“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,” said my investor, Bruce Z. I thought, “What could possibly go wrong in buying a cash flowing apartment complex?” I appreciated the confidence that Bruce expressed and knew I earned that confidence with all the experiences I’ve had over the past twenty years. However, 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 the twenty percent down for hard money loans for my flips. I also had the ten percent 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 ninety-seven-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. We want to ensure that our investment is a good fit both economically, (can they afford to tie-up their funds) as well as emotionally. This will lead to rave reviews and repeat business.
CAP Rates and cash-on-cash returns are what most investors seek when looking to deploy their capital. Every investor wants double-digit returns and that’s not possible all the time. As with any investment, we make our money when we buy. And we purchase the property on sale due to deferred maintenance or some other underlying circumstances with an opportunity for us to add value over time. We may have to wait until a lease expires before we can add value, thereby increasing the rate of return. However, if a one-year lease was signed last month, that ties our ability to add value for eleven months.
Providing a spreadsheet with current values complimented by a pro forma of future valuations is mandatory. So, our proformas usually don’t start performing for twelve to eighteen months after purchase. Our investors know that we probably won’t distribute profits until that time. When we do distributions, we do them quarterly, as four times a year is so much easier for the bookkeeper than twelve times a year.
We know a Class C property in a Class C neighborhood will never generate Class A type rents. Being realistic in your proformas gives your potential investor confidence that you know how to steer this ship.
Your exit strategy should be discussed up-front so that everyone is on the same page. Getting a phone call that your investor needs his money because his daughter needs braces is frustrating for everyone. Our plans look to hold an investment property five-, seven-, even ten years out. However, should someone come and make us a ridiculous offer, even a few months into the project, we’re going to have a conversation with our investors.
As we add time to the buy-and-hold equation, we 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 man once said, “No one has ever lost money in real estate if they didn’t have to sell.”
Finally, please note, every investor you approach will evaluate each deal differently to arrive at their conclusion. For example, there’s an investor who is an attorney and resides in Illinois that has invested over one-million dollars in Arizona and has only visited once. There’s another attorney investor who resides in my own home-town and she 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 learned is that investors are people and have different personalities.
We have reviewed 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 five hundred thousand dollars, do you want one investor with all the money? Or two investors with half the money? How about twenty investors with twenty-five thousand dollars each? The more investors you have, the variety of personalities you incur. At the end of the day you receive the phone calls and inquires 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 wife divorces me, and we lose everything.” That is, 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.