The Secret to Raising Capital for Real Estate Partnerships

I think that's okay because I feel like most people's properties aren't worth quite as much as they were last year.

But, uh, well, that's also true as well. Yep.

Welcome back to the channel. Today we've got myself, Cody, Christian, and Axel. Axel's joining us again today to talk about his partnership structures. I feel like all three of us have used partnerships and various structures to scale creatively and efficiently and effectively. So Axel, welcome back to the channel. And let's jump right back in.

This is all different ways to raise capital, right? When you run out of money, that doesn't mean that you're out of deals, right? And we always follow a model on our end. It's deal, then the debt, then the equity. And the type of equity that we raise is going to matter based on the opportunity. Now, I know that varies by strategy. Some people raise capital first, then match to a deal. We typically do the deal to match to the capital. Today, tell us a little bit about what you've done. How much capital have you actually raised through your investment career?

Yeah, over $10 million. I mean, since we've been raising the last few years, $10 million in equity. Yeah, in equity.

Yeah, exactly $10 million, 38 cents to the, to the penny.

To the penny.

All right.

But yeah, so you've raised 8 figures, so you're, you've, you've done this quite a bit. Over quite a few different deals. You've done things from 10 units to— what's the largest overall asset you took out?

I'm a co-GP on a 104-unit deal in Texas. That's the biggest one that had a meaningful participation and helped raise the money involved on the asset management side.

So it's safe to say you've been in the game for a little bit because if you raised 8 figures, you probably own multiple 8 figures, I would hope, of real estate.

That is correct. Yes, absolutely.

You passed just recently you are closer to the 9-figure club than you are to the 7.

In terms of total real estate owned and acquired, yeah, we crossed— it was a little bit higher last year. We got up to 60, 60 and change last year, but we've sold some properties down to around 50 at the moment. But yeah, we're climbing, we're cruising a little bit more each year than the last.

Well, I think that's okay because I feel like most people's properties aren't worth quite as much as they were last year.

But that's also true as well. Yeah.

But yeah, as far as picking all those up, because you've done that with partners— Christian and I, our portfolio is just under half of what yours is as far as ownership goes. We've definitely used partnerships to get there and we've gotten pretty creative on that. How did you get started in the partnership space? Was it joint venture to start? Was it syndication to start? How did you play that out?

So it was joint ventures to start, and, um, I'll give you 60 seconds on why we started doing that, right? So similar to, to how the two of you have grown your business, we use a lot of debt, whether it was seller financing. Uh, I mean, obviously that's, that's, that's been your game, but so for me it was a lot of seller financing or a lot of private money lending or, or second position financing of some kind. So basically we got a purchase price and I'm, I'm, I'm taking out a ton of leverage to buy it, right? Ton relative being to the purchase price, right? Um, and that was how I bought real estate for the first 4 or 5 years in the business. And then I found myself in a situation where, okay, you know, even if I'm buying deals at below market value and using a lot of leverage and it still makes sense relative to the current market value of the property, there's still a lot of costs that come with buying real estate— closing costs, reno costs. Um, you buy a multifamily property that's a value-add, you're probably not making money for the first, you 9 to 12 months, 18 months, depending on how big the project is, how many units you got to turn, what you're spending money on. And I felt myself just being spread really, really thin. And that was the motivation for me to bring in some investors early. And the way I did that was very, very simple joint ventures, which we can talk about now. And when I say joint venture, basically to define that terminology, it's just multiple people who are involved in a deal that all have some level of active you know, role in the deal, right? And then inverse, which I won't get sidetracked, but syndication being you have a bunch of investors that have absolutely no role in the deal at all, and they're purely investing passively and relying on somebody else to generate their returns and relying on someone else for the success of the deal. So, when we were JVing, it was, you know, maybe I'd find a deal, I'd go find a partner, you know, somebody in the marketplace that kind of did the same thing I did and said, you know, "Hey, why don't you bring half the money? I'll bring half the money." I'll keep, you know, another 15-20% equity. I'll run the deal. And, and that's my compensation for, for kind of managing the property manager and, and finding the deal. And, you know, something extraordinarily simplistic like that. We did a few small deals like that. And then I realized that there's not a lot of sophistication behind that structure that doesn't necessarily make sense. I was leaving too much money on the table as the person finding the deal and operating the deal. And, and then I started looking for investors that were okay with being a little bit more backseat. While still having a role, which we can get into and define how we actually determine that. But what really opened up raising capital for me was just learning about just the private equity real estate structure, right? And the high level is you can include some kind of preferred return so that you pay your investors a non-guaranteed rate of return. And then once you pay them out that return, there's some kind of split above that, right? And that's how Real estate deals have been structured in the, you know, whether it's $250 million deals or $2.5 million deals, that's the bedrock of how a lot of deals are structured with investors or with partners, right? And there's any number of ways you can go beyond that, but that's kind of the bedrock. So, started bringing in some investors, compensating them with some, you know, kind of preferred rate of return to where they would get the first 7%, 8%, 10% of the distributions of the deal, and then anything above and beyond that, there would be some kind of a split. And that was really where we started to scale out that platform a little bit in terms of working with more investors, working with more folks in terms of bringing other people into our deals. And then that's ultimately what led to doing syndications, doing larger deals that were slightly more complex.

Now, for those who are watching and they're trying to conceptualize what a preferred return is, because you explained it, but let's say they put $1 million into a deal. And you offer an 8% preferred return on their money, and that first year there's only $60,000 in cash flow. Well, you offered the first $80,000, so does the $20,000 roll over to the next year? Like, how would that work for them if someone's trying— they maybe make a lot of money but they don't know where to put it, and then they hear that term and they're unsure what it means?

Yeah, exactly. And that's the common misconception, is it's not, it's not a guaranteed rate of return like it is if you're a lender, right? That's the big difference, is, you know, when you have an interest rate on a If you don't make those loan payments, the lender forecloses, right? Preferred rate of return, it's non-guaranteed. It's just a mechanism to basically determine how everyone's getting paid. So, let's say, for example, a million-dollar deal, they're 6% or no, it was 8% preferred return you mentioned. They're due $80,000 a year. They're entitled to that first $80,000 a year in distributions. We can only give them $60,000 in a given year. The difference of $20,000. Then accrues to their, uh, we call it in the business as the legal term, right? Accrues to their capital account, right? So the next year they're, they're now due, you know, $1,020,000, and their preferred return is based on that $1,020,000. And then when we pay them back, they're due $1,020,000, um, and so on and so forth, right? Our goal is to stay current in the deals that we do, but sometimes you don't because there's more construction or it's like a longer-term business plan or something like that. But that's fundamentally the goal there, right? And then above that, you know, and I might be stepping ahead here in terms of where you want to go, but you have the split above and beyond that, right? So the inverse, let's say again, same deal, $1,080,000 or excuse me, $80,000 is what they're doing, their million dollars. But in a given year, we distribute $100,000, right? So we went above what they would do. Um, the $20,000 above that $80,000 gets governed by that split. You know, maybe it's 50/50. The investor gets half and I get half as the sponsor, right? So, they get $10,000 and I get $10,000. And that's where we start to get into where we make money as the owner of the deal, right? Or the sponsor of the deal is what we call it. But that's the most basic structure that we can get. And then, the big money comes when you either refinance or sell. Let's say you sell and you make $500,000. You get the investor their million dollars back. And then you have $500,000 of profit left, that's where you get into the split. You know, maybe it's a 50/50, they get $250,000 and I get $250,000. And that's kind of the bedrock of the deal structure that, that we use.

Nice thing with the preferred returns for anyone who's tracking along with all of this, I know this is a more technical episode and I'm glad we get to share this stuff. When you're doing these splits, the preferred return is a lot of the first money is going to the investor. So what it does, it aligns all the objectives. When the operator performs better, they get more money. Like a lot of the, the bigger splits, like you were mentioning, like a 50/50, or a lot of the bigger profit shares are done later in the deal as you do better and better. So your ability as an operator makes you more money, which as an investor would make me very, very comfortable because I'm like, huh, they make a lot more money if they knock this thing out of the park. My return is, is my return, but We hit a whole new stratosphere when they start making more money as the operator. And so that's the main thing on any of these— JV, syndication— you want to make sure that the investor goals and the operator goals align. Where I've seen some of these go wrong is when you have newbie syndicators who are raising upfront. They're like, hey, I'm doing this and I'm focused on my upfront fees, and that is the part that I'm excited about. I can get a big fee. What I loved about your explanation here is you are completely focused correctly on the structure of, hey, this is how I'm making money on the back end by knocking this thing all the way out of the park. And that's the correct way to look at it.

But there's one piece I want to segue off of that. There's a lot of folks online that are saying, well, you can just syndicate, get a massive fee, and then if you get a big enough fee, then you could buy any size deal you want. I've, I'm seeing people in their first deal is like a 400-something unit complex. And they're trying to fund everything that comes up out of their fee and hope that they can hold it together. At what point— I mean, you started with the joint venture, which I do like because that's what we did when we started partnering together after I got my first 30 units. But how big would be too big for someone that's jumping into this? Should they start with a joint venture or should they jump straight into syndication if they're doing a little bigger deal?

I mean, honestly, in my opinion, it's, you know, contrarian to what a lot of people talk about online. Maybe not you two, obviously, because I think we're on same page here, but like a lot of folks that talk about this on Instagram or, you know, whatever, podcasts, or it's like bigger is easier, bigger is better, just go do big deals. And it's like, okay, some of it's true. It does take roughly the same amount of effort to close a 100-unit deal as it does to close a 20-unit deal. There's maybe it takes a few more hours, but it doesn't take 5 times as much time. So that's accurate. But people don't understand your risk is 5x because the deal is 5 times as big. It's just math. And, uh, you know, I'm a huge fan of like, I think that people start to, it gets like numbed down. Like it almost, people forget that in order to invest $50,000 with somebody, right? That's the average investment size in this kind of world. If you want to invest $50,000 passively with someone, um, or, you know, if you're sponsoring, you're taking $50,000, like there's an enormous amount of weight that comes with taking other people's money. Like somebody worked their butt off to make that $50,000. They might've traded their time for that. They might've You know, they're taking a huge bet by even doing that. Um, at least that's what we tell ourselves so that we take it as seriously as we possibly can when we're raising capital. And for me, if you're going to raise somebody else's, if you're going to raise money from other people and you aren't incredibly confident in your ability to execute on a deal, then you're in— one, you're just not, you're not a quality fiduciary of this individual's money or these people's money. You're violating that kind of, underwritten rule of raising capital. And you're just, you're just being reckless. I mean, that's my take on the whole thing. So the, the idea of just getting straight into bigger deals, raising money to do it, I think is short-sighted. And if you think about it purely from a business standpoint, it doesn't even make a lot of business sense because it's unlikely that you are going to knock it out of the park if you haven't done a deal of that size, or you haven't done a deal at all, or you haven't done a deal on that market. Like, you're probably going to make some mistakes. You always make mistakes when you size up in a deal or when you enter a new market or if you change asset classes or whatever. There's always mistakes, but you want to minimize the mistakes and you're going to make more in the early deals, which means you're going to be offering a lower return to your investors, which is short-term business, right? That doesn't make a lot of sense because the goal when you start raising capital initially is you want to knock it out of the park for your first 5, 10, 15 investors so that they tell their brother, their uncle, their coworker, their friend. And then you start to exponentially grow your investor base. Like, that's good business. That's how you build a long-term sustainable business doing this. And yeah, the first 2, 3, 4, 5 deals, you should give up more than you need. You should probably be doing deals that you really, really feel comfortable doing so that their returns are great, so that you build a nice bedrock from a foundational standpoint, both your reputation in the marketplace, just delivering for your investors. And then it just makes it a lot easier to then go and start scaling and doing slightly larger deals. So yeah, it doesn't— it's a little bit more work and, you know, maybe you're leaving some money on the table personally, but you're investing in the long-term reputational growth. So for us, when we started doing syndications, we were doing them on puny deals. We like 20-unit deals that I could have just bought myself, and I had the option to buy them myself, but I was like, I'm making a conscious decision to make less money on this deal right now because by doing so, I'm going to make these 6, 8 investors happy. And in the long term I'm going to make more money by building unbelievable relationships with these folks, by knocking this deal out of the park, by providing them a great experience, and by being a good person to work with. So you have to mentally make that trade, and if you're doing the opposite of that, you're just stepping over dollars to save pennies, in my opinion.

Love it. Yep, that is like dropping the mic.

Yeah, that is just the perfect way to describe it. For those who didn't see all those Instagram people that you mentioned online, oh yeah, buy the bigger deal, it's gonna be— you just can't make as much money. It makes sense to scale. I'm a huge fan of buying bigger. I think most people get stuck in duplex to fourplex land, and I don't think that's where you need to start. I'm a huge fan of start bigger than that. I learned it by buying two duplexes.

Next deal we did was a 38-plex, and we learned a lot scaling up to a 38.

And you mentioned that one made a lot of money, and it made a lot of money to the investors. It was a good deal.

However, it also hurt.

Mistakes were made though. There are things— we talk about this all the time— the way that we structured the capital, the way that we did the repairs, the way we over-improved a bunch of units. We could have made a lot more money. It was an excellent— it was just a straight-up excellent deal.

And it wasn't about making more equity, it was like liquid cash, which is so valuable when you're getting started.

Yeah, we did. Yeah, we basically made a bunch of equity. We made our investors whole, but we did not get to pull out a lot of liquid cash, which we could have made them way more than whole. Oh yeah, way more than whole. I mean, like, we got their investment plus plus because we ended up buying them out early to refi. I But as we put that deal together, like investors made money, we made money, good deal. That was not our best deal of all time because of structure. If you can eliminate those mistakes on a bigger deal, that's where your investors make stupid returns and you actually get to walk away with liquidity, which you mentioned previously. I don't remember if it was earlier this episode or in the last episode, but you mentioned, hey, I'll come into these deals 50/50. It turns out if you don't have liquid cash ever, which is common when investors are starting, uh, you don't get to do the cash contribution into these deals. That is a stage that is coveted, and I think a lot of people forget that cash flow, best thing ever. Equity growth looks great on paper, uh, liquid cash is a different thing, and you only get that when the other two go right on any deal. So I love what you said there, though, the way that you stack your deals, your earlier deals True of us, I'm sure it's true of you. You've learned stuff throughout, whereas you've gotten bigger and bigger, you can protect that capital because you add more zeros, the risk is more zeros. It's hard to earn your way through $100 million versus $1 million.

Yeah. And it's hard for people to fathom earning through $1 million if they're working on their first $100,000.

Exactly.

Yeah.

And I could, I could go so long on why people should sell more often, why you should probably turn over more projects early in your business to free up that cash so that you can have the freedom to spend a little bit of money on marketing, you know, maybe hire the VA. You know, look, find more deals, co-invest in more deals so that you can raise more, you know, so you can do more deals, raise more capital, etc. But you're right. I mean, liquidity is oftentimes overlooked and it's, you know, we're driving a car by being in this real estate business. And if you don't have gasoline to put in the car, it doesn't matter if you have a Ferrari. Like, it's, you know, it doesn't mean anything. You can't go anywhere. Right. And, and I think people find themselves stuck in that position when they're trying to do a high volume of deals without bringing in investor capital. And it's a really stressful way to run a business. Um, and that was really like, I kind of had a moment where I was like, I was trying, I was so obsessed with maximizing returns and maximizing growth. And I was like, I'm doing all of this at the expense of like running a lower stress business. And I was like, I'm just cool making a little bit less money. Like I'm cool making a little less cool. This being a little easier. I'm cool. Just, you know, put my head on the pillow at night knowing I got a bunch of, you know, a bunch of liquid cash in the bank that could solve a bunch of problems for me. Um, yeah, I could probably grow faster if I redlined the car a little bit, but But it doesn't really make a lot of sense to do that, I think, especially now, especially mid-2023. It's just, that's a really, really, it's a really high-risk way to run this business. And the reality is you make all your money in real estate when you get to year 5, year 10, year 15 of being in this game. Like, so much of the money is made, you know, at the upward part of that compounding curve when your relationships kick in, when you start finding more deals, when raising capital is just as simple as texting 20 folks and they're all going to wire you $100 grand whenever you tell them to. That's where you make all the money. So don't screw up until you, you know, on the— on your way to getting there, because that's just— that's the shortest focus, you know, shortest— shortest-term focus thing you could do, I guess, is what I'm trying to say.

Well, that is a perfect wrap for this episode. On episode 3, we're going to jump into— you mentioned something earlier, you've got more deals than money. So super excited to dive into that because most people have the opposite problem. They can come up with money but don't have the deals. So, uh, thanks for jumping on for episode number 2, and for everybody watching, we'll see you next time. Make sure to hit the subscribe button.