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The Real Estate God

@TheRealEstateG6

Jun 12

You want to start your own real estate private equity firm but you don’t know how much it’ll cost

Here’s how to think about start-up costs:

There are basically 2 ways to set up a real estate private equity firm

1. First way is to start a fund. This means you raise the money first and find the deals later

2. The second way is to operate deal-by-deal, which means you only raise money for specific deals as you need it

Starting a fund involves a ton of legal costs, compliance costs, administrative costs

Wouldn’t recommend even thinking about this path unless you’re planning on raising a lot of money ($50MM+)

It involves a ton of startup costs and a ton that can go wrong

So I’d recommend option 2 instead: operating deal-by-deal

It allows you way more flexibility with how you operate

It also involves minimal startup costs. Why’s this? Because all the “startup costs” are layered on the deals themselves (which investors pay for), not your firm

Legal costs are registered as “deal costs” for the specific deal

“Administrative costs” are the asset management fees you receive yearly

You’re able to off-load your startup costs onto each deal, meaning that your actual startup costs are very low (sub $25k if you do it right)

This means that the hardest part isn’t the startup costs. It’s the *ongoing costs*

Real estate is a long game. It takes years for a deal to pan out (even a great deal)

How’re you going to put food on the table in the mean time?

That’s the main question you have to answer

You can’t eat IRR - you need money to live off of before your first deals sell

And you need money to invest as a co-invest into any new deals (REPE GPs usually contribute ~10% of the equity). So you have to get creative

You basically have 4 options to “navigate” this tricky initial period

Read 9 tweets

The Real Estate God

@TheRealEstateG6

Jun 10

There are 3 main debt metrics in real estate:

1. Debt Service Coverage Ratio (DSCR)
2. Loan to Value (LTV)
3. Debt Yield

Here’s how to view each from both a buyer’s perspective & a lender’s perspective:

// DSCR //

Definition: The DSCR is the ratio between the net operating income (NOI) from the property & the debt service associated with the loan

Formula: NOI / Debt Service

Example: A property has an NOI of $100k/yr & a debt service (inclusive of principal and interest) of $65k/yr. $100k / $65k = 1.67. So we would say the DSCR is 1.67x which is healthy - the property can easily service its debt

Buyer Perspective: This metric is probably the most helpful to understand how risky your deal is. It essentially asks the question: can the cashflow from the property satisfy the debt payments? If the answer is no & the DSCR is below 1x, you’ll need to come out of pocket to pay the loan, which is obviously a disaster. A deal like that inherently carries quite a bit of risk & you can lose more than just your initial investment

Lender Perspective: A traditional bank will likely not be interested in providing a loan unless the DSCR is at least 1.25x. Remember, the DSCR is inclusive of the principal payment, so even if you’re in an interest only period, the lender will calculate the DSCR as if the loan is amortizing. If you know the DSCR will be below 1.25x you will likely need to find a bridge, or hard money lender who specializes in transitional properties to give you a loan (or lower the leverage).

// Loan to Value (LTV) //

Definition: The LTV is the ratio between the total loan amount and the purchase price.

Formula: Total Loan Amount / Purchase Price

Example: A property valued at $2MM currently has a $1MM loan. $1MM / $2MM = 50%. So the LTV would be 50%

Buyer Perspective: LTV can serve as a proxy for how much additional risk you want added to the deal. More leverage will amplify the return (both positively & negatively). Below 50% leverage is seen as conservative, 50% to 70% as moderate, & anything over 70% is aggressive. This only applies, however, if the appraised value is accurate at the time the loan is made. Often, the appraised value simply matches the purchase price even when the buyer has secured an above or below market price. When a property is worth more or less than the appraised value the LTV can be a “fake metric” that overstates or understates the risk

Lender Perspective: Lenders heavily anchor the amount they are willing to lend on the LTV. During good times, traditional banks are generally open to lending roughly 75% of the appraised value (whether for an acquisition or refinancing). More recently, banks have pulled back and achieving leverage this high is more difficult (although the main constraint these days is usually from a DSCR perspective rather than an LTV perspective). Like with the DSCR, if you want higher leverage than a traditional bank is willing to offer, you will most likely have to find a bridge or hard money lender

Read 5 tweets

The Real Estate God

@TheRealEstateG6

Jun 9

“How are real estate properties valued?”

There seems to be a lot of confusion around this topic when it’s actually really simple

The #1 myth you’ll hear is "Properties are sold based on their in-place income"

This is dead wrong. Let's walk through why this isn’t how it works:

Easiest way to think about why this is false is by imagining a vacant 4 unit property. Vacant properties have no income. So if properties were actually sold based on the in-place cap rate, vacant properties would have a 0% cap rate and be sold for $0 dollars

That's obviously not the case. Vacant properties are generally worth more than $0 (there are some exceptions)

Why is this?

Because properties are sold based on the stabilized yield, not based on the in-place cap rate

Let's walk through an example. You have a vacant 4 unit property, how would you value it?

Assumptions are that the market rent is $1,200, lease-up costs are $60k ($10k per unit * 4 units + $20k in reserves), the market occupancy is 95%, the market NOI margin is 65%, & the market cap rate is 5%

First thing you need to do to value the property is to find out the stabilized NOI

Income: $1,200 market rent * 4 units * 12 months * 95% occupancy = $54,720
Expenses: The market NOI margin is 65%, which means that expenses are 35% of income

$54,720 * 65% NOI margin = $35,568 NOI

Now that you have the stabilized NOI, you can calculate the stabilized value

Stabilized Value: $35,568 / 5% market cap rate = $711,360

The next step in valuing the property is accounting for the costs to "get there" (to stabilization)

Read 6 tweets

The Real Estate God

@TheRealEstateG6

Jun 6

What's the relationship between cap rate, return on cost, and stabilized yield?

This is arguably the most important relationship in real estate and most people don’t understand it at all

It’s actually really simple

Let’s start with the basics:

- The cap rate is the NOI divided by the purchase price. When you buy a deal, you buy it for an in-place cap rate

- The return on cost is the NOI increase of a specific action (usually a renovation) divided by the cost of that renovation

- The stabilized yield is the new NOI divided by all the costs in the deal

Stabilized yield is an extension of the cap rate through the duration of the deal by adding the NOI changes to the numerator and by adding the additional costs to the denominator of the formula

For example, if a property was purchased for $1MM and the NOI was $100k, the *cap rate* would be 10% ($100k NOI / $1MM PP)

If you executed a $100k renovation and that increased the rents and therefore the NOI by $20k, the *return on cost* of that specific renovation would be 20%

($20k NOI increase / $100k renovation cost)

Then you add the NOI increase to the numerator ($100k + $20k = $120k) and the cost increase to the denominator ($1MM + $100k = $1.1MM)

Which leads to the *stabilized yield* being 10.9% ($120k new NOI / $1.1MM total costs in the deal)

So you take the initial cap rate and add in each return on cost action (the new revenue gets added to the numerator and the new costs get added to the denominator) to get to the stabilized yield

It’s that simple. People try and complicate RE a lot but it’s literally division

Whole idea is to get your stabilized yield above the market cap rate in order to sell for the market cap rate and get cap rate compression

That means that every action that would result in a ROC greater than your market cap rate, you do

But any action with ROC < MCR, don’t do

In the example above, if the market cap rate was the same as the entry cap rate (10%), the property would be sold for $120k / 10% = $1.2MM

The total costs were $1.1MM. So your total profit on the deal would be $100k

The reason the profit on the deal is so small is that the spread between your stabilized yield (10.9%) and the market cap rate (10%) is so small (only 90 bps)

Typically you want to shoot for at least a 150-200bps spread between the two if you want to make good money

And that’s basically it. It’s very simple. In place cap rate gets altered by every action you perform at the property (and each action has a return on cost)

The cap rate + all the return on cost actions = stabilized yield

Stabilized yield > market cap rate, you make money

If you’d like to learn how to do this yourself and buy your own deals,

Apply in the next tweet for the Acquisitions Bootcamp to work 1-on-1 with me

If you don’t have a deal within 2 months, I will work for free until you do

Read 4 tweets

The Real Estate God

@TheRealEstateG6

Jun 5

One of the biggest places beginners get tripped up is the property tour

They don’t know what to look for and they don’t know what anything costs

Here’s what to look for when touring a property so you can accurately price the renovation costs:

Generally a renovation for a Class C 1-bed unit costs me $15k-$20k

Below are the items I focus on when touring to maximize rent and minimize cost

You should think about the property in the 3 categories outlined below
1. Bathroom (~$5k)
2. Kitchen (~$8k, grouping in all appliances & materials)
3. Floors/Paint/Other (~$2k)

Bathroom
1. Shower/Tub: What’s there right now? Do you have to rip everything out or can you reglaze or tile over? Does the shower valve & fixture need replacing? Will you tile the shower or install an acrylic shell? [Costs to redo can run you between $250 & $2.5k]
2. Floor: Are you going to tile the bathroom or run LVP? Can you run the LVP over what’s there now? [LVP is going to run you ~$5/SF & tile will run you $7-15/SF]
3. Toilet/vanity/mirror/lights: Do you need new ones? [Price materials online, the labor for installation should be minimal (~$50-100/item)]
4. Extras: Do you want to add something extra to increase longevity or attractiveness? Embellish walls (tile, shiplap, wainscoting), shower niche, sliding glass shower door, stone countertop, shower ledge, etc [Here costs can get out of control. Way to avoid this is to look at the comps achieving the market rent in your market. Only renovate to that scope & do nothing more. Additional renovations won’t get you a higher rental rate]

Read 6 tweets

The Real Estate God

@TheRealEstateG6

May 27

Probably the most common question I get from younger guys is “How would you do it all again if you were my age?”

I’ll do you one better. Here’s an extremely realistic gameplan to get from ~$0 to $1MM in 5 yrs

I’m going to assume that you have a W2, are roughly 22 and have limited capital coming out of college

We’re going to get you from $0 to $1MM in just 3 deals

// Deal 1 //

You’re broke and have no skills. Everyone was here at some point. You can either whine about it or you can get moving

Reason most people think making money is hard is that they focus on how hard the end goal is (making $1MM) instead of focusing on the first step of the process – gaining the knowledge necessary to start making money

This first deal doesn’t matter at all. The only reason it matters is to “get you in the game”. Once you buy a deal you start accruing market knowledge, you start accruing relationships (lender, investor, broker, etc) – you start to become “dangerous”

You obviously want it to be a good deal but it doesn’t need to be a *great* deal. Because the purpose isn’t to make money, it’s to gain knowledge/skills/relationships so you can make real money on future deals

So what does this mean in a practical sense?

Step 1: Figure out how much equity you either have yourself or can raise

I was literally dead broke for my first deal so was only able to put $2,500 of my own money in. I reached out to my entire network and was only able to gather ~$100k. That wasn’t enough to buy a triplex all cash in my market (which is what I was targeting)

So I reached out to friends who could possibly partner up in the deal. Meant splitting the profits but didn’t matter to me. Was going to do whatever it took. If I needed to take on 10 more partners, I would have. It wasn’t about the profit, it was about the skillset

I finally found a partner and using our combined networks, we were able to muster $200k, which allowed us to buy a triplex

I’m going to assume you can raise a similar amount, but if not, no problem. Whatever amount you can raise, you back into a deal of that size. If you truly can’t raise any money, start up a real estate social media account, share your thoughts/analysis, create a network and raise the money that way

Step 2: Finding the deal

- The market: You’re going to go into a market where deals sell for less than $150k/unit. Additionally, deals in the market should be selling for 6% cap rates at minimum otherwise you’re going to find it too difficult

- You’re going to search on Zillow/Redfin for duplexes, triplexes and quads (loopnet and crexi only really work for bigger properties)

- Open up excel. Make a list of every property listed in the market. Track the price per unit it’s listed for and note the price per unit it sells for. There should be 50+ properties on this list or you’re doing it wrong. Download any and all financial information that’s included in the listing. If there’s no information in the listing, call up the broker and get it from him. By the end of this process, you should know exactly what price per unit properties sell for in the market and exactly what cap rate they trade at. You’ll be looking to buy a property below the market price per unit and above the market cap rate (stabilized yield). Simple

- Market rents: Same thing. First use the mls/costar if you have access to it. If not, get comps from brokers (still have to vet them yourself). Worst case scenario, use Zillow/apartments.com for active comps. Put them all in excel, discard any outliers and take the average. You’ll still need to run the “market rent” for each new deal you look at as each property differs slightly, but this should get you close initially

- Expenses: Use the P&L information you now have. Line each individual P&L up next to each other in excel & for each individual line item, note the cost per unit, cost per square foot & the overall expense load as a percent of revenue. Now you’ve figured out both revenue & expenses. You now should be able to create a brand new P&L for new properties you look at from scratch

- Brokers: Every time you see a broker on a listing, you’re going to call him up, ask him a few questions about the deal, tell him your criteria & ask him to add you to his mailing list. You should start receiving “passive” deal flow to your inbox every morning. Should also set Zillow/redfin alerts for your criteria. You’ll probably have to look at over 100 deals before pulling the trigger

- Underwriting. You’re going to underwrite 3-5 deals a week minimum. You’re going to underwrite them based on their stabilized yield (if you don’t know what this is, search my tweets for it). You’re looking for a 200 bps+ spread between your stabilized yield & the market cap rate. The higher the stabilized yield, the better. The goal is to understand exactly what price per unit & stabilized yield you’d buy a property in this market for so you’re ready to pull the trigger when the time comes

Step 3: Pulling the trigger

Your “buy box” should already be established, only thing left to do is find a deal that fits it. You should be tracking the aggregation sites daily, have plenty of broker contacts at this point & have a lot of deal flow hitting your inbox

When you see a deal that fits your criteria, pull the trigger

Since this is your 1st deal, you may have a hard time getting a loan. Instead of whining about this (like most people do), you can:
1. Do the deal all cash
2. Use seller financing
3. Get a guarantor to hop on the loan

Doesn’t matter which one you use, just get the deal done. As quickly as possible

Deal 1 Summary: Depending on your access to capital, your first deal should be 1-5 units in the $200k to $500k range. The timeline should be quick (doesn’t take long to renovate 5 units or less) & the profit doesn’t matter as much so I’m not even going to bother listing it (obviously if you do raise money though, be honest about the return profile up front). The idea is to “get you in the game”

// Deal 2 //

While you’re stabilizing Deal 1, you should be working on Deal 2. It’s not hard to operate a sub 5-unit property so you’ll have plenty of time. Idea is to close Deal 2 ~18 months after closing Deal 1. This is a very realistic timeline (I know because I’ve done it)

Deal 2 is different. You’re no longer a beginner. This makes life a lot easier. You’ve already established your market, you know your buy box, you have lender relationships & broker relationships. The only thing that’s changing is the deal size, which should now be bigger

This is the big mistake people make. Instead of scaling up after Deal 1, they do a similar-sized deal. They stay in their comfort zone. This is the opposite of what you want to do. Instead, you want to treat the first deal as a stepping stone to larger deals

This next deal should be in the 10-20 unit range, $500k - $2.5MM size range. The timeline should be roughly 18 months and your personal profit should be $38k - $188k. Honestly think this is a low bar but we’ll go with it anyway (you can beat a 2x return on a deal this small)

So how will it work?

You’re going to buy another value-add multi deal using the same process laid out above. Stabilized yield 200bps+ above the market cap rate (gets you to roughly a 2x return) Let’s say you buy a $2.5MM deal. 75% debt, 25% equity. You don’t have to syndicate this deal but I’ll assume you’re still capital constrained & need to

$2.5MM * 25% = $625,000 total equity. I’ll assume you’re putting in 10% of the equity or $62,500

I’ll assume you’re able to 2x your equity in the deal over the course of 18 months (short timeframe again because of the low number of units), which is very doable for a deal in this size range. 2x means $625,000 in profit

Since you syndicated the deal (assuming a 30% promote), you’re entitled to 30% of the profits even though you only put in 10% of the equity

$625,000 profit * 30% = $188k. Not bad for 18 months of work

And you also obviously get your initial capital back, which gives you a decent chunk of change to invest in your next deal. But you’re just getting started

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