For both scenarios, lets assume you're pursuing a value-add strategy that's expected to 2x your capital in 5 years (~15% IRR)
In Scenario 1, you can stay in far smaller deal ranges. Let's say you stay in the $2MM-$10MM deal range.
If you do a $6MM deal, that would require ~$2MM of equity. A 2x on that capital would net you $2MM profit
You can probably pull off ~3 or so of those deals a year if you're running a 1-man shop with a few VAs or similar. So it's not unreasonable, once you hit your stride, to be making $5MM+/year with very few responsibilities. Few employees, no investors, only answerable to yourself
In Scenario 2, on the other hand, you need to do far bigger/more deals to yield that same profit. Typically private equity firms receive 20% of the profits (classic 2 and 20 model)
That means you'd need $10MM of investor equity to receive that same $2MM profit from a deal
$10MM equity=~$30MM deal size
Doing 3 $30MM deals each year is far more difficult than doing 3 sub $10MM deals. You can obviously also try to increase the deal size (to deploy that equity in 1 deal) but finding good $90MM deals is even more difficult than finding good $30MM ones
It's more difficult because you're now competing against institutions rather than retail. And many institutions have lower return thresholds than you. Not only that, but the marketing process is more robust. Harder to steal a deal marketed by Eastdil than one by a small brokerage
Let's say you're able to pull it off. 3 $30MM deals nets you $6MM profit ($30MM*20%)
(Yes you'll receive mgmt fees too but those are mostly breakeven until you reach a larger AUM)
But you don't get to keep all of that $6MM - you now have employees who eat up some of the promote
If you've given carry to some of your employees totaling 33% of the promote, you're now only making $4MM. So now you're actually making *less* than you would have just simply running your own money
So now you need to grow even bigger to compensate
There's obviously more potential profit in S2 since you're dealing with way larger amounts of money and it's easier to scale when you have a team. But in S2 you're now operating in a more competitive deal size range and against sophisticated PE firms rather than retail investors
So investing itself is actually way harder. Not only that but you have more added stress. You now have a team you're responsible for (and their families as well). You have added stress in that you have investors who you have to answer to and whose money you need to protect
In summary, there's no right or wrong answer. But it's important to think about what you're truly looking for (both in regard to your life and the business)
If you want to scale to the moon and become a billionaire, go for it
But growing isn't always the right option. Sometimes you can make more money with less stress by staying small
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Most people will tell you to look for population growth, etc
But that just means more competition
If 15 firms are bidding on a deal (like in bigger/higher growth markets) there's no mispricing and only way you get outsized returns is if you're lucky or have a unique biz plan
So (as long as you're searching for short term flips) I would ignore all of those "population growth"-type stats entirely
The only stat that matters is finding a market that has the most mispricings. Everything else is essentially useless noise
Since I've been getting a ton of DMs about the RE career path,
// DECODING REAL ESTATE CAREERS //: An in-depth overview of the career paths in the real estate sector, which ones you want to target and which ones you want to avoid
Got some questions regarding the flow of funds in an RE deal
The flow of funds is actually determined by the lender, which is provided in loan docs. Then, the operating agreement will have a separate FOF afterward for "excess" funds
Lender FOF on the left, LLC FOF on the right
Cash Management typically occurs when a debt covenant has been breached (usually the DSCR or Debt Yield dipping below a required threshold)
Once this occurs, all cash is swept into a "lockbox" controlled by the lender and follows the "lockbox" FOF (rather than the normal FOF)
The Cash Management Period can typically be resolved by 2 consecutive calendar quarters above a specific DSCR or Debt Yield threshold, after which time revenue is no longer swept into a lockbox and the normal flow of funds resumes
Majority of your yield is locked in at acquisition, which is why buying well is so important
Even an accretive, high return-on-cost action only represents a fraction of the purchase price - which is why having great deal flow (good purchase price) is so important
For example...
Say you buy a building for $10MM at a 5% cap rate, meaning the NOI is $500k
The building is 100 units and you plan on spending $1MM renovating it to increase the rents by $1,200/year in each unit ($120k revenue increase in total)
That's a 12% return on cost ($120k/$1MM) - which is pretty good, considering you bought the building for a 5% cap rate
After the renovations at the property are complete, the stabilized yield will be $620k/$11MM = 5.64%
Return on cost is simply the revenue boost or cost savings of a specific action (ex renovating units) divided by the cost to get there
Anytime the ROC exceeds the cap rate you bought the property for, that action is accretive
For example, on my newest deal, changing out the toilets to more efficient toilets saves ~$3.5k/year on the water bill. Cost of the toilets will be ~$175/toilet*40 units = $7k. Add in labor costs, $10k total
That’s a ROC of 35%, which is very accretive as I’m buying for an 8 cap
Essentially, the starting NOI was $200k and the purchase price was $2.5MM ($200k/$2.5MM = 8% cap rate)
That $200k NOI becomes $203.5k after the cost savings and the cost of the deal becomes $2.51MM, resulting in an 8.1% yield, a 10 bps increase from the 8% I bought it for