CREATIVE Contract Clauses

Hello and welcome to Multifamily Strategy. I'm on camera now. Hey guys, I'm getting the whiteboard set up here. We were trying a new thing where I'm actually gonna be able to screen share the whiteboard to you. So right now I'm realizing you see me behind me, which is gonna be super distracting while I'm talking. So I'm just gonna go hide the other version of me. There we are. Welcome to Whiteboard Wednesday. We're back. We're gonna have a fully powered whiteboard. I'm gonna come with a cooler way to do this, mess around with the background, but for For today, I'm gonna share one of my favorite things we're gonna do with more technology. So really excited for today. We're gonna go over 4 main topics in creative clauses, something that I wasn't able to find anywhere online. And I'm serious, I checked ChatGPT, I checked Klaus AI, I checked Google, I went through absolutely everything. I can find zero instances of some of these clauses online that I put in almost every creative contract. This is the simple bridge that we talked about in last week's video. To get from a deal that almost works to a deal that absolutely works in the fewest possible steps. I'm going to share some of my favorite clauses that end up in many, many, many of my creative finance contracts. We'll dive right in, hit the thing. Let's see if the screen share works the way we think it's supposed to work. All right. And see if we can full screen this whiteboard. You guys don't need to see me on a whiteboard off to the side. Let's see if it's possible to do that. Oh my gosh. I believe it is. Now, in theory, right now on YouTube, you can now only see the board. If this is true, let me know in the comments because also more people will start watching this video because it looks like a super active comment section. Okay. First of all, we're going to do the stair-step method. I do this all the time for deals. That don't quite cash flow. This is for deals with upside. So number 1, the stair step. This is an interest rate stair step. So you have someone who has a set price in mind. They have a deal that maybe does not cash flow enough day 1. And what are our rules for real estate? We need to have cash flow, cash flow, cash flow, cash flow. So day 1, it's a great deal. There's tons of upside. Maybe this was mismanaged. The rents are low. The property is otherwise fantastic. Your after-management value is way higher. You love the price. However, when you buy the deal at the target interest rate, let's say the seller wants 5% interest, it wouldn't cash flow day one. We don't buy cash flow negative deals, but if we have a ton of upside and a clear path to make it cash flow, we do what we call the interest rate stair step. So I'll draw this out very simply. By the way, is this working correctly on YouTube? Does this look— oh my gosh, this is amazing. I love tech. Okay, so let's say, for example, our deal in year 1 cash flows perfectly at 3% debt. The seller says, I need 5% debt. Your mission is to get everything you need, which is cash flow long-term fixed-rate debt. That's what we need. We need to buy income today so that we can make it and get paid to get through our entire project. So if 5% doesn't work day one, 3% works perfectly. We're going to say yes to your price. We're going to say yes to your interest rate. We'll say yes to their down payment. We can give them a yes on everything they need, but we're going to give them a path to get to the interest rates that we have cash flow. So in our hypothetical deal, That's not actually hypothetical. This is an actual 25-unit deal that I did in Stephenville, Texas. This was my original proposal. I'm gonna share what we actually did as our next example. So interest rates, they're still— seller wants $2 million. That's actually what they wanted. It's 25 units finished. It's worth $2.5. So I don't have a problem with this because I'm buying it at a bit of a discount for what I believe it's actually worth. However, the income on it today is only 50% of where it should be, which means I can't cash flow. They want 15% down and they want— let me think— 5% interest. Even at interest only, 5% doesn't cash flow. I can say yes to $2 million. I love the price. 15% down, that's considered low down. I can find that money. That's not the problem. So we give them a big yes here, a big yes here. If I can't say yes and get everything I need here, how would we do that? Year 1, 3%. Year 2, interest rate is now 4%. Oops. Year 3, 5% interest. I've now said yes to everything they want and give them a path to get there. So I now have cash-flowing fixed-rate debt. They have 3% interest, then 4% interest, then 5% interest. In the meantime, they got their full down payment of $300,000. They got the purchase price they want. We did this deal on 5-year debt. This is the structure that I propose, the stair-step method, to say yes to everything but buy yourself a little bit of time on one of the terms is a great way to do it. I've also used this stair-step for down payments. If I can't do the full down payment, I'm going to pay you 50% of your down payment in year 1 and 25% of it in year 2, 25% of it in year 3. I'm going to buy myself time to buy the deal out of cash flow. I did that with a 7-plex in Seattle, Washington. It worked phenomenally. All right. Let's go ahead and open a new page here. And I'm learning how to do this, so give me one second. This version is slightly different. Is this the button I'm looking for? It is not. Learning in real time. Probably this plus button. Add. Nope. Cool. Found it. Okay. Let's go to a blank canvas. When I proposed this to the seller, even though it hit everything they want and everything that we want, he said, hey, I'm not comfortable with the stair-step method. The stair-step method doesn't work for me. Let's go back to the main screen really quick. And let's, I'm gonna see my face while I explain the rest of the story and we'll jump back in. I'm gonna try to get this flow just perfect. I think we just hit stop sharing down at the very bottom there. I think so. Is it showing the right screen? It's showing you like on the side, so you can still see you. Interesting. Can we make me the only screen being shared? That should do it. All right, again, learning in real time. Thank you for doing this with me. So what we did is we ended up doing something that's called a reverse AMM. So he said, hey, I'm actually fixed on 5%. I'm not willing to put the interest at lower than 5% at any point. I need that interest to accrue even if it's not paid right now. So we did something that's called the reverse amortization. Now, on a normal amortization schedule, what you have going on— sorry, this background is a Distracting. We're gonna come over here. Welcome to my house. So what we're going to do is we're going to actually pay— it's a 5% interest, but we're gonna pay at 3%. In a normal amortization schedule, you actually pay down your loan in a fixed rate at a fixed period of time. So you have fixed payments, and on a 30-year AM, you'd pay off the loan in 30 years with additional non-interest payments. So you have your interest plus your principal paid out. In this case, a reverse AMM, your principal actually increases over time. Your payments are less than the interest you're accruing. This only works if you buy at the right price. We're going to add, in this case, $50,000 of unpaid interest onto the back end of the loan through a reverse AMM. So here's what it looks like there. Let's share the screen. This is actually pretty exciting. I like this. This is a fun way to do these. I have a better tech way to do this in the future, but this is pretty fun. Let me know what you think about this in the comments. This is more helpful, and then I'll get it like super fluid in the future. All right, so reversing— this is one of 4 things we're going over today. So to accomplish the same thing, 5% interest And I'll make my notes over here. $2 million purchase price. We agreed. $300K down. We agreed. 5% interest. We're just going to say yes. Let's say for the sake of example, for easy math, a 5% payment just happens to equal $1,000 a month. So I know this doesn't math over there, but just follow along here. This will make this easier to comprehend. Our payments, let's say, are $750. This is where the deal cash flows. So what are we going to do? We're going to accrue— what's the delta here? $250 per month is added to our actual principal balance every single month. We did a custom pay plan that just happens to follow payments are equal to 3%, payments are equal to 4%, then payments are equal to the full 5%, and the reverse AM ends. That's exactly how we structure this deal. It's a very simple way to structure the deal. The reverse AM is not as good as the stair step because additional interest accrues. That being said, we solved the main problems. We have cash flowing, fixed rate, long-term debt. It's exactly what we wanted to do. Seller got a yes to everything they want in the way they wanted it. Common creative clause. You don't use it all the time. I prefer the stair step. This one's pretty common. Next, I want to talk about our favorite play, the Hummel hack. So let me continue to share the whiteboard. And actually, yeah, let's do it this way. Okay. The Hommel hack. This is invented based on the stair step by Caleb Hommel. As a fun fact, Caleb was one of my first mentees in multifamily strategy ever. Today he owns over 335 rental units. He started at 18 years old, no money, no experience, no credit score. And because of that, he had to use creative finance for every single deal. He found a deal where a 10-unit property— so we're just going to call this our 10-plex, the beautiful 10-plex. This 10-plex right here, he got for a fantastic price. He found it in— this is in South Texas when he was living in San Diego, so he had an absolute win on price. However, there were only 7 units occupied. So 7 out of 10 occupied. They needed light renovation and it cash flowed very well with small rent bumps on the 7. And I mean like really nominal, like $25 rent bumps. And finishing out his occupancy, getting 2 more units leased, great cash flow, great stability. So his goal is is get a little bit more rent from the existing tenants, and just a little bit, and renovate units so that he can get to at least 90% occupancy, 9 out of 10 units. So the path is 9 out of 10, and he has long-term cash-flowing fixed-rate debt. Now, he bought this. This is his starting point. Does not cash flow here. So we're going to say cash flow, none. Here, cash flow. He needed to buy time. You're trying to buy time and trying to keep your payments down. You can do lower payments like the stair step, or you can do what Caleb did. He only needs to rent out 3 units. Doesn't take very long. He only needs to lease up a few units. So what does he do? He just bridges A and B. And actually, if you want to split screen here, I can, I can I can do a little bit of talking so they can see me in the background. If we can do the view where you see me and the whiteboard, that would be kind of— I want to experiment with this. Thanks everyone for bearing with me. This is— I'm having a ton of fun doing this. Let's see the one that shares the screen to go over to like there maybe. Yes, that's what I'm looking for. That's what I'm looking for. And then back to the main window, which I might be able to do. I can. Ooh, I have the power. Perfect. In theory, now on YouTube you see my face here and you still see the screen. We're already getting better. Thanks for playing along. Okay, so in this case, 18-year-old Caleb, he owns this building. He needs about 6 months of time. He needs 2 months to finish his renovations because he's new. These usually only take 2 weeks to do these units, but in his case, he needs a little bit of time. So he needs to buy time. 6 months gives him the amount of time he needs to renovate the units get the leasing, the marketing out, fill the units and get to cash flow. He just negotiates in his contract payments do not accrue and do not start for 6 months. You just have no mortgage. How many deals have you seen that would cash flow if you had absolutely no mortgage payments? It's virtually all of them unless it is horribly, horribly operated. In this case, not that bad. So Caleb negotiates here. 6 months, no payments, no accrual, nothing. Gets through his project, gets to his 9 out of 10, eventually gets the 10 out of 10 units. He cash flows every day from day 1. It's called the Hommel Hack. I put this into almost every value-add project. I'm actually doing this right now, 9-unit building. Our 6 months of no interest just ended— or sorry, no payments just ended. I just started making the payments, and conveniently It's a space that has 3 retail tenants and 6 multifamily tenants. We just signed our first lease today. I have 2 other people who are expecting to move into the building, filling out all of our retail right now. Right as we hit the tail end and the payments start coming in, we finished the leasing. This thing is cash flowing like crazy. And even better, we're refinancing into lower interest. It's going to cash flow even more. It let us bridge from A to B. This is more common on value-add projects. If you're bringing new spaces online or you're doing heavy renovations, saying, hey, I'll fix the problems here, but I don't want to pay you while I'm fixing the problems. If you're a seller, you got your price, you got your down payment on a deal where you put $200,000 or $300,000 down. They're just going to have to live on that poor little $300,000 down payment for the first 6 months before their mortgage payments come in. For that reason, it's usually accepted as long as there's a down payment They get everything they want. They wait a little bit for the payments, but it's an easy way to say yes to everything. There's one more clause that I put in literally every contract that you need to do. A lot of people don't do this and you're missing out. It's called a ROFR. I'll share it with you guys here. I do that every time, don't I? Oh, that's supposed to be an R. Spelling also matters. Right of first refusal. That's a tongue twister. Right of first refusal. What is a right of first refusal? The right of first refusal simply means you have the first right to buy the debt if someone decides to sell it. This is on a seller finance contract. If I am the seller, let's say I do a million-dollar note to Christian And I actually had someone do this to me with a little over $3 million note, $3,050,000 to be exact. They want to sell it at a discount to someone else. Let's do this with easy math though. Let's just call it $1 million. You have a $1 million note. They go, hey, I want to cash out early. I still have 7 years on my note. Someone will buy a 7-year note, let's say $800,000. They'll take a $200,000 discount to get their cash right now. They don't want to wait the time. It's still worth it for someone else to buy the note. They go ahead and sell their note. I have the first right to buy my own debt. So if they negotiate and they get an actual agreement from someone who says, hey, I have a million-dollar note at 6%, I will sell this to you for $800,000, they want cash now, I can come in and raise brand new money to buy my own note at $800,000, saving $200,000. It is going to be mathematically significantly better. To buy a note, let's say the interest is at 6%, or yeah, let's call it a 6% note. If I can raise money and put together money at 7% interest to buy my note at $800,000, that is going to be remarkably better than owing 6% on $1 million. I have the first right. If they want to exit early, they have to sell it to me before they go sell it to anyone else. And if they get an offer, I have the right to match that offer. This goes in all of my seller finance contracts. It's simply just called a right of first refusal. That's the whole thing. So it's just exactly what it sounds like. Right of first— there's an A in there. Well, I don't know how to spell. That's fine. Also, my handwriting sucks, so you guys probably can't read that anyway. ROFR, right of first refusal. I have exactly what it sounds like, the right of first refusal to buy any of my debt. Eventually, if any of my sellers want to get liquid, I can save hundreds of thousands of dollars by absorbing my own debt. Also, if I happen to be heavier on cash, I can just write the check and pay off my loan at a huge discount. There's a bunch of other special clauses you can use, but these are my most used. I don't find these commonly online. So this should be a little extra bonus content for all of you all watching. Kill my screen share here. So we have a few questions. As always, go ahead and ask your questions here. I will answer them. If we can post the first one up on the board from Oscar. What's another go-to creative strategy that you use when the owners don't agree to a reverse amortization? I know it depends on the deal's numbers. It does. So the stair step is still the gold standard. You want to do the stair step before the reverse AMM. So if they're fixed on everything, if the seller's fixed on price, fixed on the interest rates, they're fixed on the down payment, your two options are the stair step, the reverse AMM, or you can go to that HOMEL hack if it's a value-add project. You can say, hey, I need time to get this up. Otherwise, there's not a whole lot that you can do What I will typically do in these situations is you either have to come back and you just have to negotiate a better deal. You have to tell them, hey, this is where I'm at. You just kind of wait. They'll usually come back to you and accept your terms if you really did hit everything thereafter. Or on select occasions, if it is really just a management play, you can look at doing something called the lease option. So a management lease option, I'll take full management of the property. I'm going to get it into a position where it would cash flow when we close. I'll still pay an option fee, but it's not going to be nearly as high as the down payment. So I'll pay an option fee for the right to buy the property at a fixed price in a fixed period of time. So an example would look like, I'll take full management of the property. I will give you, instead of a $300,000 down payment, I will give you $25,000 now. I will start doing these renovations and managing the leases. I want to get the income up. And then I have 18 months to 2 years to execute on a contract to close this deal at the agreed-upon $2.5 million. To get the financing and the cash flow that I need to do the deal, I need to take over and fix the problems to actually get us from A to B. You'll get that accepted more often when you're an experienced operator because you can actually show a track record of why this is going to work. Otherwise, you just have to write an awesome business plan and convince them that, hey, I am actually going to run this better than you're running it. Don't phrase it that way, but that's what you're trying to communicate. What else do we have from Oscar? When investors bring all the money, typically what percentage of cash flow do you offer? I know if the deal offers an equity multiple of 1.7 or double. Okay. So this is a good question. So you have two ways to reward your investors. You can pay them out of monthly cash flow or out of the future upside of the project., which is an equity multiple. You put in $100,000, in 5 years I give you $200,000. That's an equity multiple. You can blend that with cash flow. If I have a deal that's cash flowing 15% cash on cash, I have no problem whatsoever giving my investors an 8% preferred return. First 8% goes to you, we're going to split everything above that. I'm still making money with no money in the deal. So it depends on how much cash flow the deal has. Cash flow is cheaper than equity because equity they have to wait for. They always want a premium, which I would too. If I'm going to park money and not see a return for a while, I want to see a higher return than one that pays me back every single month. So you want to give them as much cash flow as you're comfortable with to lower the amount that you have to pay on the back end. If you have a deal with a lot of upside, you're going to offer a higher multiple. If you have a deal with a lot of cash flow, you're going to give them more of that cash flow. Let your deal tell you what it can do. But a deal that cash flows, so say 20% cash on cash, You can easily give investors a 10% return, which they're happy with. You probably don't even need to offer an equity multiple. 10 to 12%, they're going to be happy. That's a great dividend. That's a fantastic monthly dividend. Pay that cash flow out to them every single month and have an option to buy them out at principal value in the future, or maybe a small kicker, like a 1.1 on what they put in. I give you $100,000, 5 years, you buy me out at $110,000, and we split the cash flow all the way through. On a deal like the one I presented earlier where we had to do a stair-step, cash flow is constrained in the beginning but gets better later. I'm probably going to offer them more on the multiple because we're going to increase the value of that property through increasing the net operating income. Any other questions today? If not, that's fine. You don't have to have questions. I just recommend it because this is free and it's Whiteboard Wednesday. As I did last week, I'm going to run one more time the creative finance webinar. So if you guys are here and you're listening to this for the first time, you're like, hey, this is actually pretty good information. I'm actually going to run a whole webinar today specifically on creative finance. So it's going to be creative finance. Beyond that, how to buy from banks $0 out of pocket and how to get paid to buy deals that pay you every single month. I'm going to go through each of these over the course of about 90 minutes. You can register. I don't think I actually have it in our comment section. So The link for this is multifamilystrategy.com/workshop. If you go to multifamilystrategy.com/workshop, there's a few spots open. I opened 500 spaces, I think, for this week, and we were at like high 400s. So if you want to join that completely free, highly recommend. Other than that, oh, it looks like we do have one more question. Go ahead and throw that up here. Man Paina, the $50 billion man, teaches to make sure you have the super vote in a JV or a business partnership. Do you advise the same in real estate? Control is very important, especially— so more specifically than that, let's go with Ray Dalio. His book Principles, he talks about running everything as an idea meritocracy. All ideas from all your partners are heard. And this is how I run all of my LLCs. We have meeting minutes. Even my limited partners, my LPs on a syndicated deal, where they don't technically have a vote, I still have them attend the meetings. I still take feedback from them. I like more ideas. I like diversity of ideas. You want as much authentic diversity on your team as humanly possible. An idea meritocracy simply says you put a weighting on each person based on the experience that they bring to the table. For example, I have 4 different partners. They invested, each of them in different states. One has single family, One has run an RV park, one has 10,000 units in the same state, and I have 500 units. I really am going to put a very heavy weighting on what the most experienced operator has to say. However, if I am doing a deal and I raise capital and I am the one ultimately responsible, the managing member of this LLC, I need to have control. So when I run the LLC, it's very clear I'm the managing member because of my experience. We all get a vote, we all get a say in things, but I am the tie-breaking vote. Or there's certain LLCs that just say, hey, because of the lack of experience of other members, I am still going to hold meeting minutes, we're still going to converse on everything, but at the end of the day, I need to be in the driver's seat. What you want to avoid, and this is to this point here, you do not want to have 6 people in the driver's seat of your deal. You need to make sure that you can't have someone override you. A real thing that happened to me early in my career, and this is something that can happen to anyone if you structure this wrong. We had 3 partners, 33%, 33%, 33%. We all had equal ownership. The other partner, the least experienced one, bought out my other partner, my equally experienced partner. When we started this, the 2 of us could just outvote them. This wasn't a big deal. About a week after they bought him out, They've held a meeting without me for our LLC, voted me out of the managing member position, took on a whole bunch of extra debt, started doing projects that made absolutely no sense, and started just dumping our company money into renovations that did not need to be done on a Class B building, trying to make it Class A in a Class B area. The money was completely wasted. Worse, they moved tenants from the most beat-up units into our newly renovated units. Guess what happened? The tenants who vandalized the original units vandalized our new units. When I finally got through that, and it unfortunately involved lawyers, I came to an agreement to have new partners buy them out before they completely ran it into the ground. I got rid of those partners. We fixed the deal. It's now making money, but we almost lost hundreds of thousands of dollars, and I did have to come through, renovate the unit they moved people out of, And I had to go and then re-renovate the brand new unit that we just moved the wrong people into. Management is very important. So idea meritocracy is really your answer. It's not really about power and control, but if you raised money, you have the business plan, you're the one responsible for the deal, you should take full responsibility for the deal. I've successfully pitched deals to multiple investors, but I'm always willing to learn more. Can you please share a successful pitch you use for a deal? Yes. And I actually have a whole bunch of pitch decks that I've actually done that live in the multifamily strategy course. But there's a few things that you do in every pitch deck. So first, you start with the property. You want to actually talk about the project itself. Oftentimes I'll see pictures of a deal. I'm like, oh my gosh, I hope these numbers are amazing because this would be the coolest property ever to own. You want to paint the picture of what you're doing because that's 90% of your buy-in there. When I pitch anything, I want someone to want it. I use this example too often. I've never sold a car in my life, but if you're buying a car, you go to a car salesman. When I see the car that I want, I hope the price works for me. I hope the terms work for me. I'm already excited about the actual vehicle. In the same way, you're painting that picture through pitch deck. Nothing is worse than dumping a whole bunch of numbers in someone's face and going like, look, it makes money. I have an opportunity. Show me what we're buying. Most important part of a pitch presentation. Get the buy-in on the project, not the numbers. The numbers are going to validate the project. They are not what you are pitching. You are pitching the project. Then we're going to make sure it makes numbers. So number 1, the vehicle. Number 2, it is more important that you do not lose their money than it is that you make them money. Now we want to make everyone money. We want every deal to go perfectly. Why is their money safe? I'm going to talk about the safety of the investment. What is happening in the market? Why do we believe in this area? What has happened at the property? What does day one cash flow look like? What's our worst case scenario? I always go through all these first. One, you're going to pre-overcome most of your objections, but two, you're doing the main thing. I'm about to give you money. I do not want you to lose it. That is the most important thing to me as an investor. Lastly, you go through the rest of the numbers. Here's the returns, here's what we are offering, and here's our timeline before we close. So when I say deal debt equity, which I say on probably every video, this is why that's so important to go in order. We need to establish the vehicle we are investing in first. The rest of the pitch doesn't matter. So when people pitch on like, hey, I have this business idea and I'm going to buy a bunch of apartments, where are the apartments? Why am I safe in this? What's your experience? What's the— you don't have any of the pieces. When you have a deal, you can now present the property, the security of the property, and the projected returns based on the actual numbers of the performance of the property and your conservative game plan. That's it. Awesome. I think we rocked this. I don't see any other questions, you crazy people. Um, so every Wednesday we're going to get this a little bit more fluid. There's a way to actually have a remote producer where we're gonna actually have like so that you don't see the weird screen transitions. Look at this thing a little bit more fluid. But if you appreciate this whiteboard, let me know that in the comments. I actually really appreciate it. If you liked this method of learning and we want to do more of this, let me know. We will absolutely 100% do more of this. Excited to have you guys here. Whiteboard Wednesday is back. It's not just creative finance videos anymore. We're back to the whiteboard. So I'm really excited to share this with you guys. Seriously, attend that webinar. I highly, highly recommend it. I spent a lot of time on it. And this is the second and maybe the last time I'm going to run this in January. So attend that, see up there, that is multifamilystrategy.com/workshop. I will see you guys on the next episode.