The 5 Biggest Factors to Consider when Investing in Real Estate with Adam Hooper

Foreign.

Welcome everyone to the Main Street Business Podcast with Matt Sorenson and Mark Kohler. We're excited to be with you today. And we even have a guest.

Wow, this is special. And his microphone looks better than ours too, so that's intimidating. Yeah.

You know, this is Adam Hooper. He's the CEO of Real Crowd. He also has a podcast himself and apparently he's got better podcasting gear than we do.

I don't know, you guys. That's what we were saying. You're, you're far more ambitious doing, doing video and remote. So we just, we just hide out in the podcast studio and try to keep it simple.

Okay. Well, you can see, you know, we're just working from our offices or Mark's on the patio there, you know.

Yeah.

On location.

That's right. Because, you know, there's, there's no vacations from the podcast.

All right.

There's no such thing. You must show up. Well, today we're talking about a cool topic, the five factors to consider when investing in real estate. And so Adam has been, is the CEO of RealCrowd. They're essentially a funding portal for people who want to invest into real estate deals or people investment sponsors raising money for real estate deals. And this is usually bigger than the duplex down the street. You know, these are usually larger real estate offerings, of course. And so I think he's got a lot of great insights from there and growing out that business. They're also, they are an RIA now working with other RIAs who want to get their clients into real estate. So I'm interested in his perspective there on just, you know, helping other RAs get over the real estate hump. Right. They just want to sell them a mutual fund or a whole life policy or something, you know. So why don't you tell us that? I'm, I'm just curious on the outset, like, what, how are you guys working with RAs and what's the conversation like on getting them to be engaged in real estate?

Yeah, And I think maybe even taking a step further back than that. Right. The progression that got us to that stage was really a reflection reaction to what we were seeing on the marketplace. Right. So the core business Real Crowd started that almost eight years ago now. $7 billion of real estate through the platform, all self directed with individual investors. Throughout that time, we would see people making investment decisions based on a target return. Right. That was really their primary investment criteria was which one has the highest return. And I'm just going to put all my money into that deal, which we didn't think is necessarily the best investment philosophy. And at the same time having a bunch of RAs that were investing their own capital into these deals but they couldn't invest their clients capital because hey, I found a cool deal on the Internet didn't really meet their fiduciary standards. And so we saw now a need to. Oh yeah, go ahead.

I've got to ask you to do this too because there's a lot of listeners of ours out there that don't even know what an RIA is. Could you define that for us? That might be a good starting point

too, if you don't mind. Sure, sure. So, so an ria, not an ira. So an RIA is a, is a registered investment advisor, right? A, a wealth manager financial advisor. We choose to work with independent RIAs, right. So not they're not with a big brokerage house. They're typically a fee only, so they charge just a flat percentage on assets under management. You're not charging commissions for trades and tend to look at things through a more holistic financial picture than just a product pusher. Right. So when we looked at how we wanted to change our business and we formed again a wholly owned subsidiary. It's called reallocate. Pretty simple. Just reallocate.com trying to figure out who we wanted to work with in that space and going with the independent advisors we, with that fiduciary standard was a better fit for how we wanted to help people make better decisions. Like in the context of their whole portfolio, right. Not looking at just their real estate bucket in the silo, but really working with professionals that have, you know, they have the planning tools, they have the tax optimization strategies, they have more of a holistic plan with their, their financial picture in total. And then we can work with them at Reallocate to figure out, you know, where does real estate fit into that and then how do we make sure that we're putting the right portfolio of risk into their, into their investments rather than looking at a real estate investment just through a return lens or without any context for the rest of their financial picture.

Now Mark and I, it's funny, I was just up in Mark's house in Idaho last weekend complaining about financial advisors who it's like can we get some that can like talk about a self directed IRA that can talk about investing in real estate? Like how does someone find a financial advisor? We find them very hard to come by that can find a financial advisor that'll talk to you about your real estate deal, talk to you about your Business talk to you about self directing. Are those out there, are they like unicorns?

Yeah, they're. They're hard to find for sure. Right. And I think the distinction between again, a fee only independent ria, right. They have the latitude to be more custom in how they approach things. They're not being, they're not being pushed product from the top down and saying you can only sell these different investment vehicles. So independent RAs generally, you know, they're their own small business owners. They have much more flexibility in how they can look at a retirement portfolio or just overall investable assets. We've actually partnered with one of the bigger ones in the country called Mariner Wealth Advisors. We have a partnership with them for people that are interested in getting. Maybe they're not working with an advisor right now, but they want to have a more holistic financial picture. They understand private investments, they understand real estate. We work very closely with them to help get those people access to someone that can look at it holistically and then figure out with us where does real estate fit into there, how can that fit into their portfolio. But I agree it can be challenging to find someone and we were just talking on our show, Matt, of the kind of legacy financial services are so locked into those cookie cutter products because it's more work, right? I mean it's more work to try to figure out how to include that in your portfolio than just here, take this bucket of mutual funds. It's a lot easier for the advisor. They're getting paid the same thing. So a lot of them don't want to take on that extra work. And that's where we see we can kind of slot in there as those real estate experts use a lot of this methodology that we've created living at that intersection of client risk and real estate risk and make it much more accessible and easy to understand for them and how that can work for their clients versus the traditional publicly available REITs and other vehicles.

All right, so you have some referral sources that if a client came through your office and said I want real estate, I don't have an ria. I would really like someone to help me with budgeting and help me with Social Security allocation or and really look at my overall investment portfolio, whether or not sold the next coolest thing for the month at. We shouldn't mention any brokers names, should we, Matt? So I'm just gonna say the next

whole life policy so that that guy can qualify for the cruise, right?

Yeah. So you can send us refer. I mean send clients to interview some RIAs also, I just encourage our listeners to start googling in your local city, your local area. They can also be nationally helping clients, so don't feel like they have to be down the street. Gratefully, with COVID we've all learned how to use Zoom better, so I'd encourage all of you to look outside your normal circle of friends or clients in a local area. So when someone says, I want to find an RIA and buy some real estate, we really want those two people on the same page. The person that's going to be selling us real estate and the RA so they can help guide us. Is that. What's your perspective on that?

Yeah, and I think that's what's so important to us is again, looking at the real estate component as it is a component of the overall portfolio. Right. And so making sure that that is in line with the rest of their goals and the rest of their financial picture. That's why we find so much importance in working with an advisor that understands that full picture and then digging in a little bit more about what we're doing at Reallocate is really, again, that intersection of client risk and real estate risk. Right. So part of our process is an interview with the clients and an interview with their advisor of what are this client, what is their need for liquidity, what is their need for current yield? Are they higher risk, are they more aggressive, are they more conservative? What stage of their life in, Are they more for capital preservation or wealth creation? Understanding what their financial goals are, and then we can fit that into one of our portfolio models and then it gets into the real estate risk side, which is what Matt led off with, which are these five factors that we look at in our, in our methodology. And it really started around, you know, I think it's funny, our industry in the real estate space, we talk about risk adjusted return, but how can you have that conversation if you don't actually understand how much risk you're taking? Right. So, so our, our starting point was how can we actually quantify the amount of risk that people are taking in their. In these real estate investments? Put a framework and a methodology around that, and then we can build a portfolio of appropriate risk for these clients rather than just you kind of the gut feel of we're going to buy something that's 85% occupied, spend 12,000 a door to renovate. We'll target a 16% return. So we'll call it value add. Right. That, that was about as scientific as it got in our space. And so really Focusing on a methodology where we can figure out, you know, where on the x axis of risk, how much risk are we actually taking in these investments? And then how does that fit into the overall picture? Right. And so the five major factors that we settled on were, are the market, the manager, the physical asset itself, how the investment is capitalized, and the partnership structure. And so across those five different categories, there's, I don't know, 350, 400 different metrics that we look at and we analyze and then we distill that down into the more, I guess, industry standard terms of core, core plus value add opportunistic. So based on our methodology, we figure out which risk category does this asset really fit into? How much risk are you taking in this investment? And then we build a portfolio model around that. And that's what. Then the decision making process is, is, is making sure that there's a, the correct allocation to risk rather than just focusing on those target returns. And that, that works really well. Yeah, go ahead.

Sorry. I was like, oh, that was a lot there.

Yeah, I threw, I threw a lot of you there.

Yeah, let me, let me go back. So I think on, just to tie off the RA comment, so you mentioned raa, you know, and, and that is like, you know, in Tony Robbins book, people, you know, read his book. What's it on, on, what was that? Something like that. Yeah, something like that. But anyway, Tony Robbins last book, of course he goes after the financial services industry, but he comes out and says RIAs are fiduciaries. Right? This is the one that's like, are you a fiduciary? And you know, where they're not forced to sell you certain product, like Adam said. So if you're out there and like Mark said, doing the Google search, RIAs are more likely to be kind of no conflict of interest. They're more likely to allow you to do real estate because they're not forced to sell you an insurance product. If they're like, you know, if you're, if your financial advisor is at New York Life, you know, no, no offense, but what do you think they're going to sell you as an investment? A bunch of New York Life policies. Okay, Some whole life, some annuities. And so there's no shocker. They're gonna not be like, they're, you're gonna like, oh, I want to invest in this, in this fund that's buying in this apartment building. Nah, they ain't gonna do that. So let me summarize those five things though. I, I wrote Them down quick because you rattle them off pretty fast. So the five factors, and let's walk through each of them. The market, which makes sense. I want to talk about that. How do you know you're in a good market? The manager who's running that deal, the physical asset itself obviously would make sense. Now what's the fourth one?

The capital capitalization. So how, how is that project capitalized from, you know, debt and equity and some of the more typical financial metrics is what we look at there.

Okay.

And then the partnership structure.

Exactly. Yeah.

Okay, presuming a fund structure here, what's the, what's the structure for you?

Yeah, fund structure or even an individual deal. Right. So that an individual asset, again, this is, this is more generally investing in a, in a typically syndicated investment. This isn't if someone's going out and buying their own property on their own. Right. This would be more if you're partnering with a professional manager as an LLC or a limited partnership is what we typically see in our space.

Got it. Okay. How large are these projects too?

You know, on the marketplace side, I think our average deal size is 25 million, 25 to 30 million. A lot of multifamily. We've seen a lot of value at multifamily, especially in the last 12, 13 months. Right. The multifamily space has held up a lot more robustly than some of the other asset classes. Industrial obviously has done very well. Also on the, on the advisory side with Reallocate, though, the first, the first two deals we, we worked on, it was about a $340 million portfolio of two assets, one in Bellevue, Washington, one in Phoenix, Arizona. So those are pretty big, pretty big deals. And again, I think it's the, the caliber of manager that we want to work with on that side. These are still sub institutional in size, generally is what we'll see because there's still inefficiencies in that capital markets. Right. Once you start dealing with the bigger 50, $60 million plus properties, you're competing with institutional capital. And a lot of times the, the yield on those does get compressed just because there's so much capital chasing those deals. So the sweet spot, again, I would say under 50 million is kind of the typical deal size that we'll see. Sub institutional in size. But beyond maybe the mom and pop local regional buyers is where we see most of the, the assets in our, in our space.

Okay, well, let's go to one. Should we just start, number one?

Yeah, start there with the market.

The market. Phoenix, Arizona.

Phoenix Arizona and Bellevue, Washington. Right. So with the market, a lot of what we look at there is centered around employment, right. And unfortunately, given everything that's been going on the last year, plus with the pandemic, the employment's been hit pretty much across the board. So the market is one that's been interesting to watch in the sense that it's coming back as an elevated risk pretty much across the board. Right, Right. So we look at things like historical employment, right. What is the, what is the recent employment growth? What does current employment look relative to historical employment stats in the, in the market? Things like units are under construction, right. What is the, what is the new supply coming online relative to the current supply in the market? Right. Are we, if there's 100 units under construction and you have a 10,000 unit marketplace, that's less risk than if there's another 5,000 units being deployed or coming online in the next, you know, 12 to 18 months? So, and I guess how we, how we approach this model is really trying to look at based on what we know today and based on these factors, how they look historically, what is our assessment of risk at this point today, rather than a predictor of future returns or a predictor of future risk. Right. So we're looking at this based on all these factors that we look at that we know of, that we can quantify today. What's our snapshot of risk right now? And then how do we think that fits in relative to the historical picture of risk within those different, those different factors that we look at?

What about, are you guys looking at population growth? Like, is that a factor there too? I mean, obviously I think you want to be place where population's growing, there's demand for housing. This is whether you're a single family rental, you know, or you're buying a big multifamily deal. Then you want, you don't want unemployment, so you want strong employment.

I'm just kind of employment, you know. And, and also what is the nature of that employment? Right. Is it where there is one major employer that, that has the bulk of, of all the employment in that, in that area? Right. If you lose one employer and all of a sudden you've got a massive spike in unemployment, again, that's going to be more high risk than if you have a well diversified economy, right. Within jobs. So again, those are just kind of like the major factors that we look at. There's, there's a whole bunch of different, you know, sub factors to that. And again, population growth is a big one. Migration Patterns, you know, some of the coasts are seeing some, you know, we're seeing some exodus from some of the major metros into more, you know, southwest and some of those states. So definitely population migration patterns are another factor in that for sure.

And I presume that in this, these five quadrants that you're looking at, if you give up on a market, that might be really strong rental market and marketability, but you're looking at the market, but we might have a bigger shot for appreciation. So we're going to look at pros and cons of those five and say someone's more interested in long term growth versus cash flow. That's going to change what type of project you might look for them, I presume.

Yeah, and that's so. So part of the model and the methodology that we really tried to focus in on was to the extent we can, discounting any future projections, right. Underwriting pro formas, it's a set of guesses, right? I mean, let's be honest, it's. There's a bunch of assumptions and we're just kind of making a best guess at what we think the market might do in the future. And that's really hard to quantify objectively. Right? That's a lot of the kind of the art that still comes into real estate underwriting. And so with the model and methodology, we tried to separate out as much as we can. Now some of the financial metrics, of course we look at projections, but they're very low weight relative to some of the other ones that are more kind of concrete metrics that we know today, like loan to value at closing. Right. That is a fact. What a target IRR or what a stabilized cash on cash return is, that's more of a guess, right? That's kind of this future prediction based on these assumptions. So, so within the methodology we really try to look at what are those more concrete factors that we can quantify today objectively without assumptions and then, and then base our decisions around that. So in the appreciation side, again, that comes into somewhat of the capitalization, right. We look at some of the metrics at closing, relative to stabilization, relative to exit that would come into the partnership structure, right? Where we look at what percentage of returns are coming from cash flow versus appreciation. Right. Generally if you have a higher percentage of the returns coming from cash flow, that's going to be less risk than like a ground up development where almost all of your returns are going to be coming from this, this kind of capital event at the end of that asset versus you know, a 25 year absolute net lease to Walgreens, that's almost entirely cash flow. Right. So just different, different risk specters there. When you're, when you're looking at the composition of those returns as well, I think maybe that's, that's kind of what you were getting to.

Yeah. Yep, yep. What's the minimum investment for someone too? I just want to get that out there too. Like if someone says, hey, I want to use my IRA, my 401k or personal money, how can they.

Yeah, it varies, you know, sometimes down to 25,000. Usually 25 to 50,000 is where we see the sweet spot. Some of the investments, again, if it's a larger investment, could be up near a hundred thousand. Some of the funds that we've seen have been at 100,000, but generally between 25 and 50,000 is that sweet spot of where we see those investments, minimum investments. Which is, which is what's really exciting is that we can leverage all the efficiencies and everything that we've built in on the marketplace at RealCrowd. We can leverage that same technology and that efficiency to bring that into this advisory space. So instead of one investment of $250,000, and that's someone's total allocation to the asset class, you can build a portfolio of five to eight investments within that same 250,000 and get a much more diversified pool of risk rather than going all in on one deal, which historically, you know, 250,000 was, was kind of the minimum ticket size.

Okay.

All right. Anything else you want to say on, on market or should we start talking about the manager?

Yeah, we can talk about the manager. I mean, again, the market that's, it's a really interesting one, especially given what we've seen with jobs right now and these migration patterns. Right. So that's one that we're definitely paying attention to and has thrown models throughout markets.

Do you think are like underlooked at or appreciated? Like, you know, I mean.

Yeah, I mean, I think it's, it's, it's the things that you mentioned. Right. Where, where are the. More you. We've talked about on the podcast, some of these kind of transition economies, right. Economies and markets that have gone from more of your kind of manufacturing jobs to more of the knowledge based jobs. Right. Pittsburgh is one that's been talked about. You know, there's some markets in Florida, Texas, Austin, obviously Denver, Salt Lake. Right. Some of those markets that are seeing the transition of the composition of their jobs, that'll be more, you Know, maybe more insulated going forward. And obviously caveat all of this with, you know, we're not providing investment advice here. Some of those markets that will be insulated from these disruptions going forward and ones that are seeing influx of people with this kind of urban migration, urban exodus that we saw, obviously with the health crisis, but quality of living. Right. Cost of living, some of those areas that are attracting younger people that are going to have more of that, I think more insulation from some of these job disruptions going forward. I think those are some of the better markets to look for out there.

If I could throw this out too. When you come to markets, you're looking at residential versus commercial as well, because some of your projects are one or the other. Right. And commercial has been, I have to presume, a little bit impacted by this Covid thing. So many businesses are saying, man, I can send my employees home. We're not re upping this lease. How does that play into some of your analysis?

Yeah, and that's, you know, on, on the advisory side right now we're just focused on multifamily. That's been.

No commercial.

That's. Well, I mean, we consider multifamily as commercial. Right. Bigger apartment complexes. So no single family residential. But yeah, you know, retail obviously has been pretty impacted throughout the health crisis. Industrial has done really well, has been for a long time, and I think we'll continue to do so. Multifamily has held up extremely well. There's been a lot of resiliency in the multifamily space. When you look at rent collections and certainly, you know, capital that's. That's going after multifamily. But office is a really interesting one. Right. That's when we don't know yet how that'll play out. Right. You've got these competing narratives. You've got remote work. You know, is this the kick that finally makes remote work and work from home more commonplace? There's probably some of that. So. So you could argue that the companies will need less office space. But then you look at what is, you know, how do you use an office in a post Covid environment? And do you actually need more space per employee to make up for some of that social distancing or whatever that might look like? So office is a really. That's an unknown right now, I guess in terms of how that recovers or what that looks like coming out of this. I think the nature of how we use the space will definitely change. Right. More looking at the office as a place where that's more for collaborative work, that's more team and then having a space where you can go and certainly get some more focus time independent on more like that work from home, remote space. It'll be interesting to see how that one. I don't have an answer for you yet, but it'll be interesting to see how that plays out.

Yeah, I thought commercial meant office versus multifamily, but you'd consider those within commercial and that's good for people to know that.

Yeah. Generally we look at commercial as investments. Assets that are held for investment is generally commercial. Right. So we would include multifamily, office, industrial, retail in that we make the distinction again between single family residential and then you've got a blurred line between some of these build to rent communities of single family rentals. Right. So we've got some people that are looking at building a housing, you know, a single family community where they would normally look at those as for sale product but they're going to retain the whole portfolio and rent them out as single family homes. That's something that we've seen as in kind of a new asset category that's coming up kind of between those lines of single family and multifamily.

Huh.

Interesting.

We've seen you see a little bit of that in Arizona. I've heard about those. So tell us about manager. Let's get to number two. We got to start working at the list here.

Yeah, we got some ground to cover. Yeah. So manager is one of the most important. Right. That's one of the most heavily weighted in the, in the model. And a lot of that is down to their, their past experience. Right. If you've got a manager that's done $2 billion of multifamily projects and now they're all sudden they're going to try to raise money for a ground up retail construction. Right. That's a very different risk profile than if they're going to buy another stabilized multifamily unit. So a lot of the manager, again it's, it's who is actually running the project. Right. What is their experience historically? What does their background look like in terms of, of you know, executing on deals like this both within that market, within that strategy, within that asset class. Even within multifamily, have they, you know, they only bought units that are complex, that are 50 units or less. Now they're buying a 500 unit complex. Right. So really trying to match up their historical experience with, with the current investment and then looking at their track record. Right. Have they lost capital in the past, what's their litigation history look like? Do they have any bankruptcies or foreclosures? How many principles are there? How long have they been in business? So really trying to get an understanding of the qualifications and the experience of that operating entity and how does that compare with the subject property that they're, they're looking at entering a new market, right? That's, that's going to be more risky for someone than if they've had, you know, their entire experience in Charlotte, North Carolina. They're going to go buy something down in Orlando. That's going to be inherently more risky than if they're buying another property in Charlotte. Right. So, so a lot of those things, again, relative to what is their historical track record look like or what we're looking for in the manager. Okay, all right, number three, Number three, the physical asset itself, right. This one's pretty straightforward. When was the property built? When was the last time it was renovated? You know, some of the standard metrics. What's your, your acquisition price to replacement cost or to appraise value. If you look at what is your capital improvement expense relative to how much you're buying the asset for? Right. If you're buying something for 40 million and you only need to spend half a million on capital improvements, that's less risk than if you buy something for 40 million and you're going to spend 20 million on capital improvements. Even more granular, what percent of those capital improvements are deferred maintenance? Right. Are you just fixing issues that the prior owner didn't fix or are you actually going to be adding value in the asset? Is it lead certified? We look at some of the walk score issues. Where is it actually in the neighborhood in that sub market? We look at things, you know, again, trying to get an indication of what is the business strategy, right. What is your. Where one of those forecasts that we look at is how much are they trying to grow the net operating income to get to stabilization. So if you're buying something and you're going to grow rents at 2% per year, kind of keep pace with inflation, that's less risk than if you're trying to juice the rent 7 or 8% per year to get to that goal. Right. So trying to look at some of the business strategy there of is this more of a stabilized asset? That's a much more lighter touch, or would this be a ground up development where your, you know, your growth from, from acquisition income to stabilized income is, is infinite. Right. Because you have no income at the beginning so that's where we try to get to kind of some of those, those underlying factors about what's the business strategy of the asset and how much value is trying to be added at the asset level as an indicator of, of the risk with the actual execution, execution, execution risk in that strategy.

On the replacement cost, are you seeing that is, you know, prices have probably gone up, you know, in multifamily, as has in many other real estate classes. But have you seen like the replacement costs and people just being like, man, I can build this cheaper. Although building costs I hear are like insanely high.

Building costs have gone crazy. Yeah.

So the replacement cost analysis like gone up significantly is that it has.

Construction prices have gone up huge. Right. I mean, you just look at the, the material cost. I mean, a lot of the, the DIYers out there listening to the show will know that, you know, a sheet of plywood is like 50 or 60 bucks now when it used to be 20. Right. You can, you know, two by four is eight to nine bucks where it used to be two. Right. So just the, the hard cost of construction have gone up incredibly. You look at land costs, you look at the permitting and regulatory costs, and you look at just the time of holding until you can get through a permitting process. So replacement cost has definitely skyrocketed, which makes existing products actually look more attractive. When you consider all those factors and what it takes to actually replace that, I think that's generally a challenge within. Certainly when we talk about affordable housing, Right. It's, it's near impossible to build new products at any rents that will, that will justify that for, for any kind of less than, you know, ultra high end class A luxury apartments. Right. That's where that's a lot of the pipeline that's coming to the market is that luxury class A product, because you just can't make anything less than that pencil from a return on what those construction costs have been. So we've definitely seen replacement costs go up incredibly over the last handful of years. And I don't, I don't know that we'll see that come down anytime soon. Especially with all the supply chain disruption that we saw from, from the pandemic. I think that replacement cost is still going to be pretty high and I don't see that coming down anytime soon.

Okay. Okay. So, I mean, in the analysis of a property, I mean, I presume you guys are doing a, you know, I think most investors are familiar with buying a home or a single family rental, let's say. And you know, they're used to the home inspection process. You know, like, what's a good inspection process? I mean, for someone doing like looking at a multifamily deal, like how much analysis is going into that and are people investing before the deal is bought? Typically. So the money's being raised before it closes.

Yeah. So a few questions there. So first on, yeah. On the inspection side, again, the managers that are actually, they're, they're buying the property. Right. They're going to coordinate all those inspections as part of their due diligence process. A number of inspections. Right. You're going to do, you're probably going to do seismic depending on what, what, you know, part of the country you're in. You're going to do general property condition report, you're going to get roofs checked, you're going to get mechanical H Vac, you're going to get all those checked out. So there's a pretty extensive suite of inspections that go through this process. And that's again, that's kind of standard due diligence for, for the manager, the, the sponsor that's actually buying the asset. They've always got their due diligence process that they go through. And you know, we get a, we get a report that's, you know, hundreds of pages with a property condition report and all those findings. Environmental too. That's a really big one. Is there any remediation, you know, you can do different level one, level two environmental reports to kind of see what they're, if there's any issues underground. Right. So that's on the, on the kind of inspection and due diligence side. And then in terms of the timing of the capital raise. Yeah. So typically we'll work with the manager when they're, they have the property in escrow, they're going through their due diligence phase. They're going to be lining up their senior loan. Right. And we'll talk about that in the capitalization piece. They'll be lining up their debt and then also raising equity concurrent with that. So usually they won't call for funds until after they've gone hard. Right. That earnest money deposit has gone hard. They're going to close that transaction. Then they'll usually call for funds, you know, a week, 10 days before they actually close the asset and then they'll use those funds to purchase the property. We've seen a number of deals though, where the sponsor will close a portion of it on their balance sheet. Right. So they'll use their own capital where they have a warehouse line with A financial institution or just their own, their own balance sheet come in and close the asset and they can syndicate that post close, relieve some of the time pressure. Again, six and one half dozen the other. It kind of goes both ways on that one.

Now as you're talking about raising capital, how does the average person that's like, hey, I do want to get into these multi units, we're raising capital, what should people expect? On the flip side, distributions are those monthly, quarterly, what is a cash on cash return? That's average. A lot of people just look at cash on cash, you know, and I don't know if that's realistic in these larger deals.

Yeah, so that's, we're at an interesting time right now in terms of where yields are going. Right. We've seen them compress pretty substantially over the last 12 months, which is certainly again in the multifamily space, which is counter to what most people would think. Right. We just went through, we went through the, one of the greatest health crisis or country and world has ever seen. Still going through it. You would think that that would create, you know, a higher return expectation. But actually we've seen, we've seen cap rates compress, we've seen those yields compress. Debt has come down. You know, debt is still super, super cheap to get leverage right now, which is then increasing the value of these assets. So we've actually seen cash on cash returns come in and tighten a little bit. And again, again it varies depending on what spectrum of the risk categories you're going into. Right. A core asset is going to have a lower cash return than something that's a value add or more of a kind of a core plus investment. Right. So it's hard to say unless we're talking about a specific opportunity. Generally core properties, cash on cash returns, anywhere from kind of mid single digit range. And then you work with some of the higher cash on cash returns. A value add deal where you go in and you renovate the units and you increase those rents, those will maybe stabilize to you know, high single digit, low double digit leverage, cash on cash return and then again variability all within there. So returns are still one that we're trying to, again trying to understand what's the appropriate amount of risk to take. And the returns will, I mean they'll work out to what they will be. Right. We can have an expectation of what those will be. But really that's one of the things we're trying to shift is making these decisions based on are you taking the right amount of risk in Your portfolio based on what you're trying to achieve and building the portfolio around that, rather than the historical notion of just the cash on cash, again, that is the primary focus or equity multiple or irr, trying to bring in some other decision factors beyond just a target return to help make a better decision by understanding those risks.

Yeah, because let me just.

Matt, if it's okay, just to follow up on that. So is the average investor's going, hey, I like this. These guys are so thorough. It's so hard to find the single family world or duplexes or fourplexes, that management always gets to be a concern. So being a part of a bigger group that is doing this type of work is so powerful. But as we try to. As I talk to clients and try to bring them across that bridge and go, okay, come over, look at this other side of the field. The grass is pretty green over here. Um, should they expect also that return upon the sale of the asset? Like say, okay, I got my cash on cash, you'll talk about distributions in a moment. But then we sold, you know, the property, there's an exit strategy or they want out, they're going to play in the equity or the appreciation piece on top of the cash flow.

Absolutely. Yeah. And that. So that'll come into the partnership structure. Part of our model and methodology. That's one of the big things that we look at is what's that gross to net? Right. What is the, what's the delta between the actual gross returns at the property level and the net returns to investor? So that's going to come into the structure, which is, you know, how. How is the, how is cash flow treated both from kind of your normal operations and also what's, how's that cash flow treated on a capital event? And that's where we talk about that partnership structure, which is the preferred return, and then any kind of a promote or waterfall structure beyond that again. And it's all across the board in terms of the structures that we see out there for deals. Project by project generally, though, project by project, 100% generally, though, we'll see a preferred return. So, so all the investors will get, you know, call it 8%. Right. So they'll get 8% before the manager takes any kind of a outsized share of that, which is called a promote in the. In the real estate space or a carry in some, you know, in the venture space. So preferred return, that rate generally, I'd say between 7 and 9% is what we see most of the time as a preferred return. And then beyond that, if the manager exceeds that, they're going to get an kind of a disproportionate share of the profits beyond that. Right. So the manager is going to get an extra 20% of everything beyond that. And so that's where again we look at what is that percentage, what is that profit share that's going back to the manager versus to the investor both in a again kind of gross to net at the property level and then just the numbers of, you know, again getting a bit into the weeds. But you know, we've seen waterfall structures where there's three or four or five tiers of promotes, right. So from a 8 to a 10 the manager gets 20%. From a 10 to a 15, the manager is going to get 30% of that. So they can get really complex. Generally the more simple though, if you can keep it to just a simple promote, it's an 80, 20 over an 8% preferred return. That's going to be easier for investors to understand and we think generally less risk than if you have a multi tiered waterfall and you get to that final promote, that's maybe a 50, 50 over a 25 IRR. So there's a lot of nuances in how those structures come together and unfortunately there isn't what I would consider a market standard. They're as unique as the investments themselves, unfortunately, which makes it less little bit complex at times to understand what's the

time horizon on that though typical in a, in a fund of we're buying a new asset, you're going to get some cash on cash and then there's going to be an event down the road when we sell it. Is there typical timeline of that?

Most of the deals I think of the 45 or 46 deals that we've seen exit on the marketplace, I think the average hold is somewhere in that 2ish, you know, a little over 2 year range. Granted this was a lot of those were earlier in the cycle, right. So those ones that are being held longer haven't exited yet. Most of the underwriting we see these days, three to five years is probably on the more standard or shorter end for some of those value add projects. And then you look at some of the core plus deals that are going to be more cash flow driven, those will be anywhere from even seven to 10 years. So the time horizon and the illiquidity of those, and you mentioned that before, the illiquidity of these is something that's definitely needed to be considered going into this is if you're going to invest in a property that has a seven year business plan, you kind of have to assume that your money is going to be locked up for that full seven years. There's not a lot of ability to create liquidity prior to that capital event at the end, which is where it's great for retirement accounts. The timing of not needing to touch that money for a longer period of time matches very well with what we would typically see as a longer term horizon on these real estate projects.

Okay, let's hit capitalization. That's number four.

Yep, number four. And we kind of, we kind of COVID we jump partnership structures, we kind of COVID that one. Capitalization is again some of your standard financial metrics. Right. Loan to value. What's your debt service coverage ratio? What's your debt yield? We look at a stress test which is in again financial speak here. Stress test is basically how much of your gross income can you lose until you get to a 1.0 debt coverage ratio. So if you can lose 20% of your income at the property level until you, until you just barely cover your mortgage payments, that's going to be less risk than if you only have 5% of your of your income to lose before you get to that 1.0 debt coverage ratio. So capitalization, again, fairly standard financial metrics. And that's really again a lot of that centered around the loan, the loan terms. Right. A 80% loan to value is just inherently more risky than 30%, 35, which is more risky than buying something all cash. So capitalization, again pretty straightforward. More the kind of typical financial underwriting metrics that we look at in the real estate space. Both looking at the mat acquisition and then to a lesser extent, what are some of those factors at stabilization and at exit, which again as we talked about with those forecasting in the pro forma, we kind of discount those future values and look at it more at acquisition in terms of what those metrics are.

Okay, what about rate? Are you looking at rate much? Whether it's variable or fixed? I mean, is that something in this kind of multifamily space that's common is to have variable rates and you can have a rate change and they're super low now.

Yeah. So we both, we look at what kind of loan, right. Is it a fixed, is it a fixed rate or is it a variable rate? We look at whether or not it's interest only or fully amortizing or if there's a period of interest only. We look at what kind of a loan is it, Is it From a mortgage reit? Is it from a private equity, you know, a private equity mortgage lender? Is it from a, you know, a senior bank? Is it from a life insurance company? Right. So the kind of loan is the CMBS loan. The kind of loan can impact the risk and certainly again, one of the bigger ones is the interest only period. Yeah. And we've seen, we've seen some pretty crazy loan quotes out there. We had one that was it the rate, I think it ended up at like under 2.7% for a 66,67% loan to value 2.7% full 10 year term interest only, which is just insane. Absolutely insane. Wow. The mortgage markets are super, super competitive. Yeah. Right. Definitely juices the cash flow. So. Yeah. So all those factors that we look at in terms of the type of mortgage, what some of those terms, again the interest rate risk is definitely, you know, that's a, that's a concern right now. Right. We have to assume that we're going to be going into a rising interest rate market. We've been saying that for seven years. At some point it's going to come true. But you know, there's been, there's been a lot of money pumped in the financial system and at some point someone's gonna have to pay that. Right. So we think there's, you know, getting longer term fixed rate debt is super attractive right now and that'll help, you know, ride through any of those, those waves that might, we might see fluctuations in the market on a longer term horizon. Yeah. Generally fixed rate debt is, is far, far less risk than variable certainly in, in current environment. And just generally, and, and I have,

I have a great stuff and I a quick comment and question. So for our listeners, I want to remind them that this is just to go between. This is an opportunity at real growth where they're looking at real estate projects. But as this sounds so complex at times, that's what your RIA is for, your accountant, your lawyer. We're going to help the client look at this stuff and go, hey, here's some ideas and we can help answer these questions. And so I hope people realize I don't have to know all this.

Exactly, exactly. Yeah. And that's why we've done what we've done. Right. The number one question, and again if you go to buildmyroadmap.com, that's our kind of site where you can learn more about the advisory piece. That is the number one question that we get is what should I invest in? Is this the right deal? For me, and historically, prior to launching Reallocate, we couldn't answer that question as a marketplace. We weren't allowed to answer that question for people. And so a lot of this was driven by constantly getting that question of, should I invest in this? Right? And that's, I think a lot of the opportunity that we saw is we understand it, right? We get all these different components. We've built this ridiculously complex model to be able to simplify it into these categories. And we want to be able to help people make a better decision, right? We don't want them to have to be able to recite everything that I just gave to you guys. We just want to help them make that decision and make sure that their portfolio matches what they need out of their. Out of their investments. So simplifying it down and distilling that into this intersection again of what they're doing at the client level with their risk and how that interplays with the real estate risk. We take care of all that and then we make that investment recommendation that their advisor will sign off on, and then we go and we deploy that capital into the deals.

All right? Now, the question was to. So that cash flow, I wanted to get back to that.

We didn't.

We got off. And that was my fault is if I'm getting an 8% cash on cash, then I'm seeing cash at 8% per annum going into my retirement account, quarterly, monthly, whatever the distribution frequency is. I'm sure it's going to be project by project. And then when there's the capital event they sell, they're like, okay, sweet, I'm out. What, what else do I get on top of my 8% and my original investment back? Can we really distill it down to that simple of a analysis?

It's.

It can be that simple. Yeah. And again, you're looking at. So you're looking at assumptions, right? You're looking at projections. So there's a target. I think that is one of the challenges that we've seen in the marketplace is people will often, they'll look at those targets and they'll think that's a guarantee, right? They'll think that that's a. That's what they're going to get. We've seen deals dramatically outperform that, right? Yeah, exactly. Go invest in it.

You want to guarantee, get a cd, right?

And I mean, I can't.

I can put this in a box for you and promise to guarantee, but all you got is an FBI.

The number of emails that we get that, you know, an investment targeted a 13% and they get a, they get a 11. We get, we get people so upset if it misses by two points. Right. Like you still got an 11. That's pretty darn good. It didn't hit the 13. That was a target, was an assumption. But like you still did pretty good overall. So. Yeah. So generally, you know, cash flow will be distributed mostly quarterly. That's what we see most, some, some managers will do monthly, but most of the time we see quarterly distributions for cash flow. And then at the, at the end. Right. So there's, there's two other triggers that can return capital. Right. One would be a refinancing. And so if you, you know, if you develop a property or if you do a value add, you go through and, and the value has jumped from 40 million to 55 million. Oftentimes the manager will put longer term fixed debt on that project and then return a portion of the capital to the investors from that refinancing from the proceeds of that debt, which will come out typically tax free or at the end of the property when they sell that Asset, if there's 10 million of profit, investors would get the first 8% of that profit and then the rest of that would be split with that 80, 20. Right. So they'll get a check at the end of the day that'll go into their account and then they can kind of, you know, again, if it's in a tax or a qualified account, no taxes due on that unless there's the debt and the leverage that obviously you guys talk about a bunch. And then they get the money and they can go forward and do what they want. They can reinvest that into another project, park it in their account, you know, do whatever they choose with those proceeds after that investment is sold. Cool, thanks.

And number five, where I know we're short on time.

We did hit it. But what do you want to say on partnership?

Yeah. Part partnership structure. Yeah. So that's partnership structure. Again, things like, you know, what's the actual sponsors co invest. Right. What is their net co invest, how much of that money is actually coming from their balance sheet versus other money? That's a big one. Again, the composition of the returns, that's one of the higher weighted factors.

Is when you say co invest, you mean how much of their own money are they putting in? Do they have some of their own skin in the game? Is that what you mean?

Yeah. So if a property, you're going to buy a property for 30 million, $50 million. Loan, there's 15 million of equity. How much of that is coming from the sponsor's balance sheet? Right. Are they going to put in half a million or are they putting in 5 million and then peeling that back in their layer further of that $5 million, is that actually their money or is that money that they're raising from other people? Right. So really getting to how much skin do they have in the game after fees? Right. So if a sponsor says, I'm going to put in a million dollars, but I'm taking $1.2 million in fees, they just made $200,000 on that acquisition. Right. Versus actually having a million dollars in there after fees. Right. So those are things that we look at on the, on the structure side, again, preferred return, gross to net, what that difference is, waterfall structure, composition of the returns. You know, all those, all those factors that we touched on.

Cool.

All right. Super, super complex, right? Like, and that's, I think what we bring to the table is we have all of that, right. We figure all that out and, and then we distill it down so that the investors, they don't have to worry, they don't have to think about that. Right. Like, it's great to understand and we have a ton of education about our methodology and obviously we want people to understand the work and the thought and the care that goes into coming up with that rating of risk. But once they understand how our methodology works and they trust that, then they can look at what that output is and then see how that fits within their portfolio. So really trying to simplify it, that's a lot of what we see. The challenge in the space is.

Okay, and I'm sorry, I was going to ask one hard question.

Go for it.

I think as people that get fed up with single family homes and they're like, and they've made more money and they're trying to figure out how to deploy it, you become a perfect fit. I get it makes sense. In the single family home model, an investor makes a lot more than the manager. They own either 100 of the project or there's three or four or five partners. But the manager role and their profit is minor. But in these deals, I think some of the concerns is, well, the managers with their fees and their management and this, that and their share, they're making more than me and they give me 8% and I should be happy with that, but they're making more. Is that a false assumption? How should someone look at the role, the manager, in relation to my share of the profit as the 50% of equity. We raised 15 million in that example. So normally we'd own it and we'll hire a manager. Well, the manager's like, well, we put the deal together, so we're gonna make more than you. Is that a false assumption? I think it's a concern people have.

Yeah. And I think there's maybe conflating a property manager with the real estate manager. Right. The, the operating company that's actually finding the deals, doing, doing the construction management. They will hire a property manager, Right. Or they'll be vertically integrated and have a property management firm, you know, internally. But there's a, there's a big difference in a property manager that's going to deal with the tenants in a single family home and a real estate manager that's, you know, their business is adding value in their real estate. So that, I think that's the first distinction. And the second part again is when you look at the, at the profit splits, the manager's getting 20%, you're getting 80%. Right. So, yes, they will get a. If they put in 10% of the money, their promote might be an extra 10%, but you're still getting 80% of the profits. Right. And so that's one of the things that we look at, as I said, that gross to net comparison, how much of that value are they actually taking at the end of the day? So if the property sells for a gross IRR of 20% and as an investor, after fees, after the promote, you get 17% net IRR that 3% difference, that's less risk than if it's a 12% IRR net to the investor. Right. So what is that delta between at the property level, what does that sell for? And how much of that value is a manager actually taking versus going back to the investors? Certainly comes in the equation there. So I think the. Again, long answer. Maybe that's a little bit of a different role that you're thinking of with a property manager that's kind of doing the tenants.

No, I meant them. I didn't mean the property manager. I meant the promoter.

Okay.

Yeah. The guy that puts this deal together. It's making more than me and controls the destiny of this because there's a ppm. And I think people are like, I get nervous about going into deals like that. Can you somehow tell them not to be nervous or what should they look?

Yeah, I think it's, it's, it's what gets into the alignment. Right? I mean, you have to look at the alignment. Are they in that case where we said, you know, if they're putting a million dollars in on paper, but they're actually taking a million two out in fees like that's not very much aligned. Right. They're, they have nothing in the deal so they're all profit at that point versus some of the managers that we look at. You know, they'll put 10, 15, 20% of their own cash into the deal and they'll have, you know, they'll have a 20% profit promote. But they have, you know, of that 15 million, maybe they've got 5 million of that or 3 million of their actual, their own money into that deal. So you have to kind of look at the alignment of what those co invest pieces are and also with the fees, right. They have an operating company, they need to keep the lights on. So there's going to be some kind of asset management fee that's going to come out of that to kind of keep the operations going. So that's all part of it. Again, trying to make sure that there's alignment between the, the manager and the investor. And I think that's something that I think can be a little bit misaligned. Right. And feels, it feels like you're on the opposite side of the table. And I think that's what we're really looking for in managers is how do they, you know, you're on the same team, right. Like making sure that everybody is incented for this property to make as much money as possible because everybody's gonna make more money that way. Right. So, so trying to make sure that there's alignment both in the structure, both in how they've, you know, how they, in the case that there was an impairment on a property in the past, if they lost money, what did they do on behalf of investors to try to maximize what they could get out of that? Very atypical. But we saw one manager that on, I think they had lost money on maybe two or three deals during the cycle. The principal himself covered that. He wrote checks to the investors that lost money out of his own net worth to cover that. Pretty atypical. Don't expect that. But some of those things that kind of create that alignment to really, to really drill home that like you, you are on the same team. Right. They are getting a promoted share of their profits, but they're incentivized to make as much money as possible because you make more money too.

Yeah.

So again it's a comfort thing. It doesn't come natural to everybody. I think there is this Perception that you're on other sides of the table. But at the end of the day, you know, you want to make as much money in those assets as you can, and they're the ones that are making those decisions. So how do you build that trust with them that they're going to do that? That's. That's a lot of it.

Yeah. I always used to tell clients that are kind of like a cash partner in a real estate deal that make sure that that other person you're working with is making money with you, not making money off of you. And so one thing, one thing I tell clients to look for is when they're making money, you're making money. And there's an equation. Yeah. And so obviously, if they have skin in the game, that's good, but if they're getting paid out money for this property, so should you, you know, so you want to be making money with them, not them making money off you.

Totally agreed, Matt.

That was so good. I'm gonna needle point that this weekend.

Oh, I want a little. Can you make it put on a pillow for me?

Yep, you can put your nice little head on that pillow and sleep at night.

That's the other. Other podcast you guys have crafting hour. We do.

We do a little. We do some fun stuff on our podcast, you know, Good deal. Well, thanks so much, Adam, for your insights. You've got a couple websites people can hit. Realcrowd.com. that's your marketplace for people looking for deals to invest in. We talked quite a bit, too, about reallocate.com and I think you gave out buildmyroadmap.com. buildmyroadmap.com.

Build my roadmap.com. yes. So that's. That's for clients that again, if they. If they're maybe working with a financial advisor or don't have a financial advisor and want an introduction to work with one of our partners. That's buildmyroadmap.com and they can again, look at their kind of financial picture holistically and figure out where real estate fits into that.

Okay, cool. Anything else? Any other resources or places you want us to send people? Are those the ones, man?

I mean, we got our podcast. Right. Which, if you guys want to listen. Matt, we just did back to backers here. So we'll be launching that one soon. That's the estate investing for your future podcast. You know, you can find it on all of the. The podcast apps out there, Itunes, Spotify, wherever you listen to them. So Matt will be on there here pretty quick and a lot of really good information. Again, kind of foundational. Foundational real estate knowledge is what we bring to that podcast. So definitely recommend to listen there as well.

Cool.

Okay.

Well, thanks so much, Adam, and thanks everyone for tuning in to this week's Main Street Business podcast. If you're listening to the show and you're still listening now, I think that means you liked it.

So.

So go give us 5 stars on iTunes or Spotify or thumbs up or, you know, however you can tell us this podcast rocks. Just do that on your podcast channel, please. We'd appreciate it. And we'll be back next week. Is it open form, Mark? What do we got coming up?

Are we recording?

So, okay, that's the podcast where we take your questions. So you can go to mainstreetbusiness.com and submit your questions. Just if you one that pops in your head, I think how this would be good for the Main Street Business podcast. Throw it in there and Mark and I will hit it on next week's open form podcast. We'll see you there.