When a deal promoter brings you a property, they often focus on the cash flow, or the market, or the value-add upside, but in my opinion those are literally the least important parts of a deal.
Of course the financials matter, but the question you need to ask is, “who exactly are the people behind it?”
People are the connective tissue of a deal. They’re the ones who find deals, underwrite them, perform due diligence, hire attorneys, loan money and on and on and on. If the people aren’t good at their jobs, the deal probably isn’t either. Let’s look at some of the ways people play a role.
Does the broker understand what you are looking for? Do she anticipate the questions you will have? There are more than a few brokers and wholesalers who just send you every property that comes across their desk, regardless of whether it meets your investment criteria. Even worse is when he gives you incomplete information. We have a checklist of required information that we need before we can even make an offer. Too many brokers shade the truth by projecting future cap rates and hope you ignore the current performance. We must see at least 12 months of operating history before we can even begin to craft an offer.
Internally, the company making the offer (BlueSpruce Holdings in our case) must have someone with a keen eye for numbers and be willing to say “no” to the majority of deals. In our case we have Brad Lowery.
Brad looks through dozens of offering memoranda every week and only makes offers on properties that fit our criteria at a price we think is reasonable. With a degree in mechanical engineering, Brad comes right out of central casting as a “just the facts, ma’am” guy who approaches every deal with an investor mindset. Since not every seller is forthcoming with financial information, an important part of Brad’s job is to patiently explain that “we can’t fall in love with the property until we fall in love with the numbers.”
Aside: some brokers won’t even send you the information unless they believe you can actually close the deal, so sometimes they ask for proof of funds. Fortunately we have that, but if you decide to venture out on your own be prepared to show proof of funds or, if you have the gift of gab, sweet talk them out of it. 😛
This is where the rubber meets the road, and speed of execution is critical. Once you have a deal under contract, the clock is ticking on contingencies and the closing date. You need good inspectors to look at the foundation, mechanicals, plumbing and roofs. However, it’s critical that we do our own inspection in addition to the paid inspectors. We walk the property and look inside Every. Single. Unit! You can have 149 excellent units only to find tenant number 150 is a hoarder who hasn’t taken out the trash since the first Harry Potter book came out.
That doesn’t necessarily mean you back out of the deal; it’s just important to know that you may have unexpected CapEx to clean up the mess.
In addition to physical inspection, it’s just as critical to do a detailed “economic inspection.” This means reviewing the rent roll, the T-12, bank statements, tax returns, contractors and any other obligation or source of income related to the property.
This also includes calling the local tax authorities and figuring out what future property taxes will be (not always as easy as it sounds). Insurance is a critical item to review as well. Sometimes the seller is underinsured, and that can have a dramatic effect on NOI.
Then there is market due diligence. Is the neighborhood on the upswing or down? Are there crime problems? Are there any supply constraints or surpluses, either now or coming in the future? Who are the primary employers in the area, and what are their plans?
You can learn a lot about what’s going on simply by calling the city or county’s economic development board. For example, during due diligence for our first Branson multifamily deal we met with the city and learned of plans for a massive water park being built just a half-mile from our community. The park is expected to create 900-1200 jobs, and the projected investment of over $430 million is a massive vote of confidence.
Most of our due diligence is handled by Manny and me. We take turns visiting properties for physical inspection and divvy up the economic inspection between us. Manny is a licensed agent and so handles all of our contracts, title and insurance. He also runs the Colorado Brokers Association so make sure to say hello to him at one of their frequent meetups.
Most of our deals require debt financing. There are literally hundreds of lenders to choose from, and they all have their own standards. Rather than learn every single lender’s needs, we work with loan brokers. They interview us to understand the deal parameters, put together a preliminary package and reach out to lenders they think are most likely to want to fund it. Once they get responses from lenders, they present us with three or four “best and final” offers. There can be lots of variation in the offers — interest only, interest only for two years, 25 year or 30 year amortization schedules, different length of terms, assumable or non-assumable, and varying prepayment penalties. A good loan broker will explain all the options and also give you a sense of what it’s like to work with each lender. We work a few excellent loan brokers such as John Romero, Eric Stewart and Greg Downey. (If you would like an introduction, feel free to send me an email.)
Lenders don’t loan $5 million, $10 million or more to just anyone. They want to know the backstory on the sponsors, and of course want to verify that they have the financial strength and credit rating to justify loaning large amounts of money.
As we do ever larger deals, we must recruit credit partners to work with us. And as part of that process, these credit partners rightly ask, “who are these BlueSpruce people anyway?” It’s a fair question, and we would be worried if they DIDN’T ask this question.
We recruited an excellent Advisory Board to help answer this question, and we started a podcast to demonstrate our expertise. Ultimately, however, it comes down to LOTS of one-on-one conversations with potential partners to establish trust, then backing it up by acting with authenticity, integrity and speed.
On the surface this is similar to raising debt. That is, we need money to close a deal, so we ask for it. But lenders and investors are two very different animals in terms of their goals.
Lenders are institutional. They have a cookie-cutter process for underwriting deals, and an army of lawyers generating paperwork to protect their downside risk. However, investors don’t usually have these kinds of resources at their disposal, so they have to be extra careful in evaluating an opportunity.
Furthermore, investors can have wildly different needs and expectations. Some investors primarily care about safety of principal while others have more of a gambler’s mentality. Some need to act quickly (for example, because they have a 1031 exchange in progress) while others have a rule to wait a year or more before investing with a new partner. Some investors already do real estate full time and so they leverage that expertise and ask a lot of questions. Others are less interested in the deal per se and more interest in the people behind it. Some investors may be looking for portfolio diversification while others may overweight their portfolio to real estate. Some want to shelter their income through depreciation.
Finally, newer investors are often anxious about real estate. They may have heard about it from their friends and co-workers, or read about it on BiggerPockets, or seen one of those mostly fake TV shows promising big profits. But like with any decision involving tens of thousands of dollars, it can be psychologically very hard to “pull the trigger” on that first deal. This is doubly true when you’re signing the documents. There are often a half-dozen or more signatures required, sometimes notarized, and every one of them presents an opportunity to back out.
I’ve been through that myself. My first real estate investment purchase was a house in Colorado Springs. My hands were shaking when I signed the contract. Six weeks later I sold the house for a $35,000 profit. Victory! Wow, that was easy! My next flip, however, didn’t go so smoothly. In fact, it went pretty terribly and dragged out for eight months. I ended up breaking even, but during the process I realized I don’t like the “hot money” nature of flipping. It’s all about moving fast, getting in and getting out. I prefer to think on longer time horizons, which is why I ultimately moved into multifamily.
When raising money for a deal, it’s best to have a single point of contact who can answer all questions about the deal: valuation, due diligence, the loan, key deadlines and so on. This person should also keep track of all potential investors in a spreadsheet or a CRM like ActiveCampaign. I handle most of this for BlueSpruce Holdings, with lots of assistance from Robin Deibel.
Though this post is about people, it’s impossible to talk about people without mentioning communications.
Clear and efficient communications are critical to closing a deal with the least amount of hassle. There will still be hassles, of course, but much can be prevented with a clear communication plan. A plan will include timelines for creating a comprehensive deal package, creating a deal page, announcing the deal to your investor list, scheduling one to three webinars about the deal and following up with them one on one. It goes without saying that having good persuasion skills can make a huge difference in whether a deal closes or falls out of contract.
Investor communications doesn’t stop after the deal closes. You should communicate with your investors at least once a quarter, and even more often if there are milestones such as construction and repositioning activities.
In addition to communicating with investors, your internal team must have an efficient way of sharing important information. Email is the goto tool for… everything, really. Email is fine for simple communication, but I strongly encourage anyone working in this business to use collaboration tools like Trello.
What Do You Think?
The goal of this post is to outline some of the many ways people affect a deal. Do you have any tips for working with people in real estate? Any horror stories? Please share them in the comments.
DJ has been a serial entrepreneur for over 20 years, founding multiple companies in the software and media industries. He began real estate investing in 2016 and loved it so much that in 2017 he decided to focus on it full time.