Step 6: Part 2

Welcome. This is the Insider's Edge to Real Estate Investing with James Nelson, the principal and head of Avis and Young's Tri State Investment Sales Group. In this program you'll learn game changing strategies to outperform the market. James will teach you how to source, execute and capitalize on the best real estate opportunities in New York and around the world. Now here's your host.

Welcome everyone to episode number 123 of the Insider's Edge to Real Estate Investing. This is your host, James Nelson, principal and head of Tri State Investment Sales at Avison Young. Thank you as always for joining. It means so much to me your comments, you're reaching out. Many of you have linked in with me at James Nelson nyc. You've asked questions that we're getting to, we're addressing on this show and the whole point here is we are helping you gain the inside edge to real estate investing so you can outperform the market. And that is the title and subtitle of the upcoming book that I am working on with my writing partner Rachel Hartman. Looks like we are on track for a release end of January, early February. So good things to come. Some of you have asked when do the pre orders begin? I appreciate that we are getting set up for that now where we will launch that on James Nelson.com youm can go there now. That's where you can find the show notes to this episode as well as helpful resources for you to be the best investor possible. So if you're just joining us for the first time, we're in the midst of a series which the book is based on where we're taking you step by step how to Become the Best Investor possible. And we are at step six which is raising capital and this is a part two. So if you did not hear last week's show I would go back and give that a listen. But today we have a special treat for you. In with us we have Derek Aiken who I've known for quite some time and in the interview I'm going to give you a little more information on how we've worked together successfully on raising two funds and executing those with River Oak nyc. But now Derek is a portfolio manager and at RMR which is a publicly traded asset management firm. They have over 30 offices nationwide, 37 billion assets under management. So tremendous experience that he brings to the table. He is also an adjunct professor at nyu. So for those of you who are in the New York area, I would definitely check out and see if he's teaching that course I always get asked, James, if I want to go back and get some higher learning, some education. I don't know if I can take on an entire master's program. Well, look, you can go to schools like NYU or Fordham and take a couple courses and start building towards that over time. But Derek teaches a great course on underwriting. Today he's going to be talking about the capital stack and we're going to talk about how you structure those investments. So in this episode, Derek is going to talk about the layers of the capital stack, covering debt and equity components along with the risk and rewards to be aware of. He guides us through sources and uses documents and explains why it is essential essential to create one when raising capital. Rachel, who you all probably know by now, does an incredible job interviewing, asking the right questions. She pens content for Fortune 500 companies and is a regular contributor contributor for U.S. news and World Report. So with that, we're going to have a brief word from our sponsor and we're going to get right into that discussion with Derek and Rachel.

A different approach to putting our clients first Avis and Young's Tri State Investment Sales Group sells multifamily office, retail, development and specialty sales throughout the New York metro area. As experienced thought leaders in our industry, our 35 member group is available to help you make informed investment decisions by advising you on your current holdings or identifying new opportunities in the marketplace. Our one unified team is built on an industry unique platform which promotes unparalleled collaboration and and teamwork. We share core values of hard work, integrity and expertise. We put our clients first providing tailor made strategies to achieve superior results. Please Visit us at aytristateinvestmentsales.com and follow us on Twitter, LinkedIn and Instagram amesnelsonnyc to learn more.

So welcome everybody. I've got a great treat for you today. I've got my friends Derek Akin and Rachel Hartman here on the show and for once I'm going to be stepping back a little bit and that's tough for me to do because if you've been listening to my show for a while, you know that I like to talk. I can't help it. But Derek has incredible knowledge here that he's been gracious enough to share with us. So I met Derek over it's probably been at least 10 years when we.

Reached out and ended up working on.

A fund together River Oak NYC 1 and 2 and we worked on we raised about $50 million. We invested in almost three dozen assets with a total capitalization of $350 million. And Derek, it was a small fund asset manager, so he wore a lot of hats ultimately as the chief investment officer. But he had a direct hand not only in helping source these opportunities, so finding out, you know what all about the deal, underwriting them, underwriting the sponsor also, and then structuring the transactions. And that's what I really want our listeners to hear about today is how these deals are put together. The capital stack. So how do you raise equity, how do you finance, how do you underwrite these things? I know you all are going to get a ton out of this and Rachel has such an awesome way of kind of breaking things down, asking these questions, helping unpack all this knowledge. So I'm going to just turn over the mic to Rachel and I might not be able to help myself. I might have to jump in there, maybe ask a question here, there, maybe give, you know, a little bit of commentary. But I'm going to sit back because I know whenever I hear Derek, I learn a ton as well. So Ra Rachel, over to you.

I completely agree. Derek is just a mastermind. He's such an expert in this area. And yes, James, you're always delightful to listen to as well. So feel free to jump in. But I'm really looking forward to diving into this topic. I think it's so important and critical piece as we look at real estate investments to understand. So I'd love to dive in, Derek, and have you walk us through some of these common terms that you hear as you go through this process. I know sometimes, and actually James just mentioned it too, we hear about the capital stack. Could you walk us through what that's referring to? Perhaps would be a good starting point and then the value of that capital stack.

Absolutely. And James, thanks for having me on. It's a pleasure. Love the show. I also like to manage expectations when it comes to acquiring my properties when I'm wearing my investor hat. So when the word mastermind is used, I immediately worry. But at any rate, let's dive in. So yeah, capital stack, that is a big term thrown around a lot and really, in short, it's really just a summary of the equity and the debt that compiles a transaction. So you could think of it also in the form of sources of where the money is coming from to purchase a specific asset that an investor is chasing after. And really the two main categories are equity and debt. And depending on the complexity of the transaction and the investor, those two categories can get as simple or complicated as you can possibly imagine. So think of it. On the most basic form of an investor that wants to buy something, all cash, that is just putting in their money and there's no debt instrument and so forth. The polar opposite of that would be something that's highly leveraged with components of senior debt. It could be another layer of debt after a senior first instrument. And then on the equity side could have partnerships as well, that kind of break into further subcategories of member interests and preferred equity partners, common equity partners. So, you know, when we kind of refer to the capital stack or the cap stack, the other component aside from just those pieces would be this concept of risk and reward. So going back to that original point about an investor that purchases something on an all cash basis, that's really a low risk structure in the sense that there is no lien, there is no lender, there are no debt covenants that a lender might tell that investor, hey, Mr. Owner, you now are in kind of default of your loan because you're, you're not hitting a certain requirement or covenant as it's commonly referred to. And so it's really a very conservative way of structuring a transaction and then going to the other side of that. The more partners that you bring on, on the equity side, the more debt that you structure, the potential higher reward you can generate and we can get into that later. But also the higher the risk. And so it's a typical kind of positive correlation in the sense that the higher the leverage, the higher the risk, but also the higher the reward. And we can talk about that further. But I'll take a pause at this point.

Certainly. No, that's a great way to get us started. I watched a presentation you gave on the Sources and Uses document and how that comes into play during these steps. And, and as I was watching it, I thought this is something that all beginner investors should be watching with me. So I'm really happy to have you here to share a little bit about that with us. Perhaps we can start with an overview of what the Sources and Uses document is so that we have a working definition. And then you talk a little bit about how it's used.

Absolutely. So, so we've talked about Capital Stack and now we're kind of going back to sources and uses. And so just terminology wise, they are two different terms that are quite similar though. Sources and uses is really a breakdown of how the investor will spend various sources to acquire an asset. And then the sources are really just where the capital is coming from and as it correlates back to the concept of a cap stack, really the capital stack is that sources, but with that concept of risk and reward layered in. And to your earlier point about beginning investors, I just wanted to note quickly, even if an investor has never purchased, I think, an asset before and they're just thinking about it, or maybe they've purchased a home, whether or not they've actually realized it, they are in fact putting together sources and uses, especially if they didn't purchase their home with cash, which is usually not the case. So what's happening there is you have to pay for various transaction costs. Right. You've got to pay the lender, they've got various reports that they have to pay, and ultimately the transaction has expenses beyond just what the purchase price of an asset is. And that all kind of comes together as your, your total uses. And then the question is, where does all that money come from? That is your sources.

Perfect. Thanks for tying those two together and talking about the correlation between the two. So when you look at the Sources and uses document, I'm curious if you can talk about how that's created, for example, if a beginning investor is making that document, if they make it and it's done, if it's something that might change and how it might change as you go through the process.

Sure. And just to back up too, I think that when you're creating the document, you may not necessarily. You might be creating it multiple times or really thinking about it in your mind at the very beginning in the sense of if you identify a specific asset to go chase after because you like the looks of the price for the bricks, you've already kind of in your mind circled a portion of your sources and uses, that being the uses side. Right. Because you like the price and you're starting to frame out in your mind how this thing could be a potential investment. And then you start layering in, well, I've got X for dollars to put into this, or maybe I have various kind of commitments from either if you're starting out family members or on the more institutional side, maybe you have a partner that has kind of a mandate for you to go out and buy XYZ property types. And so you start to round out in your mind how much equity and or debt, slash, leverage you want to put into a specific transaction. So it's really, I think, to think about the sources and uses as a fluid instrument throughout the life cycle of an acquisition and even beyond that is the right way to think about it. And it will iterate over the periods, the various kind of due diligence, pursuit, acquisitions, and then through closing, it will change and invariably it will not. What ends up being your actual uses and your actual sources can fluctuate throughout that period of time.

Perfect. That's a great overview. So I've heard some of your examples on the presentation that you gave. I'm curious for the sake of this podcast, if you could walk us through. Let's say we have a beginning investor. They want to make a sources and uses document. They have a property in mind. Can you talk us through about how they might go about building that? Maybe we can use an example of a type of property as well.

Of course. And I'll do my best not to get into specific numbers so I don't trip myself up on the fly. But in thinking about a beginning investor and just in James's neighborhood, let's use New York. So you've got a lot of multifamily assets in that kind of smaller middle market size. And an investor may hone in on a two or a four bedroom structure and start really thinking about, okay, you know, this is a $4 million purchase price, but these bedrooms, they look like they need renovated. And it looks like this previous owner really just cared about, you know, maybe they lived in Florida, maybe it was something handed down through an estate, an estate and therefore they didn't focus on maximizing every last dollar out of this investment. And I can go in and create some value by renovating these, these apartment units. Or maybe there's some base building work that needs to go, go into it as well. And going back to the sources piece of that does that match up? Say I've got a rich uncle James, if you will, that has, has promised to help me start out my, my career and he's willing to, you know, provide X, Y, Z in dollars and that's equity, by the way, to kind of springboard my career in real estate. And so does that, you know, we, I think I said $4 million acquisition before. Does that match up with what, what I have available to me, so to speak, in form of equity? So, and going in again to that cap stack and structure, maybe you only have, you know, a $400,000 equity commitment. So if you're looking at a $4 million buy and you're going to try to renovate those units, it's going to cost money to do that. Where's the money all going to come from? And how much does that look like in total? Maybe it's actually $5 million in total uses. Right. The $4 million purchase closing costs and then cost to renovate the units. And you can only get maybe 75% from a bank perhaps, and whatever that math is, right, $3 million of debt. And so where are you going to get that $2 million of debt that $5 million of total uses less that $3 million of bank sources? And maybe you need to look at it and say this is a little bit too big for me. Or maybe you go out and you find some more, you know, pass the hat around your family. And so that's really kind of starting to develop out in investors mind how that sources and uses looks. And almost in a way, of course, what you have available to you will dictate what you should be looking at in terms of size of opportunity and also in terms of risk. Because if you know, rich uncle James doesn't really want to put his dollars at risk, then maybe buying multifamily in New York makes sense. But maybe buying in a tertiary or secondary market where $4 million building is now $2 million and you can do it has less liquidity to it based on the market. So all these are factors that I think as a beginning investor are just, it's invariably going to have to be a. Let me start cutting my teeth on a deal learning process because really you want to read and educate yourself as much as you possibly can, but nothing is going to replace actual real world experience.

Hey guys, Uncle James here.

No, James, that was a rich uncle James. This is a different James we're speaking to now. Go ahead.

So you said so many great things there. So I just, I want to mention one thing in particular that you talked about finding the seller's motivation and that value add, and that is a really, really big piece of the value equation here is finding that opportunity not just a great price, but also what you really think has been mismanaged. And so I know you're going to get to this and talking about the importance when you invest, kind of looking for the right sponsor in the business plan. But I wanted to make sure that our audience caught that because finding out the seller's motivation is super important. And then the other question I was going to ask because you talked about, you know, you know, equity sources and you talked about, you know, rich uncle James or you know, finding, you know, a fund, but maybe talk a little bit more about that because that is one of the biggest, I think fears, I think that a lot of aspiring investors have or hesitations, where are they going to go find the money? So you know, you deal with Sponsors all the time, you know, who are looking for investment. I mean, where are they? How are they usually pulling this together? What are the various sources out there? And I know you got a lot more to talk about, but I think it's maybe important just because you've got that.

Sure. Well, you know, in thinking about that question, the reality is that they're not. There's no easy answer in the sense that as you're starting out as an investor, if it was an easy way to make money, everybody would do it. Right. So part of this is it's a competitive world. And as you're trying to find an opportunity, especially in the likes of a New York City or one of the more highly competitive markets throughout the country, it's obviously not recreating any wheels. So I think part of it is just educating yourself as best you can. But then in terms of going to your point about where do these investors start out sourcing equity? A lot of the times it starts out with a relationship because there's trust there. And that's why I gave the example of the family member that that's kind of taking a flyer on you potentially. And that's not to say that there aren't hundreds or thousands or whatever the number is of successful entrepreneurial minded investors that have done it from scratch. We can all think of number of folks that click that box. But a lot of the times starting out small and building what we call a track record with kind of friends and family money, if you will, is how investors will kind of be funneled into starting the process because of that trust factor and because finding institutional sources at a smaller deal size is not exactly commonplace. In fact, there's few funds that I can think of that are willing to cut kind of smaller checks. But the good news here is that I think if you're willing to put in the sweat equity and the time and the effort, and you know, the good news on real estate is you're not creating the next vaccine. It's not rocket science. On some level it takes hard work, it takes a roll up the sleeves mentality, but you can do it. And I think that the point being that if you build that track record and you generate returns for investors, for your friends and family or whomever your partners are, you will start to build a reputation. And that I think in this industry is worth well more than the knowledge itself alone. And what can kind of generate you an easier path on a move forward basis as you're looking to acquire more real estate and source it on the equity side and debt as well.

Perfect. That's just an excellent explanation. Derek. I have a few follow up questions. Let me start with this one. You mentioned institutional lenders. Can we maybe just give a quick explanation of that so we know what we're referring to, especially when we talk about what beginning investors might have access to and what they might not?

Of course. And by the way, there are institutional investors, both from the standpoint of debt and equity. And so, you know, when I say that it's hard to tap into that institutional marketplace, it's like anything else. The devil's in the details. There's kind of a gradient or a scale or a spectrum of different institutions out there, ranging from kind of a smaller, more basic fund to the Wells Fargo's of The World or BlackRock or KKR and Blackstones that are raising multiples of billions of dollars and putting that equity out. So I think that in general, though, there are smaller funds that are willing to potentially work with what are called kind of emerging sponsors and sponsors, just kind of a jargon real estate word for the person who's buying the real estate or the entity who's buying the real estate. And again, the better that a aspiring real estate investor protects their track record. Keep that close to your chest. More so, more importantly than return, more importantly than anything else, you want to make sure that you don't take kind of initial undue risk because if you come out swinging for that grand slam and you miss it might not necessarily be your fault that you missed. It could have been for exogenous market factors outside of your control. But if you take a more conservative standpoint, you'll reduce that likelihood of having a lose situation for one of your first few investors. So in my opinion, I'd always want to start out small. And that's also going to translate again into being more attractive to those smaller institutions that you'll start out accessing.

Perfect. That makes sense. Thank you. We've talked a little bit and mentioned a couple of times reaching out to family and friends as, excuse me, as a natural part of this process. I'm curious if you could share with us if any tips you have. For example, how does that process go? What are some best practices you often suggest to others when working with family and friends. Are we talking about handshake deals? Are we talking about getting things in writing?

Yeah, those are good questions. And I think perhaps this falls into the category of a common sense comment or not on my behalf, but I think for me it all comes into transparency and communication. That is accurate and timely. Nobody wants to be told one thing and then find out something else later on. And it could be by the way that you tell them one thing and that something does change. But I think the communication of transparency and timely communication is important in the process of establishing what it's going to be like to work with you as a partner, as an equity investor. And I think of course you want to do your best to provide the right information that that specific investor would like to see. And that's not always the same across the board. There's varying degrees of what one investor thinks is important as opposed to the next guy in the room. But I think generally the idea is smart, honest, transparent communications that are frequent so that especially at the beginning of building rapport, your investors at the very minimum feel like you are on top of investing their money in a safe, smart and sophisticated way as best you can. And I think if you're in this business long enough, you'll realize not every investment is a winner. But I think if you have a strong relationship with your various partners and have communicated along the way, opposed to if you have a negative news situation that just feels difficult to communicate and you don't want to have to tell somebody that. And so you sit on something until it's too late and, and they hear about it the wrong way, that that is how you can probably create a short, short life industry or I should say a short career in the industry.

Which we don't want. Right. These are great tips. Thanks for steering us on the right path with that. Okay, good. And you know, I'm curious, we talked about how things can change, the importance of being transparent at every step, which I just love. I'm curious if you can talk us through an example using that sources and uses document about how things might change. Perhaps we can go back to that example you started with with the 4 million or $5 purchase you might be considering.

Happy to do it. And again, if I get my math wrong on the fly, apologies in advance. But let's say, let's say that you're going out and you think that that $4 million buy is a good buy and you think a million dollars is the right number from the standpoint of all your closing costs and what work is going to be required to kind of renovate that apartment building. And then later on in the due diligence process you come to find out that there is some what we call base building problems or the roof needs some work and you didn't really know that at the initial kind of development of your budget, your uses. And so you have to kind of do a couple things. One, add that into the equation. And two, as your uses increases in this specific example, so too is your need for your sources to increase. Because one kind of key takeaway is your sources always needs to equal your uses when you're presenting to various investors. And that's not to say, by the way, that in actuality, your budget, your uses, is going to equal exactly your sources, but when you're presenting it, when you're underwriting it, that concept is there. And so, you know, to go back to our example of your uses going up and then what happens on your sources, that money is going to come from somewhere, right? So let's say your $5 million was, I don't know, $3 million of debt and $2 million of equity, and now your. Your costs are going up. Does that mean your $2 million of equity becomes $2.2 million because you need a $200,000 renovation that you didn't include? Or does that mean that potentially you can go back to your XYZ bank and say, you know, we need a little more, a little less, you know, or maybe you were a conservative at your, your 75% LTV, and they can go up to 80% or maybe, you know, just to be a little bit more realistic, it was a scenario where you're only 50% leveraged, because I think generally 75, 80% is pretty high. But, you know, is there room for your lender to accommodate the situation, if you will, you know, or do you need to kind of go back to equity?

Right, exactly along those lines. I'm wondering if you can talk to us a little bit about those options. For example, might it be pretty common that the lender would, in that case you mentioned, extend or include more or. Not necessarily. Obviously, this is all hypothetical. I'm not asking you to make concrete statements that we take away forever and ever here. But I'm just curious as far as, when we look at equity funding options, what might be available? Especially because we've talked about that sometimes, you know, that access to some of the institutional funds might not be available.

Yeah, I think generally that it's harder on the debt side for adjustments to be made. And I think it ends up kind of falling on the shoulders of the equity side. And by the way, going back to our cap stack and high risk, high reward, the equity in a project has a higher kind of theoretical return on it for taking that additional risk. And the debt has A lower theoretical return. And so there's this concept of a leveraged return where just taking a step back again, why does one even go out and get debt at all, assuming just a world where you have all the equity to buy it? Well, the answer is because you can generate what's called a higher leverage return. And so if you're buying a piece of real estate and you're generating whatever a 12% or a 13% return on it, but you're borrowing 75% of the money that's generating that return, and you're only paying an interest rate of 3 or 4%, say or 5%, perhaps today, then you're kind of leveraging that borrowings, you're paying a fixed interest expense, you know, a payment to that, to that specific lender on something that you're going out and you're investing at a higher rate of return. And so you have a positive arbitrage there. So that's just kind of like a side note. I hope I didn't digress too much.

Your timing is actually perfect because I wanted to circle back to the risk and rewards that you brought up earlier. So thanks for leading us into that, especially when we talk about these stuff steps. I'm curious if you can speak a little bit more on those risks and rewards that you brought up. What should beginning investors be aware of?

Sure, and I'll drill down into naming too. So, you know, obviously there's those two kind of sides of it, the debt and the equity. But then let's start with the higher reward, higher risk side within a equity stack, if you will, or within the part of the stack that's equity, you can have what are called kind of common or preferred equity components. And again, this is getting into slightly more, you know, complex. But even if you have that kind of simple example of friends and family, what you're likely doing is structuring some agreement between the two parties. Say perhaps you have $100 of equity into a transaction and you're borrowing 80 or 90 of it from, from family and friends and putting in 10 or 20 of it yourself. And maybe you're, you're offering up that 80 or $90 of friends and family money that you're going to pay them back their money first plus some return on their money. And then only after that will you start kind of participating in it. And then by the way, those dollars aren't, you know, return dollars aren't going to be available until you've kind of satisfied your debt service requirements on any debt that you've layered into the equation as well, which, you know, again could be senior debt, mezzanine note instruments and so forth, but that have typically a fixed payback based on some percentage. And it could be amortizing, it could be interest only and so forth. And so that kind of, let's say a transaction does very well. Right? And so you've got that 75 or 60%, whatever your debt component is, that you have a set fixed payback to them. You could have a floating rate instrument as well, where that does vary over time. But just for simplicity sake, you're paying them kind of like a fixed number to pay that obligation. And then you get to move into paying your equity and your common and your preferred and so forth. And even within that, you can have what are called kind of preferred equity partners that maybe you have a fixed 12% rather than like a debt instrument that's a fixed 5%. And for that kind of preferred equity component, you're paying them that fixed 10 or 12%. But then after that's paid off, you get to keep everything that's left. Right. And so on a highly successful transaction, that could be that. That's unlimited upside. Right? That's what we're talking about with higher risk, higher reward, because you get paid last, but you get paid, you know, an uncapped amount, if you will.

Are you saying that we should rename our book or show unlimited upside? That sounds like Sign me up for that T shirt. I want some of that.

I didn't get the nickname Mastermind for nothing. No, please, that's not what I'm saying.

I love it. You do a good job of laying out the risks, but then like you said, there's also the reward and the potential there. So that actually is one of the things I wanted to ask you. I'm curious. You know, we talked that about the sources and uses document. We've said it's an important tool. Can you talk a little bit about why the value in it? I'm particularly interested in are there positive outcomes that you see happen when this is created? Well, perhaps, you know, you also could speak to the downside. What happens if it's not? I guess as well.

Sure. And pardon me if I don't, and if I don't directly answer that, but I think you're kind of getting also towards underwriting, the concept of, you know, figuring out what the transaction costs and the business plan will cost numerically. And a lot of the times you can have conservative underwriters, you can have more aggressive underwriting And I think the wins are those times where there's good news situations. It didn't cost you extra money, you reserved more money than you need, and now you. Therefore it's a boon to the numbers as opposed to we got to find more money. And again, as that pertains to sources and uses, if you just look into kind of the uses side of the equation, for example, you really have buckets of various uses. You've got purchase price, you've got transaction costs which include all your due diligence, your attorney's fees to put docs together, and brokerage commissions, I don't know who pays those. And then, and then you've got, really, if it's a development or something that has a component of work to it, you've got hard costs and soft costs. And really just think about like hard costs as something that you're actually, you know, renovating or doing, and soft costs, which are more like architectural fees and, and leasing costs and marketing costs. But my point being that all those various categories have kind of estimations to it. And with that comes the concept of a contingency. Right. And if your contingency is conservative enough, 5 or 10% of your total hard cost, for example, then you've got room there between actuals and budget, where you don't have to go, so to speak, over budget, if you will, and getting accurate and sharpening the pencil enough to the point where you don't have that surprise situation again is, I think, where every investor is just trying to look to be perfect.

Also, speaking up to the importance and value of this document, I'm curious if the sources and uses document, if you could share with us, if this is something that you're going to see at every deal. Are people asking for it? Not necessarily, but it's good to have talk to us about how it comes out. Who's looking at it?

Sure. Well, certainly on a more institutional basis, it will always be part of the equation. And it will be part of the equation for all of the various parties involved. The lenders will want to see it. The investor should absolutely be working in it daily. Various equity partners. I think it's through and through, very important. And whether or not, by the way, on a smaller, less institutional acquisition, you are actually doing a sources and uses, it does exist. Whether or not you're putting the pencil down and scratching it out and visualizing it and creating does absolutely exist.

Do you mean that it does exist, maybe in a different form? Maybe we see it in a business plan or a separate Document.

I just mean that if you're buying something and there's transaction costs to it, there's whether or not you're actually thinking about it or producing it for a lender or so forth, obviously the concept exists, it's just whether or not you're putting it together. That's really what I just meant.

Perfect, that makes sense. Thanks for clearing that up. And then James and I have talked about with some of these other steps, the importance of building a team, you know, bringing in other team members. This is certainly not something that anybody does on their own. So I'm curious, when it comes to the sources and uses document, who is making it or who are we asking for input? Who are we bringing in from the team to contribute it to it? I know we talked about who's looking at it, but, but if you're looking, you know, if I'm the investor, who am I bouncing this off of? Who am I asking for input on?

Well, I think if you're that aspiring investor that's actually going to be going out and finding the real estate, that they are the quarterback and ultimately the person putting this together now, that means that they're going to need to go out and get this information from many different sources. So, you know, for example, the bank is going to provide that investor what their costs for doing business are going to be. The investor is going to need to go to various third party providers to run kind of typical reports, property condition report, environmental report, getting a cost estimate perhaps from contractors on what their scope of work may cost. So, and then, but just ultimately that investor is the one who really takes that close to the vest, ownership of the document and putting it together.

Perfect, thanks. Thanks for that explanation. I know in one of our previous discussions you had talked a little bit about. You have what adding more equity means for the return, especially when it comes to the internal rate of return. I'm curious if you can talk, you mentioned a little bit before. I'm curious if you can talk a little bit more about how that plays out and your thoughts on it.

Yeah, sure. And you mentioned internal rate of return or irr, which is really a common metric in finance, which just really helps an investor compare apples to apples, different investments together and what you're doing not to get too far into it, but in understanding the time value of money, there's a future cash flow stream that you expect this investment to generate and it will yield some return. And the IRR is the metric by which that return is measured. But just going back to your question, about equity and what happens when you have to put more equity in a transaction? If you think about it and you, you give somebody a hundred dollars and they prompt or you give somebody a dollar or now yeah, yeah, you give somebody $100 and they promise you to give you $10 every year for five years and then give you $200 at the end of that period of time, then you're gonna have made some certain amount of money and that will ultimately translate to some IRR and everything else. But all of a sudden if you need more than that hundred dollars, that person says, you know what, it's actually $200 that I'm going to need from you. But that return stream that, you know, $10 for the next five years plus, you know, payout at the end of it is going to stay the same. Well, what happens, you have less for more, if you will, or the same amount for more equity. And so the more equity you have to put into the transaction, the lower your return gets. But at the same time, pulling this back to what I was trying to explain before about wanting your first couple of deals to be successes, the more conservative you get or the more padding a transaction has, the more comfort you are that you're not going to get into trouble with a bank or you've got reserves if something unforeseen comes up. And so I would err on the side of probably for the first few deals making sure you feel over capitalized, if you will, on the equity side, despite the fact that that will in fact reduce kind of your return metrics. And another good one by the way, in addition to IRR is cash on cash, which in that simple example I said before, when you're getting $10 for $100, that's a 10% cash on cash return, if you will. The cash on cash will go down the more money you have into a deal. But again, I think the end all be all big picture is you have to protect your track record vigilantly and nothing can get in the way of that because that's ultimately going to be what helps you generate additional equity sources in the future and build more magnitude and velocity in your career.

So true and great point. This has been incredibly insightful and helpful. Thank you, Derek. I think as my last question I would ask there's any final key takeaways you'd like to leave with listeners, especially when it comes to this important document we've been talking about sources and uses for the capital stack.

Sure. No, this was a great conversation. Happy to partake and again, thanks for the invite. I would only leave you perhaps with one general thought as a new potential investor is looking to get into a market or into the field. Real estate is a hyper local market. So at the risk of sounding like a commercial for James, I think it's important that you have brokers that you can trust and players in the market that you can trust because you're going to need to get into a lot of different details and it's going to be impossible to do it all yourself. So you're going to need to find trustworthy partners as you're building out your career. And there's just no better way to do it than just picking up the phone or walking in and having a coffee with someone. So I would say in real estate, it's a hyperlocal market. Stick to your knitting, pick one location and become the maven and know the players.

Perfect. Great ending. And that speaks to some of the other points James and I will be talking about and have covered in the other steps along the way. So thanks again, Derek. We really appreciate you joining us and we look forward to connecting in the future.

Thank you, Derek. Yeah, that was awesome. I hope our listeners took a lot of notes. I definitely learned something and we really appreciate your. You're breaking it down. So thank you again.

Thank you.

All right everybody, that wraps another episode of the Insider's Edge to Real Estate Investing. Thank you as always for joining. Thank you for listening and telling your friends about this and week by week, hopefully these are building blocks that you are taking in and you are getting certainly game changing strategies to outperform the market here. That's, that's what we're doing. It also happens to be the subtitle of our book that we're working on. Great Things to Come and Derek is also helping collaborate on the book. We want to make this the best possible product so we are really, really grateful. Rachel, as always, awesome job, incredible questions. I love how you break everything down. So until next week everybody, thanks again for listening.

Foreign.

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