Top 5 Lessons Learned From Selling 192 Units: Coming Full Cycle!
Today we sold my first ever syndicated deal, purchased back in 2017 – The Joseph.
Looking back over the past 5 years, a lot of lessons were learnt about managing investors’ money, managing deals, and meeting expectations. Below are my top 5 lessons learned coming full cycle!
But before we dive into the good stuff; back in 2017 I wrote one of my very first articles about the buying the Joseph (originally called the Gables): Top 10 Steps, Tricks and Lessons Closing on 192 units. I highly recommend re-reading article.
Ok, let’s get into the good stuff..
Lesson #1. The Importance of Coming Full Cycle
Given this deal was the first for my business partner and I, as lead sponsors, many investors took the leap of faith with us and invested. At the time we only had a few years of experience buying multifamily in Central Texas as Co-GPs (not lead sponsors) and without our initial investors we wouldn’t have been able to grow the platform to what it is today. Over $650MM AUM and counting!!
…a big thank you to all those investors who helped me get my start!
With that being said, as an operator it is hugely important to not only close on a deal, but bring it full cycle. Why? The answer is twofold: 1) Investors trusted us with their money and thus we had to be sure we were able to repay that trust by preserving their capital and giving them a healthy +17% IRR return! 2) Getting a run on the board means we can say “we did it!”. We did what we promised we would do, we were good stewards of people’s capital and that builds trust! This trust helps form the foundation of this business.
Lesson #2. Investing in Commercial Real Estate Actually Works!
I remember embarking on this journey way back in 2012 and at the time I was educating myself about the benefits of buying and investing in commercial real estate (specifically multifamily) in order to generate passive income and long term wealth.
Today, I proud that I have been able to
1) preserve investors capital,
2) protect their money against inflation and
3) help them grow their wealth by returning a fantastic profit!
The Joseph by the numbers:
- +20.4% Annualized return
- +16.5% IRR
- +1.90x Equity Multiple
Lesson #3–Don’t Get Fixed Rate Debt….
Some of you are probably screaming at your computer monitors/iPhones when you read #3 heading, but hear me out….
The power of looking back and assessing how I would have done things differently is why I want to share these lessons with you all. Hindsight 20/20, right?
For those of you that don’t remember, back in 2017 we were in a different interest rate environment than what we are in today. At the time we all thought rates were going to the moon so we decide that the best option to protect investors capital would be to get fixed-rate agency debt. In fact we executed on a 7 year fixed loan at 4.53%, with 24 months interest only. It was a smart decision at the time for newer operators like us; however, given the lending environment we are in today I would have chosen a floating rate debt option with a rate-cap in place. This would mean we would have had
1) benefited from the low interest rate environment today, which would mean more cash-flow for investors, and
2) we would have had more exit options sooner as we wouldn’t have had to pay a prepayment penalty at sale for breaking the 7 year term.
Today, I am choosing my debt options more wisely to allow more flexibility upon exit, but I am glad I have gone through this lesson as it makes me a better investor for the future.
My advice for borrowers today: I would lock interest rates today as they are historically low.
Lesson #4—Allow for Flexible Preferred Payment Options with Investors
When I started raising capital, with limited experience as an operator, offering a preferred payment to investors is a good way to attract capital.
For those of you who aren’t familiar with preferred returns (“pref” for short), it means that any cash flow/profit from a deal goes straight to investors up until a certain return is met (ie: 8% preferred return). Once that threshold is met then the remaining cash flow, or profits, are split between investors and the operators (i.e. 70/30 – 70% of profits go to investors, 30% of profits go to the operator).
In today’s market multifamily deals are spitting off less and less cash flow as cap rates compress. In order to combat this I now offer investors a more flexible preferred return structure in my deals today;
- Two classes of investors exist – Class A investors, and Class B
- Class A is for investor who want the certainty of cash flow; this class is limited to 25% of the total equity needed, and they get paid a 9% pref return (paid current). However, for being in this class they don’t get to participate in the upside once I sell a deal.
- On the other hand, Class B investors also have a pref return but it isn’t paid current, it accrues. However, the benefit of being in this class means investors will get 70% of the profits once the asset sells.
The idea behind these two classes is that it offers investors optionality; if you want current cashflow you invest in Class A; if you want long term appreciation you invest in Class B.
I rolled out this structure in late 2018 in response to what I was seeing in the market. This structure doesn’t burden the deal with unrealistic cash flow expectations, and it forces investors to decide what is more important: cashflow, or long term appreciation.
Lesson #5—Manage the Property Manager as if they are your employee
I say this often but I will say it again: You make when you buy, but you lose it through bad management!
In the business of commercial real estate investing employing a good 3rd party property management team to run the day-to-day operations is paramount to the success of an investment.
We employed a PM firm (not to be named) early on and at the time they suited our needs: they had a small portfolio under management, about 6,000 units, and we only had a few deals.
However as we grew I soon realized the need for a change. At the time I didn’t realize how important a PM company’s culture is for attracting the right talent to manage our investments. The right bum in certain seats is key.
Looking back I equate this firm to the first car you buy; in my case it was a 1992 Nissan Altima; great, reliable car, somewhat fuel efficient, and could get me from point A to B. But what I learned quickly was that as we grew the company, adding more deals to the portfolio, we needed to attract the right type of people to oversee the day to day management onsite. And ultimately we started to outgrow the Nissan Ultima; we needed to upgrade our ‘”car” to a new BMW that had all the “features” like seat warmers, electric windows… well, you get the point.
By upgrading to a BMW you ultimately pay more for it but you also attract different type of talent to key positions within the portfolio.
Don’t underestimate the importance of a property managers company culture, mission and values as the people who work for that company will work on your asset and you only want the best.
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