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“I know if this deal goes south, it won’t be because you didn’t try everything humanly possible. I have complete confidence in you,” my investor, Bruce, said to me. I thought, “What could possibly go wrong in buying a cash-flowing apartment complex?” I appreciated the confidence that Bruce expressed and knew I had earned that confidence with all the experiences I’ve had over the past 20 years. However, it also led me to think, “How does one gain experience?” Have you heard the expression, “Good decisions come from experience, and experience comes from bad decisions”?
When I first started investing in real estate, I self-funded my deals. That is, I had 20% down for hard money loans for my flips. I also had 10% down for traditional lenders to purchase rental properties. What I learned over time was that eventually, one runs out of money — or at least I did. So, I had to learn different ways to finance my deals.
The success I’ve had using other people’s money (“OPM”) came from learning a few key issues that real estate investors look for. What do you need to keep in mind to successfully raise capital for your investments?
First, your potential investor should understand real estate investing, specifically the deal that’s on the table. My 97-year-old mother would gladly give me the funds for a real estate project because she loves me. However, she would not know what to do with the property should I get hit by a bus or struck by lightning. Your investor should have some basic knowledge of what to do with the property in case “what if” happens. So, requesting funds from someone who only invests in the stock market may be a dead end.
Another component for onboarding an investor is ensuring them a comfortable deal. You want to ensure that the investment is a good fit for both participants economically (can they afford to tie up their funds?), as well as emotionally. This will lead to rave reviews and repeat business.
Capitalization rates and cash-on-cash returns are what most investors seek when looking to deploy their capital. Every investor wants double-digit returns, but that’s not possible all the time. As with any investment, you make your money when you buy. For example, say you purchase a property on sale due to deferred maintenance or some other underlying circumstances with an opportunity to add value over time. You may have to wait until a lease expires before you can add value and increase the rate of return. However, if a one-year lease was signed last month, that halts your ability to add value for 11 months.
Providing a spreadsheet with current values complemented by a pro forma of future valuations is mandatory. So, pro formas in the above circumstance usually don’t start performing for 12 to 18 months after purchase. Investors should know that you probably won’t distribute profits until that time. When you do distributions, I recommend doing them quarterly, as four times a year is much easier for the bookkeeper than 12 times a year.
A class C property in a class C neighborhood will never generate class A-type rents. Being realistic in your pro formas gives your potential investor confidence that you know how to steer this ship.
Your exit strategy should be discussed upfront so that everyone is on the same page. Getting a phone call that your investor needs their money right away because their daughter needs braces is frustrating for everyone. Plans often look to hold an investment property for five, seven or even 10 years. However, should someone come in and make a ridiculous offer even a few months into the project, you’re going to want to have a conversation with your investors.
As you add time to the buy-and-hold equation, you are anticipating increased rents as well as appreciation. Buying the property on sale creates instant equity and a buffer just in case the market shifts. A wise person once said, “No one has ever lost money in real estate if they didn’t have to sell.”
Finally, please note that every investor you approach will evaluate each deal differently to arrive at their conclusion. For example, I know an attorney who resides in Illinois and has invested over $1 million in Arizona and has only visited once. There’s another attorney investor who resides in my own hometown and wants to visit every property and look under every sink before she invests a dime. Two attorneys evaluating the same opportunity with different measuring styles. Though they may be looking at the same property, their comfort level with each deal varies differently. The lesson to be learned is that investors are people and have different personalities.
We have discussed a few crucial items that investors look for when deciding where to deploy their capital. Now let’s take a moment to review what you want from your investors. If you’re looking to raise $500,000, do you want one investor with all the money? Or two investors with half the money? How about 20 investors with $25,000 each? The more investors you have, the bigger the variety of personalities you incur. At the end of the day, you receive the phone calls and inquiries on the project. So, how many do you prefer to work with? For me, the fewer the better.
As a consultant, I have reviewed hundreds, if not thousands, of business plans. Not one of them had an ending stating, “My partner steals all the money and leaves me broke,” or “My spouse divorces me, and we lose everything.” That is to say, every plan has a happy ending. So, why invest with you? Ultimately, it’s due to the confidence the investor has in you. And we get confidence with experience in making decisions.