you at? But with a hammer or I guess you could call it a carrot and stick model of a mandatory capital call works pretty well. My name is Tilden Moschetti. Those are the ways that we set up capital calls most commonly for a real estate syndication, or occasionally for business as well. If we can help you set up yours, please don’t hesitate to give us a call. We specialize in Regulation D rules 506b and 506c
If you finally want to do it, you know a lot about real estate, and you think it’s time to start a Real Estate Fund? How do you go about it? And what’s the process? Let’s talk about it.
So just how do you go about starting a Real Estate Fund, you know a lot about real estate, and maybe you’ve invested quite a bit yourself, but everything’s owned by you already. And you want to grow, you want to make more money, you want to own more properties, or be a piece of that. How do you start a Real Estate Fund? Well, it always starts with two things that you are always always doing as a syndicator, you are always looking for investors, and you’re always looking for deals, those two things are never gonna go away, those are the most important. Those are the fuel for the fire, right? without either of those, there is no deal, there is no real estate fund, no real estate, no fun. No investors, no fun, it just as simple as that. So you’ve are always looking for investors and deals, I like to think of it as a funnel, because you’re working on these things all the time. And you’re sifting out to see what exactly you’re going to be working on. As deals come in, you need to be start identifying and start choosing while these, this is a possibility, this is a possibility. This is a possibility. And at the same time, you get investors who are thinking, hmm.
I’d invest in that. Right. So investors are starting to think that I’ll invest in that and you get an idea of who those people are. Those are your prime candidates for being in future investors with you. As soon as you think you have those best properties, you now go into this phase called underwriting. This is the financial analysis model. But more than that, because underwriting is financial analysis, but also with the component of Do you personally want to take this project on? Does that meet your criteria of what would be worthwhile? And are you willing to put your name on it? So underwriting becomes the key thing. At some point, a deal is found. And you’ve identified that one deal that you want to work on, you put the deal under contract. And you’re done. Right? Wish it was so well, you’ve got two things going on. Now at the same time, right, you’ve got this deal that just went under contract. But you’ve also got the security to worry about this, so you’ve got to do a contract, you need to close and you’ve got a security that you need to fund. So you’ve got two things happening. You’re always going to be have the same process. And in order to get the deal done. As it relates to the contract, right? You’ve got your due diligence, you might have some additional financing like a loan. And then ultimately, you have a closing. But your question for being here as probably more on the security side, what exactly do you need to do in order to do this security? You’ve got people who are raising their hands, right?
Have those people who are raising their hands saying they’re interested, but how do you get them from here, all the way down to here? Well, it starts with you need the proper documentation now that you’ve already identified those people and you’ve got those soft commitments. Soft commitments. Now you need the paperwork that lets you do this legally. You need a PPM the ppm is what does what you give to your investors. It describes the entire investment it describes the terms that that are going to be taking place. It lets your investors know what the risks are, what the conflicts of interest that naturally exist in your DLR. It gives them a firm basis so that they understand what they’re going into. And lets them know also wow if they have additional questions, how they can get a hold of you and ask those questions. You also need the operating agreement. The operating agreement is the rules for the road, it’s what tells the LLC that probably is the basis of your syndication or fun. Exactly what what it can do. And what it can’t do. It is the manual, it is the law. It is what it is what takes place, the PPM explains the operating agreement, but the operating agreement itself is what actually rules the day. But your investors don’t sign the operating agreement, almost all never. So they sign another agreement called a subscription agreement. So they sign a subscription agreement. And what that does, it binds them to the operating agreement. It says in exchange for this money that I’m about to give you, I am entering into this operating agreement as a member of this LLC. And that’s what that does. So now you’ve got your all of your legal documents together, but you’re still not at the closing window yet. Because this down here, you still don’t have any money, you don’t have their money. Yeah. So you’ve got the documents in place, this really now becomes a process of I call latching. So you’ve got the people that have raised their hands, you’ve got the documents, you need them to latch on to your investment and commit in order to do it. And that’s a lot of the work that takes place in this whole phase here. Your syndication attorney is going to take care of the documents and make sure that those are all to getting done. But this latching period is what really kind of takes takes place to make sure that we latch properly, get your investors lined up, get that money in, get those signs, subscription agreements, if you’re doing a 506 C offering, get the verification that they’re an accredited investor, and then get their dollars so that at the end of the day, you can go to the closing table as well with that money that you have that you need. This is the broad picture on exactly how you start a real estate syndication. Now under a Real Estate Fund, what you’re necessarily doing is you’re just not doing this part quite yet. Right. So here your underwrite, you’re still underwriting deals. And you’re coming up with your founder investment theory. But you’re not necessarily doing that. But you still need to do those other things, you need to get these the the documents in place to latch those investors. The end of the day, now you have this big pool of money. And I apologize that I don’t know how to draw a pool. But this big pool of money as you’re closing. When that happens, as soon as you start making sales, you’re filing your form D with the SEC, and you’re notifying the states
of where your investors are coming from. And that’s how you start a Real Estate Fund. As you’ve got this pool of money to now you’re putting it into deals. Right, you’re buying different different assets for them. And then you’re just using the money as as you need to, you’re using that money in order to make those investments. And the returns are going to your investors in the way that you promised them. Right. So they’re getting that money back. And they then you it’s just a matter of keeping constant communication, making sure they’re happy and know what their money is doing for them so that they keep investing with you in the future. And this is how you start a real estate fund. I thought it was helpful to draw this out. And I thought it was helpful to also draw it out as a syndication versus have fun, because the only difference really is you may not have a transaction going at that time. My name is Tilden Moschetti. I am a syndication attorney with the Moschetti syndication Law Group. If we can help you put together a syndication or a fund, be happy to talk to you about it. We specialize only in Regulation D and in rules 506 B and 506 C. We’d be happy to work with Few we’ve worked with people of all levels, people who are just starting out who’ve never put a deal together before but know that they want to and are committed to the process, as well as large private equity funds with over a billion dollars under management. So we service everybody in between. We can help you please don’t hesitate to give us a call.