Ever wonder why Wall Street makes money in both up markets and down markets?
It’s because they use a model that can create wealth for its investors, day in and day out.
This is the Total Commercial Real Estate Strategy—the unbeatable model I’m sharing with you today.
Think about how many cities you’ve been to around the world. Think about your own city where you live.
Whose names are on the tallest and nicest buildings you see?
What very few people understand here is that the real money is made in all forms of real estate… . by thinking like a bank and being a financier.
Not a landlord.
Here’s why: It’s much easier for you to get into deals that you would never be able to get into on your own by placing capital into real estate deals.
And this capital comes in different shapes and sizes. Where does that capital come from?
These are called retail investors, and are usually wealthy “mom and pop” professionals such as doctors, dentists, successful business owners, and other high-income professionals.
They usually have at least $500,000 to $3,000,000 in cash to invest. They are liquid, and prefer to use tax-advantaged vehicles such as Self-Directed IRAs to invest in real estate deals. An example of a Self-Directed IRA Custodian that we use would be Vantage IRAs.
High net worth individuals are seen as being patient, as long as they know exactly what is going on. For example, when rates are really low, they will invest in a deal with a 7-year term, such as an apartment transaction. They may tell you they know a lot about real estate, but, in most cases, they really don’t know as much as they think they do and are less likely to ask the hard questions.
This is the gateway drug for most money managers starting out in managing other people’s money.
Collectively, they are great for a real estate investor to target for real estate deals since these folks are usually ignored by the big investment houses as they aren’t large enough to deal with or to make money from in fees.
So they are motivated to get into those deals that no one else is getting into and have that feeling of exclusiveness.”I’m in a deal with Arnold Schwarzenegger… “.
These are funds of pooled capital that invest and trade in a variety of investment vehicles, ranging from anything from stocks, defaulted mortgages, and foreign government bond to expensive artwork and precious metals.
These institutional investors are seen as being sophisticated and agile, and as people who will take larger bets if they can understand the deal and the exit strategy. Their investors are other larger, institutional investors. No retail investors here. Just fellow whales.
This money is less patient, and is looking to get in and out of deals quickly. Therefore, a long-term hold is not something you’re going to want to approach a hedge fund with. Perhaps an opportunity to cross a real estate trade (we’ll define that more in a moment… ) is a better fit for them.
When you think of Paris Hilton, you (usually) think of a very wealthy family.
They have their own business and their businesses usually throw off a lot of cash flow. Or their wealth was the result of selling a business or many shares of stock after a company sold or went public via an IPO.
They have their own CFO, CIOs, and attorneys on hand (in case Paris has legal problems… again) and an administrator. These family offices range in size from $50 million to as high as a couple billion. Some of them team up and do”club deals”, meaning 2 or more families will pass a hat around and chip in a few million dollars for a deal. It happens all the time.
To operate a family office costs about $1 million a year.
An endowment can best be described as an investment fund set up in which regular withdrawals from the invested capital are used for ongoing operations or other specified purposes.
Endowment funds are often used by nonprofits, universities, hospitals and churches.
Think about some of the largest charitable donations you can think of, today. Those monies raised are invested into real estate deals.
This Pyramid of Priority Blueprint outlines how you want to approach this and how those industry professionals and participants rank in the value of how you should spend your time sourcing deals flow.
And experience talks — this Pyramid of Priority is based off of our 17 years’ experience in the commercial real estate space throughout 2 funds when we had the proverbial gun to our head to source deal flow to our Limited Partner investors. If you manage money, it represents both an opportunity and a challenge to get that money out working, meaningfully.
Start at the top. Follow this. Resist the urge to listen to the line of lies that your new found friend at a seminar last weekend told you about. You don’t see seminars on the Pyramid of Priority Blueprint, do you? There’s a reason for that. (Industry conferences, however, are a whole other animal… )
Call these firms and simply ask them…
“What do you have on your balance sheet you’re looking to clear?“
We’ll get into what to do with those opportunities in just a minute.
Types of Assets
These are the first things you should concern yourself with — The”Four Food Groups”.
And remember we’re looking at income-producing commercial real estate.
There are 5 types of retail properties
First are the grocery anchored retailers.
They are the most stable, as everyone has to eat. These are Safeway, Winn Dixie, Publix, Ralphs, Whole Food, ShopKo’s, and ShopRite and Pathmark in the northeast. We like these a lot and we are currently raising funds to buy a chunk of these from a REIT selling these in a separate fund.
Second are the unanchored retail. These are small centers, local tenants, least stable, trade at high cap rates. These are your mom and pop pizza chains, nail salons, and cafes.
Next are the neighborhood centers. These are local, and services surrounding residential areas; may have a grocery store and if so it’s probably a mom and pop business.
Then we have the power centers. These are also called destination centers. They are a combination of”big box” and local inline space: Walmart, Home Depot, Lowes, Ross, Staples, and Marshalls… you get the point.
And lastly, we have the regional malls. These are large restaurant centers, which have multiple anchors being department stores.
Multi-family residential buildings vary by location (urban or suburban) and size of structure (high-rise or garden apartments). High rises are defined as four stories or greater.
Generally they are seen as being the most stable as people need a place to live; however, multifamily is seen as the gateway from those residential investors making the leap into commercial. As a result, they are also the first to get bid up in heated markets
Multifamily also comes in 4 classes:
These are generally, garden product built within the last 10 years. Or they can be properties with a physical age greater than 10 years but have been substantially renovated.
Additionally, the high-rise product in select Central Business District may be over 20-years-old and commands rent within the range of Class”A” rent in the submarket. These assets offer amenities such as a concierge, attractive rental office and/or club building.
From the outside, they look like other Class”A” products in the market with a high-end looking exterior and are usually built with high quality construction with highest quality materials.
This is product that has been built within the last 20 years, and the exterior and interior amenity package is dated and less than what is offered by properties in the high end of the market.
Although dated, this product is usually of good quality construction with little deferred maintenance.
This describes older product built within the last 30 years as evidenced by limited, dated exterior and interior amenity package. These are more of a 1970’s – 1980’s vintage product. Any improvements show some age and there is noticeable deferred maintenance. It’s not uncommon for any appliances and baths to be original from the time of construction.
Often forgot about, this is product that is over 30 years old. These are worn properties, operationally not stable, and are situated in fringe or mediocre locations in a market. Tenants usually pay cash each month.
This product also has higher churn and burn; any system components have considerable wear and tear. There are no amenity packages offered (such as a concierge or front desk), and most garden-style product will be”walk-ups”, having no elevator.
Not all office properties are of course the same. Office properties generally come in 3 flavors or 3 classes: A, B, and C.
Generally speaking, office buildings are viewed in three classes that relate to building quality, and not location:
The newest, nicest, slickest and the best on the market
These are more of a 1970s vintage. Theses don’t have ‘modern’ features.
These are older properties, and frequently the most unkempt ones.
Office also have 3 distinctive categories too. They are…
Urban offices are downtown locations, typically higher barriers to entry. Very expensive, trophy assets.
The suburban offices are close employment bases and have fewer barriers to entry.
Lastly you have flex space. These are typically suburban, typically one story; part office, part warehouse, part light manufacturing; usually have drive-in doors and some warehouse space.
Industrial is categorized as a 'safe' asset class as it is very homogeneous. Would you rather have Amazon.com paying you rent each month or a bunch of angry tenants having problems making ends meet? Unlike office space and multifamily where the quality of the asset and space drives the price, this is not so much the case with industrial and warehouses.
Now these asset classes come in different shapes and sizes --- Not all office buildings are the same any more than any multifamily properties are the same.Now that you have enough here to get into trouble, let's move on.
I personally like to write down these 5 Data Points when I’m talking to someone on the phone or in person about a deal.
The Data Points
The NOI or”Net Operating Income” is simply the annual income generated by an income-producing property after taking into account all income collected from operations, and deducting all expenses incurred from operations.
This goes in your pocket at the end of the month and is commonly expressed as an annual figure. To find out the monthly, simply divide this number by 12.
Technically, this describes a method of calculating financial results in order to emphasize either current or projected figures. It’s a made up number. This number may or may not be achieved after you purchase and make changes. It’s essentially a lie.
But for rehab deals, called”value-added transactions“, it does play a part. Which is to try to see where the owner-operator is trying to get to after repairs are made. So if that same owner-operator were to rehab those 50% of the units that are not rented and re-lease them out at market rates, this is what he or she can reasonably expect – as evidenced by similar units in the same area – for a net operating income.
(In a moment, we’re going to discuss how and why sellers may be inclined to manipulate this number, so don’t jump ahead just yet… )
This is the total amount of all debt and equity that is currently attached to the property.
When you ask for this, you’ll probably just get the amount of the first trust deed secured by the property, sometimes called the”debt stack“.
You’ll hear other terms like”soft second” and”cash flow note”. These are promises made to investors that aren’t recorded against the property because if they were, they would violate the terms of the lender’s”senior loan” and the lender could start foreclosure if they wanted to.
Such a violation is called a”technical default”. What many people don’t realize is that lenders run title searches – sometimes monthly – on properties that they have lent on.
You will hear other terms mentioned like “preferred equity” or “pref” and “mezzanine” or “mezz piece” too. These are other forms of debt and equity that is used to finance the property. Write those down as they are important too.
These terms are almost always confused and people really don’t know which one is which. A novice move if you’re playing with the whales. You only get one chance to make a strong impression presenting a deal…
This one separates the grownups from the boys and girls. If I ask you to lend me $1,000, aren’t you going to want to know what it’s going to be used for?
If someone tells you that the proceeds are going to be used to acquire the property and rehab it, you should stop here. The sponsor should have a detailed list of repairs that need to be made with their estimated costs.
Also, not all repairs add value. Meaning, tenants expect to have toilets and a roof over their head. But what they don’t expect is perhaps a part-time concierge to manage their packages, nor do women expect to have a 2.5 hp whirlpool tub to look forward to in the bathroom when they come home from work each night. Sensible value added improvements that have a much higher perceived value to the tenants.
What is your sponsor’s strategy for getting taken out? Nothing lasts forever, and there are only two exit strategies in commercial real estate:
Selling the property for as close to retail value as possible. Investors make money, the loans are paid off.
Get a permanent loan from a life company, pull out all of the equity, and keep the cash flowing asset.
Remember, we’re only pre-qualifying these deals here. Performing triage.
Will it die on the vine or will live to see the end?
Most of what will come into your desk will not be duds, and you want to separate the wheat from the chaff so you can hold your head up high when giving prospective buyers or investors a look.
I write all of this down too in my deal book. It helps me to visualize the deal as I’m doing the pre-qualification process. This way, I can see if it makes sense or not. And after you pre-qualify just a handful of these deals, you’ll get the hang of it.
The bonus of this stop-gap? It’s used to protect your credibility; it forces you to think.
Meaning, if you’re writing these numbers down and asking the appropriate questions, then you’re less likely just to nod your head and say,”OK, OK, Right, OK”.
It will also keep you from getting strong-armed into something by someone who has a stronger personality than you with the intent of trying to get you to invest your own money – or just as important – someone else’s money into a deal.
Still with me? Let’s move on to…
Which in the Investment Memorandum looks like this:
This is where the fun comes in.
And after you’ve gone through this, you’ll understand why vetting your deal is so important. This is where you add value and where the paydays come in.
If you’re planning on doing consulting, you’re going to want to pay close attention here.
There are generally 3 ways to make money structuring your deals. And you’ll want to have these in the back of your mind when you’re pre-qualifying these deals.
This is placing capital from one institution to buyer looking to purchase or refinance a property. We call these folks “sponsors” or “owner/operators”.
These institutions are usually real estate private equity funds, otherwise called discretionary lenders, family offices, pension funds, life and reinsurance companies, endowments or hedge funds.
These same institutions generally provide capital across the entire capital structure. Meaning sometimes their debt, sometimes their equity, sometimes both. What you need to know is that the capital structure comprises of the total debt and equity at the asset level.
How You Make Money
In any deal where you’re placing capital, you as the Intermediary are usually incentivized in the form of points or a percentage of the total loan amount.
For example: if you arrange and place $5,000,000 from a capital provider, such as a bridge lender, you’ll usually get paid between 1-1.5% of the total loan amount, or $50,000 to $75,000.
Depending on the deal – and the market – it’s not uncommon for you as the Intermediary to get a percentage of the deal after all improvements have been made.
So if that same $5,000,000 loan is placed on a property that will be worth $10,000,000 after all improvements are made (we call this the “terminal value” of the property) then if you are good at negotiation, and are able to score a 10% equity stake (otherwise known in the industry as “hope certificates”), than that is another $1,000,000 in equity.
Lastly, depending on how plentiful capital is, you may also be able to make a yield spread on this.
Let’s put this into context:
When you deposit your money into a savings account at the bank, you expect to make somewhere between 1-2% in interest.
What the bank does with that money is that they lend it out at 7% interest, then pay you the paltry 1% interest (with a straight face) and pocket the 6% interest rate spread.
You can do this too. Let’s see how.
If the capital provider is charging say 8% on a bridge loan, and your operator is looking for 9-10%, tell him 9% and then tell the servicer to pay you the net difference to you.
To put this into perspective, on that $5,000,000 loan with a 1% simple interest spread, that could amount to $50,000 per year or $4,166.67 per month – to you.
When capital is plentiful and cheap, it becomes competitive and every percentage point matters to your borrower. Someone will always undercut the other shop to get the deal done. However, when capital is scarce (think of 2008-2010), then it’s going to be much easier for you to get what you ask for.
(Right now it should be clicking that it’s far easier for you to think like a bank, rather than a landlord.)
Debt vs. Mezzanine vs. Equity: Not All Capital Is The Same
The parts within the capital structure comprise of what are called structured products that all have different levels of risk.
This is something you must absolutely understand if you’re going to swim in the deep end with these institutional capital providers.
Want to solidify your credibility instantly? Always ask your sponsor or operator who is looking for capital this question: “What kind of capital do you want? Where do you want your capital provider to be in the capital stack?”
This will allow you to really effectively communicate to institutions.
In residential real estate, it’s called”wholesaling”. That’s what the little investors call it.
In commercial is called”crossing a trade” or arbitrage.
Now that we’re grown up and we’ll be facing off with grown up men and women in the industry we’ll want to use these cocktail terms.
This is simply identifying an asset that is undervalued, locking it up under a contract or an option, then either selling it or assigning it to an end buyer.
You’re”arbing” the asset. You’re buying at a low and selling slightly higher.
Not at retail or full market value because you want to leave enough meat on the bone to make your buyer truly interested and activate his or her greed glands.
Got it? Good.
Remember that you need to be careful of Real Estate Commission rules of getting paid a commission on the sale of real estate without a real estate license. Get the property under contract and then sell or assign your contract for a fee since the contract is personal property and not real estate.
Now that we got that out of the way, here's what you need to do to make sure your deal is legitimate.
There are several types of QIBs out there and all of them have different motives.
A publically traded REIT for example will pay close to retail for most assets as it's easier for them to raise more capital by issuing more shares of stock that is publically traded.
Smaller private partnerships, comparatively speaking, have a higher cost of capital therefore they are more concerned about the basis at which they are buying an asset.
Of course, it's far easier to cross a deal when you can get terms. If the buyer can assume the existing financing, then that makes the deal as a whole look way more compelling. Your retail investors, such as mom and pop investors; like doctors, dentists and accountants will almost always be more inclined to purchase these types of deals that are structured with existing financing.
The point here is that if you truly desire to be successful, you need to wear the right clothes to this party.
And quite frankly, it’s not that difficult. Those who aspire to become Real Estate Private Equity Fund Managers need to focus on using proven system to do only two things. Find deals. And fund them.
This is where you go deep.
You are going to trust what you got, but you’re going to verify. You’ve come this far. And you’re no fool.
Remember, whatever strategy you determine to use in Step 4 above, your credibility and reputation are on the line. You need to be cynical at best, paranoid at worst.
Where did you find it?
If it’s in poor repair, what’s the country music story? Do you believe that story?
Are you asking the hard questions? Dig into it like a jealous ex-lover…
Now would be the time to start accumulating those rent rolls and the properties financials. This is all that stuff that the seller or broker threw on your lap when you first asked for information. Big files. Huge files. Now that you’ve distilled what you needed to move forward, you may want to look at these huge files now.
In a future blog post, we’ll look at how we break down these financials – cynically.
Sponsor or Owner-Operator Qualifications
More On Capital Formation: How To Start Your Own Real Estate Fund
When people tell me they want to start a fund, I tell them to read my best-selling and critically acclaimed book, Making The Yield: Real Estate Hard Money Lending Uncovered.
The reason is simple and I want you to pretend this is you for a moment. Even if it’s not you today, it will be you in the future.
"If I give you a dollar, where does it go, and how does it come back?"Know where your investor's money is going to be in the capital structure. Know what your investors will make. And if you're confused, ask a mentor who knows what they are doing and whose been there before. Bonus: Markets to Target. The Weather Map Approach Many newer dealmakers get caught up in the definition of markets. Meaning, which markets to target? Many people will get caught up in the MSA definitions. But when you're sourcing deals, you're going to want to use the approach that one of my industry friends calls the USA Today Weather Map approach.
Salvatore M. Buscemi is a Managing Director of Dandrew Partners LLC in New York City, a commercial real estate advisory boutique firm that focuses on placing capital from prominent institutional investors into middle-market distressed commercial real estate investments.
Salvatore M. Buscemi also co-founded Dandrew Strategies LLC, a $30 million real estate solutions provider in the secondary mortgage market, specializing in non-performing residential mortgage portfolios.
Mr. Buscemi is a Co-Founder the J. G. Mellon Real Estate Fund, an innovative investment fund that targets commercial real estate assets in historically stable U. S. markets. The fund was built from the ground up to provide a sound and easily understandable solution to the search for high, long-term yields without excessive risk. The fund is partnered with Vantage to provide concierge services. Vantage has special capabilities in enabling investors to switch out of low-yield investments in their IRA’s and 401K’s, while protecting their tax-deferred status. The goal of the fund is 10+% returns over 10+ years.
Mr. Buscemi was also the Co-Founder and CFO of Las Vegas-based Oasis Fractionalized Real Estate Equity (OFREE), a $15 million fund oriented solely toward the low-basis acquisition, management and redemption of broken, fractionalized hard-money mortgage assets. The fund focused on corrective, development-oriented solutions to capture equity opportunities that are traditionally unavailable in a traditional receivership or liquidation environment.
Mr. Buscemi began his career with Goldman Sachs, where he spent five years as an investment banker, working with clients across a broad spectrum of industries. While at Goldman Sachs, Mr. Buscemi also collaborated closely with the firm’s divisional leadership during the transition from a partnership to a publicly held company.
He is a frequent speaker and guest lecturer on real estate finance at professional symposia and has written numerous articles on the topic of residential and commercial real estate finance in various publications, including Investor’s Business Daily.
Mr. Buscemi is the author of the critically acclaimed, Amazon best-selling book Making The Yield, Hard Money Lending Uncovered. In the book, Mr. Buscemi reveals everything an aspiring fund manager needs to know to become a remarkably successful hard-money lender in real estate. In straightforward, inviting language, he provides the reader with step-by-step guidance – from how to create the fund and attract qualified investors to how to select builders and others to lend to, choose sound investment properties, structure risk away from investors, manage the fund, and time the closing of the fund to reap maximum profits for the fund and its investors. The reader learns how to build a track record of success that will allow him or her to grow into the kind of confident, successful fund manager that investors search for and trust with their money.
A graduate of Fordham University in New York City, Mr. Buscemi has held leadership positions on several non-profit boards. As the co-chair for the YMCA of Greater New York’s Face-to-Face Capital Campaign in 2002 and 2003, he successfully co-led a $9 million capital campaign to create a new YMCA for Lower Manhattan.
Mr. Buscemi resides with his wife in New York City and Las Vegas.