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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.

But first…

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?

Banks.

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?

Capital Sourcing
High Net Worth Individuals

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… “.

Hedge Funds and Discretionary Opportunistic Funds

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.

Family Offices and Endowments

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.

These family offices are arguably the most patient capital you can solicit. They are institutional, they are sophisticated and they are in it for the long term. Their primary motivation is wealth creation and income for sustaining their family's or their cause's long term goals. This could be a cure for cancer, education initiatives, curing poverty or drought in a region of the world, or in some cases, making sure their kids never have to work again... . Are your wheels turning yet? There are other sources; however, these are the major buckets for where investment capital comes from outside of traditional banks and lenders. And with the advent of social networking sites like LinkedIn, it's never been easier. Or cheaper. Actually, it's free if you know who to target using social networking sites such as LinkedIn® Are these people who are really going to help you in your business? Or are they just people who are better off being Facebook friends? Are they true industry professionals? Or desperate flakes you met at a seminar last week? The professional poet probably wouldn't help your business advance at all or your online reputation.
Landlords Have The Most Liability Today
Being a landlord requires that you have pristine credit and a high net worth, something only 1% of Americans actually have. It requires a special skill set and it is not as easy as others would lead you to believe. Then you have to manage it:
  • Making sure everything is up to code.
  • Providing detailed financials to the bank.
  • Dealing with professional deadbeat tenants and their ambulance chasing attorneys.
  • Repairing everything that breaks because, well, they're not going to take care of anything that they don't own. (After all, who washes a rental car before returning it?)
Yes, it's a far cry from what you've heard. And it's far easier to sell the dream than the reality in commercial real estate. However, there is a system to this. Name any successful business and what they have is a foundational system in place that ensures their results. It's why people pay hundreds of thousands of dollars to buy a franchise it's because the system works. Now... let's get into the Total Commercial Real Estate Strategy. This strategy is one big revenue model with three different strategies. It's the same one that big Wall Street Investment Banks such as Goldman Sachs uses, hedge funds like Fortress Investment Group leverages, and wealthy investors like Donald Trump and Sam"The Grave Dancer" Zell have used to build their fortune. Something you can scale and turn on and off at your discretion. Not many will do this, but today I'm giving you all the downloadable blueprints you'll need to reference going forward. Print them out in color at your local OfficeMax™. Tell them you want this on tabloid-sized paper, which is roughly the size of the USA Today newspaper, opened up, and should cost about $1 per copy. (You'll also be able to get all downloads in one place at the end of this post if you miss anything along the way.) Also remember, that these strategies work in both down markets, and up markets. Some are better than others. And we'll define when and how best used. So we're going to start with the most important steps here as it relates to being a successful commercial dealmaker? Sounds good? Great. Let's get right into it.
Step 1: Deal Sourcing
This is the most critical part and where almost all newbies fail right out of the gate. You have to have a solid plan for sourcing deal flow. (RELATED9 Deal Sourcing Secrets for a Solid Deal Flow) If you ever are looking to raise money, you need to prove you can source deal flow. The key to success in sourcing meaningful deal flow is to go to websites and sources that most people do not go to. The most attractive deals are never published on the cover of the Wall Street Journal or on Craigslist. In fact, all you're going to get from Craigslist is a desperate guy with an AOL email address WHO TYPES WITH THE CAPS LOCK ON. Not a professional industry participant you want to deal with under any circumstances. If this is you, I urge you to get a digital storefront as people will judge you by your website. There are exceptions to this rule that we'll discuss, but by and large, the less known an opportunity is, the higher likelihood that it will actually become a deal. A real deal with a higher likelihood of having someone say to you,"now that sounds very interesting!" And yes, there will be people who will send you garbage. (RELATED[DOWNLOAD] Deal Triage: How to Pre-Qualify Any Commercial Deal in 90 Seconds or Less) But it's a numbers game: you can only control the amount of deals you see, not the quality of the deals you see. Lest you forget that people by their very nature are extremely lazy. So they will get involved in broker chains to source deals from people they have no relationship with on opportunities they are led to believe are real deals. This will kill your relationship with the investors we mentioned above. You will be known as a flake, and will sound desperate. Someone who didn't do his or her homework to vet the deal. Added to the blacklist as someone who always has the CAPS LOCK on. You can spot this a mile away when they say their"partner" or"associate" brought it to them. If you want to be successful, you will not rely on brokers. You will deal directly with sellers in what are called negotiated transactions; this can be either an owner-operator or a lender selling an asset. This is a relationship business. It's why computers aren't buying commercial real estate like they do stocks. It requires a human element. People fail as commercial owners and operators because of this human element. People go into foreclosure because they are humans. Bad things happen to good humans. It's the humans that screw things up. They mismanage or operate the asset poorly (the most common story you'll hear in any distressed commercial deal, bar none). We call these people"bad operators". And when money is easy to get, they all come out of the woodwork and decide now is the time to buy. The fun-loving dentist or that weekend warrior IT manager will pledge their credit to become the next Donald Trump of Sheboygan, Wisconsin. So how does one source deal flow? Where does it come from? Below you'll see whom you should be focusing on. (Meaning, if our sales desk is calling on people to source deals, we hand them this blueprint that we've made more consumer friendly for you.)

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.

These are:

  1. Retail

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.

  1. Multifamily

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:

    • Class A:

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.

    • Class B:

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.

    • Class C:

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.

    • Class D:

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.

  1. Office

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:

    • Class A:

The newest, nicest, slickest and the best on the market

    • Class B:

These are more of a 1970s vintage. Theses don’t have ‘modern’ features.

    • Class C:

These are older properties, and frequently the most unkempt ones.

Office also have 3 distinctive categories too. They are…

  • Urban
  • Suburban
  • Flex Space

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.

  1. Industrial

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.
Step 2: Pre-Qualification... In Less Than 90 Seconds.
You'll find out soon enough that you're going to have to manage a lot of your deal flow quickly and efficiently. Otherwise you'll get buried, which leads to discouragement, whose final stop is failure. Here's what you don't want to do:
  1. Read through each 20MB PDF Investment Memorandum not knowing what it is exactly that you're looking for.
  • That's how people get fooled.
  • It's a tremendous waste of time you really don't have. Just by reading this blog post you will be smarter than most of the market participants, and therefore, your time instantly becomes more valuable.
  1. Rely on someone who may or may not have an alignment of interest with yours to tell you what they want you to know.
Think of an appraisal that the seller paid to have performed on their property that they are trying to sell. (Which is the equivalent of asking any insurance salesman if you need more insurance... ) When the deals come in, you need to perform triage. (RELATED: [DOWNLOAD] The Five Core Functions of a Private Money Fund Manager) This is how our shop and many others handle this. We expect to receive certain pieces of information and those showing us opportunities to look at know what we need. Those deals where we can easily get these data points will get priority in our Deal Book (more on this in just a second). Meaning they will live to see the next steps. Those deals where we don't have all the information we need will:
    1. Either immediately die (get an automatic"no"), or
    2. If they seem like they might have something, we'll put them on ice for 30 days or so.
An example of this may be a foreclosure or a note coming due. We will want to see what happens next. Will the seller file bankruptcy after the lender file the Notice of Default? Has the lender filed the Notice of Default ("NOD") on the seller yet? Never assume anything... Case in point, the seller may be desperate and want something done before the foreclosure, which, by the way, is a week from yesterday. They are in a panic. The Deal Book You're going to want to manage your deal flow by running what we call a Deal Book. A deal book is simply an organized way to manage your deal flow as it comes in. It's simple, and requires just a pen and paper. Download the Deal Book Blueprint below to model your Deal Book after how we use our Deal Books to manage our deal flow. Everyone on our team is required to have one. And if we ever have a meeting, it's expected that everyone shows up with theirs.

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

  1. The Current NOI

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.

  1. The Pro Forma NOI

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… )

  1. The “Cap Stack”

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…

  1. Sources and Uses

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.

Many people will blindly go into these deals as either an investor or a sponsor without knowing what they are doing. Thankfully, we have you covered here and here.

  1. Exit Strategy

What is your sponsor’s strategy for getting taken out? Nothing lasts forever, and there are only two exit strategies in commercial real estate:

    • Sale

Selling the property for as close to retail value as possible. Investors make money, the loans are paid off.

    • Refinance

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.

I don't care if they are putting a Wal-Mart up right across the street, or if it's being heralded as the next Silicon Valley... Even the"Manhattanization" of a small town. It doesn't matter. I've heard them all before. And none of them ever made it when the bank lending tide went out. Do your homework. Follow your gut. Ask a mentor for help. Now you're probably asking, "How does one pre-qualify a deal?". Easy – use our blueprint. Below you'll find "How To Pre-Qualify And Deal In 90 Seconds". Read it and keep it handy when you want to pre-qualify any income producing commercial real estate deal. I already know what you're thinking and here it is: If the property is vacant, there isn't any income. If that is the case, you'll want to use the"price-per-pound" approach using the blueprint here that you'll want to download.

Still with me? Let’s move on to…

Step 3: Analyze The Deal. In 90 Seconds or Less.
No different than politics, sellers will only tell you what they want you to hear and believe. And what people won't tell you... . you'll need to figure out yourself. The sellers you're facing off with, if not lenders themselves, will all have a story. The story will most likely have a bad ending, resulting in a problem that was caused by them buying a piece of commercial real estate on emotion. There are other reasons too, but we're going to use our 5 Data Points here from the "How To Pre-Qualify Any deal in 90 Seconds Or Less Blueprint" from Step 2 above to dig into these numbers a little. Some pros may be put off by how quickly we're looking into these, but remember, our goal is as follows:  
  1. Crank up your deal flow.
  2. Pick those that are the best (that you won't be ashamed of showing to institutions or investors), and then...
  3. Use one of these 3 strategies to make a profit.
You're going to be triaging your deal flow and marking it against your deal book. Yes. No. Put on ice. It's that simple. If you look at this part of the business as being a banker or a financier, then all you are really doing is shuffling paper. You're not a landlord who is probably going to have to do a lot of heavy lifting. Make sense so far? Now let's talk about some of the common scenarios you'll see. They Will Never Tell You It's Overleveraged The most common way that property is sold based off of the pro-forma NOI. The pro-forma NOI is essentially made up. It's a lie. But it's a great tool for sellers and investment sell-side brokers to get you to pay more for the asset today. The pro-forma NOI is a guess of what the property will be worth in the future. Here's why it can be dangerous to the unsuspecting buyer... If you've ever looked at how a pro-forma is calculated, it's really not that big of a secret formula. What a seller will do is simply multiply a number to arrive at the pro-forma NOI. Let's pretend that the property is an apartment building that the seller or broker will say will throw off a current NOI of $200,000 year one. What then happens is a broker (it's usually a broker as they are incentivized to get the highest price possible when selling) will take that number and multiply it by 10% across a term of say, 10 years. If you are already an apartment owner, you know that it is almost impossible to increase rents 10% per year. People across the country are already paying close to, or over 50% of their after-tax wages on housing, so there is only so much they are willing to pay. When this happens, rents start to go down. So this"simply raise the rents!" mantra is much, much easier said than done. However, now that these new numbers have been made up, the seller or broker can assign a value to this apartment complex. Let this sink in... . You are, in essence, paying for future value that may or may not come today for an asset. Let me break it down for you: Using the same $200,000 per year as a baseline pro-forma NOI, the pro-forma for the following years is slapped together like this in Microsoft Excel:
Click To Enlarge

Which in the Investment Memorandum looks like this:

Click To Enlarge
Which is then used to justify an asking price of probably $3,000,000 at a 10% cap rate (we'll use 10% just for the sake of this discussion). Which is probably $1,000,000 more than anyone should be paying (again, using the same 10% cap rate to keep it simple). And it gets better. Want to see how many investors were shook down? Let's talk about some of the other traps. Occupancy Greater than 100%? Let's put our critical and cynical eye here to the numbers. If the total cap stack is $3,000,000, then our seller is going to want to get as close to that as possible to pay off the existing loans. Not to mention, some of these will have huge prepayment penalties on them called defeasance that must be paid off (this is another opportunity we'll talk about in later posts). These are mostly on properties that have CMBS ("Commercial Mortgage Backed Securities"), which are loans that are bundled and sold by investment banks on Wall Street to pension and mutual funds), otherwise called"conduit loans" on them, and can be as high as 10%. You now can imagine it's in the seller's best interest to convince you to buy at the highest price possible. So naturally, the seller is going to want to goose the pro-forma NOI as high as he or she can justify a purchase price needed to cover the outstanding debt. Hype and sales pressure often mask the true reason behind the aggressive sale. Now the other reason you can check if the pro-forma is real or not is by looking at the occupancy. In stabilized deals - and we'll keep with the multifamily example above – if the occupancy is 50%, then the current NOI is $100,000. Generally speaking, it's going to be quite difficult to get $292,820 as a pro-forma NOI even if all the stars aligned and you were able to get 100% occupancy and a rent increase. And no, vending machines don't add that much revenue. It's pretty far out there, it's a stretch. However, the seller would probably tell you that the $3,000,000 asking price was justified for that reason. Meaning you were making a bet on the market improving or you being able to get higher rents relatively quickly. Allow me to make this easy for you... again. Use this very useful blueprint to cynically pre-analyze any deal that comes onto your desk. You are going to want to place this on your office wall. And yes, they're on our walls too.

Step 4: Structure Your Deal

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.

  1. Capital Placement.

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 you 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.

  1. Asset Arbitrage

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.

    1. Lock Up The Property at a Low Basis.
This means that there is strong market equity in the deal today. We call this imputed equity. It's being sold for a number of reasons such as a partnership has blown up and everyone wants out, or the bank has taken it back through foreclosure or has filed foreclosure and time is of the essence to get the property sold. In other words, if I were to offer you a house for $60,000 that is worth $100,000 today, that's a strong basis. Meaning you're getting $40,000 worth of imputed equity today for that $60,000. But if I were to offer you that same $100,000 house for $95,000, that doesn't sound as strong, does it?
    1. You Need To Have Your End Buyers Identified and Pre-Qualified.
This is where everyone fails. They find an opportunity and then scramble to find a buyer. This rarely works out and what usually happens is that the deal, your credibility or both is lost because someone who tells you they were a buyer isn't really one, and they don't perform and go radio silent. It's extremely frustrating and if it's your first deal, you will get easily discouraged. The best use of time during the day is to spend about 30 minutes with yourself or someone else in your office – such as an intern or a domestic VA – finding and calling Qualified Institutional Buyers ("QIBs"). You'll want to reference this blueprint below when speaking to them.

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.

  1. Capital Formation
The third strategy is to raise capital yourself to take the asset down to place into your portfolio. These deals are usually structured one of 2 ways: usually using a fund or a joint venture structure. Those who are proficient at raising capital have the appropriate tools do so and are able to effortlessly raise capital on demand. They've lined up prospective investors, retail or institutional, and know how to approach each. They have an evergreened pitch book (a PowerPoint presentation) that they can use over and over again. They are prepared and they have planned to be nimble whenever an opportunity comes. They simply"call the capital" when they need to. They leveraged other people's proven systems to pull down the right tools from the shelf when they see opportunity. Now, after reading this, you probably now can come to the conclusion why most people who look to raise money around real estate deals fail immediately: it's simply because first, they fail to pre-qualify their opportunities. They can't seem to look at these numbers dispassionately. Usually because they are desperate to close a deal, or they are being strong-armed by a seller or investment professional who has a stronger personality than they do. Then, they merely can't communicate the deal in a convincing, persuasive, and logical format. And if you've even been pitched by someone who doesn't know what they are doing, this scenario will likely be very familiar to you:
  • They send you a 20MB Investment Offering via email from a broker. It clogs your email.
  • They can't explain the deal, so they tell you to read the whole 200 page Investment Offering.
  • The only thing they know about this deal that they are asking you to put your hard earned savings into is that it's"great", and"a sure bet".
  • You have to do all your own research.
  • There is a tremendous amount of pressure and sense of urgency to get you to invest. They have to close immediately – if not sooner.
  • No documents are drawn up, and you come to the conclusion that your operator or sponsor has no experience. You wasted all this time for nothing, or
  • You implicitly trust this operator to make the right decisions, and pray you don't lose your hard earned money.
Incidentally, there is an blueprint you'll want to review that we created for some larger news publications which discusses why you should run from any crowdfunded real estate deals – as a passive investor. Crowdfunding is seen as being the next"big thing" in real estate. History has yet to be written on the effectiveness of this approach however, here's an blueprint you will want to download and quiz your brother-in-law who is bragging about the $10,000 he dropped in a"very significant real estate deal". I assure you that this is a wonderful conversation starter at parties!

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.

Step 5: Due Diligence Deep Dive

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

Sponsor is an industry term for someone who is doing the heavy lifting in the deal. They are managing the contractors, the subs, and the whole deal rests on their shoulders. These are the guys and gals who wake up in the morning and know what they have to do to make the deal execute successfully. If placing capital into a sponsor's deal you need to ask the hard questions. Least of which is this decision-making question itself below. Just because the numbers make sense doesn't mean that you should ignore the lack of experience your sponsor has. Remember, you're asking people to invest their life's savings into this deal. If their life savings is $100,000 or $100 million dollars, it doesn't matter. Don't be afraid to find a new, more qualified sponsor if you have to. Be creative. Have integrity.
Your reputation and credibility is worth far more than any one deal. And all it takes is one deal to take you out of this business.
Step 6: Execute and Get Paid
Which one of the three strategies are you going to execute? Is there a backup plan? If you're placing capital from a fund or family office, know what assets and transaction types they want to see. Land development from the ground up most of the time isn't really that desirable. But you'll see a lot of those being shopped because the blind are leading the blind most of the time. Value their time. Protect them with your life career. Don't let the sponsors bully you. Be in control. Be smart. And be professionally mature. If you're going to cross a trade, make sure you know your buyers well. You wouldn't bring a person who is allergic to shellfish to an Oyster Bar on a date. And you wouldn't try to sell a multifamily deal in Jacksonville, Florida to a REIT that only buys assisted living facilities in the Pacific Northwest, right? Same difference. And if you're raising capital, break out your pitch book. Have your assistant or virtual assistant fill in the blanks for you.

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.

I have confidence in you that if you're reading this, you're motivated, and have probably downloaded all of the blueprints thus far. Am I correct? Most investors by the time they get to this point of wanting to start a fund usually have a few residential deals under their belt. You have gained some notoriety from some of your friends and family and they are looking to invest in your deals. They trust you. You panic because you don't know how to structure the deal. You don't know how to (write this one down, you'll thank me for it later)"structure the risk away from your investors". So you panic. If this is you, you're not alone. Read this book so you know how to structure these deals and, more importantly, how to structure the risk away from your investors. Or I promise you that your future Thanksgivings will be awkward and full of animosity when you lose other people's money... And always, always look at the numbers dispassionately. Use models that have a sensitivity analysis function in them. If things go bad and the market tanks, what happens? Is it still profitable? What if rents drop because new single family home construction is competing with multifamily (like it did in 2007)?

"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.
Simply said, when you open the hard copy of the A Section in the USA Today, on the last page is a map of the United States. And no, it's not available on the online version... And those cities are segmented as follows: The cities that have their own box are we call "Tier A" cities. They are Miami, New York, San Francisco, Los Angeles... you get the point. These are the most competitive cities out there and this is where a lot of the bigger players hang out. You're not going to find a lot of good deals in these cities as they are very, very competitive. Major investment banks and REITs compete with each other to buy and own these assets. Next you have the cities that have a dot, but no box. These we call "Tier B" cities. These cities are less competitive and examples of these cities would be Naples, Florida or Wilmington, North Carolina. These cities are where you want to source most of your deal flow from. Lastly, you have those cities that have no box and no dot. These are what we loosely refer to as "Tier C" cities. These are smaller, mostly rural areas like Spooner, Wisconsin. These towns can be goldmines for smaller investors starting out their deal making businesses. Final Thoughts I firmly believe that there is no catalyst for rates to rise back to where they were in the 90's. It used to be that retirees and savers could place money into an FDIC insured savings account and live off of the interest income. Sadly today, savers are the biggest losers. It's impossible for them to keep up with rising inflation, higher taxes and 0% interest rate policies. The government has forced them into riskier assets such as the stock market where they have no control and, perhaps most critically, no insurance. You will never be able to out save inflation and higher taxes. It is simply impossible to compete with the Fed Reserve's money printing. Forget the free advice on the morning talk shows you hear. It's free for a reason... How do you play this? Simple. Those who understand how to raise capital – like you - will be seen as Saviors to those desperate investors who are starved for yield like an oasis in a desert. This is a great business and you can participate many different ways. And today, it's never been easier to get involved. You just need to be trained to look at the world in a different way. Like a banker. And not a landlord.

In case you missed them, here are all of the Blueprints.
Beyond the 5 Data Points
Deal Book
How To Analyze Any Commercial Deal in 90 Seconds
How To Build A Qualified Buyers List
How To Qualify Any Commercial Deal in 90 Seconds
How To Use Elance To Build Your Pitchbooks Quickly and Easily
Inside Baseball The Total Capital Strategy
Pyramid of Priority
The Cynics Guide To Crowdfunding
The Complete Blueprint Set

Salvatore M. Buscemi

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.

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