If you really want to hit it big in real estate, you need to be able to raise capital.
If you’re going to attempt to depend on banks, you will die of destitution and your heirs will hate you.
If you don’t want your heirs to hate you, then you’ll want to bookmark this blog post — after you share it, of course.
Ignore the advice of anyone who talks to you about real estate without mentioning…
- Market forces
- Capital markets
- Banking sentiment
Those people are trying to sell you something, and you’ll probably end up losing everything in the end.
Market forces are more than just speculation on what the property will be worth in 20 years. The capital markets, and specifically access to debt is what drives all values today.
If the tide of debt goes out, as it did in 2008, you’re standing naked and exposed.
So what’re we doing here today?
This blog post will attempt to give you a comprehensive roadmap to follow to be able to raise capital to fund your deals, respectively. Meaning, don’t try to go out and find a deal first, only to frantically try to raise money around it.
You’ll spook your prospective investors, in-law’s and family as being a desperate flake.
So, where do we start?
First, My Experience
I’ve been a “special situations” investor for most of my career.
My last small fund was an institutional raise in 2011 that focused on buying hard money mortgage companies out of bankruptcy, receivership that were facing operational, performance (and more so regulatory) issues using a Dutch Auction technique to ensure that all investors sold at the same price.
The best way to explain this is that if you were an investor in one of these funds, and wanted to sell your share, would be that you wouldn’t get anything more than anyone else.
Everyone was Even Steven.
For you financial geeks out there, here are just a few slides from the deck I personally put together for the raise. To remind you, this is not a solicitation for investment funds, just purely for your entertainment.
Among many other things I learned was that the private lending business was deeply fragmented; there was no cohesive knowledge base. The industry was primarily made up of mortgage brokers who placed private money from doctors and dentists into residential and commercial hard money loans.
Without any knowledge of credit risk.
Without any knowledge of underwriting.
Without any alignment of interest with their mom-and-pop investors who were largely financially unsophisticated.
It was asymmetric. When one of these brokers did a loan, they would scrape their 5% off the top and, if the loan went bad, well then, it wasn’t their fault; how were they supposed to know that a convict 2 weeks out of prison would default on a loan, right?
So you can see how the brokers were incentivized to make sure the appraisals for these properties were as high as possible.
After all, 5% of $2,129,500 is much more than 5% of $1,700,000, right?
After reading that, it should be no surprise to you that my first book, which gives a step-by-step blueprint on how to make a private loan (and is 5-star rated), is currently selling for over $1,800 a hardcopy on Amazon.
Making The Yield. Hard Money Secrets Uncovered is the only comprehensive how-to book that covers how to confidently make a private loan, using other people’s money, without much risk.
It’s held in the same rarefied air as other legendary hedge fund managers’ published works, like Seth Klarman!
Making The Yield: $1,800 a hardcopy on Amazon
Seth Klarman: Seth Klarman
Now, let’s move on, shall we?
Banks. It’s Not You. It’s Them.
There is this myth in commercial real estate that banks only look at the asset and not the borrower when lending.
That couldn’t be further from the truth.
For those experienced veterans out there, you’ll appreciate why: the implementation of the retention rule and the confusion of how this will really work and how to price the risk, and the originators and banks are at a loss as to pricing this risk and cost of the added 5% capital.
If the originators cannot price the paper, and the buyers of the paper cannot price it, the system grinds down or pricing becomes much wider than it already has to account for the uncertainty.
That means lending stops and loans can be called due.
If you’ve ever worked with a smaller community bank and actually have read the loan docs, you know that you’re in technical default on Day 1. This means that the bank can call the loan due for any reason, whatsoever, at their whim.
This usually starts with a call from your lender that sounds something like this: “Hi, this is your lender, we’d like to do an appraisal on your apartment building – at our expense – and would like to know when someone could meet us there.”
“But I can sell at any time!” you say.
Well, if you have a life company or a conduit lender on the loan, you’ll have to deal with defeasance — a prepayment penalty that can go as high as 10%.
The devil is in the details. It always is.
Our own COO AJ Palmgren was a casualty of that in 2010 when a smaller local bank who lent on his farm and a multifamily complex decided to call the loan due.
So what’s an investor to do?
You start your own bank. That’s exactly what you do.
Do your homework and make sure you’re buttoned down. Your success will follow.
It is meant for the beginner to advanced investors who are tight on funds, and don’t want to shell out tens of thousands for a Private Placement Memorandum, Subscription Agreement and a whole doc set that is typical for equity syndication deals.
It is designed to solicit money for single asset deals, not for groups of properties. One asset at a time.
It’s a great way to start building your track record, too. If you’re making the jump from residential to commercial, this is how you’ll do it.
This is a debt syndication structure. And we will be talking about that only. Not deal sourcing, just how to use a tin cup to place those monies into an income-producing, single commercial building.
Preparing Your Bank
Preparing Your Bank Step 1: Only Raise Capital Around These Commercial Asset Types
This blog post I posted here contains a blueprint of which assets to raise money around using a different strategy.
The rule is the same for this: only raise money around stabilized, cash flowing assets that are throwing off a positive NOI that are close to you.
Not two time zones away.
Close to where you live. Never mind where (in the United States, of course…) the capital comes, you being the owner-operator need to be local to the asset.
If you fail to adhere to this rule, you’ll be downloading this very soon.
The reason? Simple.
You’re syndicating debt or raising money from private lenders who will hold a mortgage against the property you’re buying or are raising money around. So you will be making mortgage payments monthly to your investors via a servicing company (more on that in a moment…).
So if you default, they will foreclose on you, and you’d better be buying something that is throwing off cash today so you can make the payments.
The deal size ranges you should be targeting should be between $2 million to $20,000,000. In institutional parlance, this is called smaller-balance to middle market commercial.
Anything higher than that and you’re going to be competing with larger institutions who can borrow money from the Federal Reserve for almost 0%. Their capital is limitless, so check your ego at the door and start small.
And another thing:
If it’s not throwing off free cash flow today, don’t even think of using this structure for it.
Preparing Your Bank Step 2: Buy At A Strong Basis
I shouldn’t have to tell you this, but some of you reading this may be easily impressed by what a sell-side investment broker or Realtor® is telling you. You don’t want to look bad, or not credible. Or that you don’t have the money.
Or perhaps you’re just desperate to do a deal.
This short video below will tell you what basis is in under 4 minutes.
Now here’s the question you’re undoubtedly asking…
How High Can I LTV This?
This is a question that requires some judgement on your behalf and assumes you watched the video above.
Everyone wants to go in with nothing down. And using this strategy, you can and probably will.
Did you watch that video above? In it we talk about basis. This is the price you get in at relative to today’s value. Not tomorrow’s, not yesterday’s.
Here’s an example: let’s say one ounce of gold is trading at $1,200 today. That $1,200 represents full market value.
If you were to buy that same 1 ounce of gold for $700, would that be a deal?
The answer is yes.
But what if I were to sell it to you for $1,100? Is that still considered a bargain?
The answer is no.
Regardless of its use or how much it will be worth after the Zombie Apocalypse, the answer is that it is not enough of a price-to-value for greed glands to take over your entire nervous system.
So, now that we’ve established what value truly is, let’s talk about judgment.
Judgment is the ability to make decisions dispassionately, without rationalization, and most importantly, without emotion.
So let’s talk about the thought process a prudent and mature Fund Manager would take to come to a decision about this.
Let’s say you could buy that same once ounce of gold at $700. Today.
You have investors who know nothing about gold, have money, and trust you.
Whatever you tell them, they won’t understand. They only see you and trust you.
They’re not investing in the deal; they’re investing in you.
So knowing what you know about value, and the commensurate risk, would you borrow the $700 to buy that 1 ounce of gold?
Of course you would.
There is $500 in market equity with that trade. If you got caught in a pickle, you could sell that 1 ounce of gold for $950 and still make your investors whole, and probably more.
But what about at $1,100? Would you leverage that deal 100%? What skin do you have in the game? Nothing. So you can walk if your speculative bet was that it would go up to $1,400, and it drops to $900.
Your investors are more exposed to market risk.
Do you see where I’m going with this now?
Unless your basis is strong, as stated in the above example, don’t lever the deal 100%. Your investors trust you and you have an implicit fiduciary responsibility.
Like snowflakes, no two deals are the same. So you’ll have to use your judgment to determine how strong your basis is, or ask a professional.
(The Commercial Investor also hosts a very experienced peer group chomping at the bit to help that you can find by going here.)
At some point in your investing career, you’re going to have people trust you to make good decisions. Never take that trust for granted and always act as though your investors come before you, any sell-side broker or Realtor®.
Preparing Your Bank Step 3: Put Together Your Deck
Now that you have your story laid out, and what it is exactly you’re going to be buying, it’s time to do some work.
You need to put together a very well-written, evergreen business plan, that you can use over and over again, that will articulate your investment objectives, thesis and, most importantly (and what everyone always forgets), is to detail exactly where your private lenders’ money will go, and how it will come back.
To put together a good Pitchbook or “deck” as it’s called, costs a lot of money. Like $5,000 to $10,000.
Notice how I said “good”.
(RELATED: Total Commercial Real Estate Strategy)
Certainly, you can do it yourself and make a mess of it and then alienate your prospective investors like a creep you met on an online dating site, but you’re not going to do that, right?
And you don’t want it to read like Larry the Cable Guy wrote it, correct?
After all, how much is your dignity and reputation worth?
I hear you crying. Relax. I have you covered. Below you’ll find a single asset Pitchbook for you to download and use.
Preparing Your Bank Step 4: Create Your Elevator Pitch
A failure to plan is a plan to fail. Don’t fail. Be better than the rest.
This is where you have a boiler-plated spiel that you say to anyone you meet. It’s practiced, it’s rehearsed, and it comes naturally. Make it simple.
The person who is listening to you doesn’t know all the industry terms and cocktail jargon.
So if you were buying stabilized mobile home parks, your elevator pitch might sound like this:
I operate an investment fund that focuses specifically on stabilized mobile home parks in the Carolinas. We only buy properties that are throwing off cash flow today. We’re not buying anything that isn’t performing today. We like this asset class as we know it well, we know the area well and we think that this is a great asset class to be in as there are higher risk-adjusted returns as compared to apartment complexes in this area that we feel are overpriced. Mobile home parks, when managed correctly like we do via a qualified 3rd party, are a very stable investment for the smaller investor and larger funds generally don’t like to deal with smaller deal sizes under $20mm. So we’re in a good position here. Right now, we’re closing on our next deal, and I can get you set up with our investment concierge program for you to use any tax-advantaged funds you have in an IRA or 401(k) that you may want to use.
What did you really say? Let me break this down for you:
You Are Specific.
Focus on what your listener wants to know. Don’t try to impress them with adding anything else.
Many times I’ve heard people ramble about stuff and it was all over the place and they were investing in deals 2 time zones away, and they were the best properties, and you worked for a guy, who knew a guy, who was the CEO of a publicly-traded company and this and that. It’s all BS.
Create the elevator pitch after your deck is finished and stick to the script.
Because you have no idea what it is you’re doing until you commit to the brain damage to figure it out.
You Thought About The Asset You Have Targeted.
Whether it’s Multimedia Home Platforms (MHPs), NNN (net, net, net) grocery-anchored retail, Class D apartments in Atlanta, suburban offices in Summerlin, the mere fact you mentioned it signals to the listener you did your homework.
You Contract Out The Heavy Lifting.
Anyone who manages their own assets is a novice by definition.
A real dealmaker’s job is to source deals and get them funded. Not to worry about why BeckiSue’s ex-husband has not paid his alimony on time (while she is in route back from the tattoo parlor…).
This sternly says to your prospective investor: “I have systems in place; I know what I’m doing.”
You’ve Stated How You’re Unique.
They may be thinking, “What is it that makes you so special?”
Well, you know where the gold is in the sub $20 million assets that no larger institution will touch and you can (implicitly) source these deals because you’re so specific and know where the opportunity is, you smooth operator, you!
You’ve Intimated How They Can Get Involved. Now.
You have a process for them to get started if they are interested. If they want more info, you send them the deck. There is a sense of urgency there, which means they won’t have time to get “free” advice from their in-law’s, out-laws, uncles, bruncles and accountants who know nothing about commercial real estate.
In other words: “Look, I’m used to dealing only with grownup investors. Are you a grownup…?”
Preparing Your Bank Step 5: Get In Front Of Your Private Lenders
This is where you’re going to talk to your friends, family, or if you don’t have any friends and family, you’re going to want to subscribe to a database that you can send post cards and direct mail to.
Place your Elevator Pitch on your LinkedIn Profile. If you don’t have one, use ours here.
In fact, for those of you who are very cunning, here’s a video for you using a filthy, dirty trick I used to find private investors for one of my first couple of deals.
Keep Your Investors Even
Keep it the same for all. Why?
You’re soliciting retail (“mom-and-pop”) money and by definition they are smaller fish and they are a dime-a-dozen. Their capital is a commodity. Everyone gets paid rack rate here.
Larry the Lawyer, Dennis the Dentist, and Bob the Business Owner all get paid the same.
Even Stan the Surgeon who is pounding his fist on the table saying he deserves more because “he’s a surgeon”… (What’s so funny? What are you laughing at? Yes, this has happened to me and many others).
Remember, it is one thing to have money and access to investors…
But it’s an entirely different thing to effectively execute and deploy that capital meaningfully, with as much of the risk structured away as possible.
It’s all the same retail money.
Don’t overcomplicate this.
If this was a larger single family office (“SFO”) or multi-family office (“MFO”) then that money will have a much larger voice. Anyone with less than $2mm to invest should be treated Even Steven.
Make it non-negotiable by saying: “This deal pays a straight 6%.”
Preparing Your Bank Step 6: Stay In Front Of Your Investors
You’re not going to want to take any money from them using this syndicated debt structure I’m laying out here.
You should have some sort of an autoresponder system where you can send them emails giving them an update of your market and what is going on.
You need to and must indoctrinate them.
This communicates to your investors that you are…
- Actively sourcing deals (and you better be) and,
- That you have implicitly put them on notice that any capital they have you’re going to “call” when the time comes.
“What do you mean you’re not ready to fund?
I’ve been speaking to you for weeks about our deal pipeline.”
Preparing Your Bank Step 7: Manage Your Time
Some of you reading this may also be solo real estate entrepreneurs. That’s good; however, you need to manage your time accordingly.
You’re going to want to allocate 65% of your time speaking to investors, and the other 35% poring through deal flow.
The logic behind this is that even if you’re not finding anything for you, there are other, perhaps more qualified, owner-operators who you can place that money into the hands of.
If you have something of an organization or interns working for you, have the interns source the deals 100% of the time while you spend 100% of your time facing off with investors.
You will need to talk to the investors.
The whole reason they are calling you is because they want more intimate money management with someone who has a pulse, not a robo-advisor.
Starting Your Bank
So now we got the preparation out of the way, let’s move on to how we actually execute and close this deal.
Again, we’re going to assume you’re going to do the requisite due diligence, and that you know how to.
Starting Your Bank Step 1: Lock The Property Up In Escrow
You don’t have a deal until you have it under contract. If you don’t have the earnest money to place the deal under contract, that’s a big issue.
Technically, you shouldn’t borrow this money from your private lenders because if it doesn’t close, you lost your lender’s money and you look like a broke flake.
And because we all want to structure the risk away from our investors, you should make sure if you do go this route that your earnest money doesn’t go hard for at least 60 days.
Starting Your Bank Step 2: Start Going Hard On Due Diligence Costs
Remember, banks don’t lend money on real estate due diligence fees. And neither will your private lenders.
You could place those costs on the HUD-1 so that you get reimbursed at the close, but not having the funds to perform the required due diligence here is not an excuse. You have people’s life savings at risk.
Life savings to me is stored labor after taxes. So it’s even more precious.
So you will have to get your feasibility studies performed and a Phase I environmental, among other things.
Now this is where I will alienate some people.
In this business and in most everything in life, money is the single biggest qualifier. It separates the men from the boys and the women from the girls.
If you don’t have these resources or access to these resources, you’re not qualified to risk someone else’s money.
Which means, if you are broke and don’t have access to funds for due diligence, stop here.
You’re not qualified to use this strategy.
Now, there are work arounds, here’s a couple…
If you really do have conviction in this deal, and you’ve vetted it among some of your biggest nationally-based advocates by going here, then you may want to take one of your private lenders aside and offer them an equity kicker in the deal as an incentive to fronting the due diligence funds needed.
That individual would simply be placed onto the Warranty Deed of the property as a Tenant-in-Common, or into the Holding Company LLC as a beneficiary. And when the property sells, they would get a predetermined percentage of the sale price at the time of sale as dictated by a simple Partnership Agreement.
(The Investors Syndicate member extra: If you’re a member of The Investors Syndicate, there is a copy of that Partnership Agreement for you to download for free.)
Another option would be to give your private lender an income kicker which would be a pre-determined percentage of the NOI – on top of the income they receive as a private lender.
That’s a topic for another blog post, but I wanted to give you a glimmer of hope.
Starting Your Bank Step 3: Entity Set Up
You’ve done the due diligence.
Now it’s time to set up your entities.
You’re going to want to speak to a qualified (and affordable) real estate and corporate attorney for this. For each deal the entities should be new and as fresh as new fallen snow. Don’t worry about complicated series LLCs, just get your first deal done first.
Here’s what you’ll need, at a first glance:
The Senior Trust Deed LLC
This is where all of your private lenders will be pooled into one LLC.
This LLC will be the Deed of Trust or first mortgage recorded against the property. Each private lender has a pro rata share per their investment in that deal. Meaning, if the total amount borrowed was $1,000,000, and Alan the Accountant invests $20,000, his pro rata share is 2%.
The Holding Company LLC
This is the special purpose entity (“SPE”) that holds the asset. One asset. A single, special purpose entity. The beneficiaries of this are you.
The Flow of Funds
At the closing, the Senior Trust Deed LLC funds the property purchase and is listed on the HUD-1 as the Mortgagee, just as a bank would, and will have a mortgage or deed of trust recorded against the property.
Insurance, brokerage and all associated costs and fees will be paid out of these loan proceeds. Just like a normal closing. No different.
After the closing, your capital stack will look like this:
Starting Your Bank Step 4: Post-Closing Set Up
Now you need a servicing company to collect your payments and distribute those monthly payments to your private investors via direct deposit or ACH.
They also issue Form 1098s to your private lenders.
They’re relatively inexpensive to use. Use them. Don’t do this yourself. Remember, you’re job at this point is to move your investors onto the next deal. Not to deal with QuickBooks.
Got it? Good.
Starting Your Bank Step 5: Set Up Property Management Company
With Property Management, you get what you pay for.
Meaning budget about 5-6%.
Depending on the type of asset, such as a Class C multifamily building or a mobile home park where a lot of lower-wage workers live and use cash only, you’ll want to make sure that you have a lock box set up where they will deposit their rent directly otherwise it counts as unpaid rent.
The management company you want to avoid are husband-and-wife team who have been managing this asset already. I’ve never met a smaller mom-and-pop management company who weren’t skimming rent.
At the purchase, they will tell you how they take care of the tenants like it’s their own family. How they spoon feed the elderly their dinner each night. Ignore that. Leave the emotions at the door.
If you really want to have fun, tell them that it’s your company’s policy and procedure that you put all management company employees through a polygraph test. Then watch them turn 50 shades of white…. (Yes, we’ve done this.)
So it’s best that you find a new, institutional-grade property manager.
Starting Your Bank Step 6: Rinse, Wash & Repeat.
Yes, I know this is obvious.
But it really isn’t.
Here’s why: Too many people are perfectionists.
They want to be involved in everything. That is ridiculous and they are setting themselves up for failure.
Your sole job, your only purpose in this business, is to find deals and fund them. Anything else is just busy work and doesn’t add any value.
How do you do this?
Get back on the phones and in front of your investors. Send an email note telling them about the deal you just closed; how it was found, how it was structured, and how you’ve placed a professional management company in and the servicing company that you’re using who are paying the monthly payments via ACH directly into your private investors self-directed IRAs.
If you are focused and determined, this system gives you the ability to quietly build an empire within the next 4 years.
So… You Want To Start A Fund?
The next level is raising a fund, but we won’t get to that here, that’s all teed-up to go on my 2nd book, Raising Real Money: The Foundational Handbook For Aspiring Real Estate Fund Managers, that will be released real soon.
And that is one read you’re not going to want to miss.
And considering that my last book is trading at $1,800 per hard copy, you’ll want to buy this.
If you really like how this business works and you like these strategies rather than having to use a bank, then you’ll really love this.
(NOTE: Before you go, don’t forget to download your free resource for raising millions in capital for all your real estate deals with a “Wall Street” grade, done for you investor Pitchbook. Grab it here.)