651: Hands-Off Real Estate Investing

SHOW NOTES FOR EPISODE 651: HANDS-OFF REAL ESTATE INVESTING

With increasing inflation and recessionary concerns in today’s economy, many investors feel that the only wise place to invest is in real estate.  In today’s podcast, author, public speaker, real estate investor and CEO of Praxis Capital Inc. Brian Burke shares how and why passive real estate syndications have become a leading investment strategy.

What You Will Learn

• How to invest in real estate with absolutely no money
• Creative ways to raise money for real estate investing
• Understanding the risks involved in syndication investing
• Is syndication investing really passive?
• How to get started in syndication investing
• How to find a good sponsor
• How to identify a good deal

About Our Guest

Brian Burke

Brian Burke is President / CEO of Praxis Capital Inc, a vertically integrated real estate private equity investment firm.

Brian has acquired over 800 million dollars’ worth of real estate over a 30-year career including over 4,000 multifamily units and more than 700 single-family homes, with the assistance of proprietary software that he wrote himself. Brian has subdivided land, built homes, and constructed self-storage, but really prefers to reposition existing multifamily properties.

Brian is the author of The Hands-Off Investor: An Insider’s Guide to Investing in Passive Real Estate Syndications, and is a frequent public speaker at real estate conferences and events nationwide.

More About Brian

• Born in Southern California
• Family moved to Northern California, in the wine country, north of San Francisco
• Started investing in real estate right out of high school
• He knew nothing about investing in real estate and had no money to invest
• Didn’t know anyone who invested or had the money to invest
• Bought his first rental house with no money down
  • He got a loan on the property
  • And convinced the seller to carry back the down payment as an unrecorded second note
• Had a horrible experience but kept buying properties
• As time went on, he still didn’t have any of his own money and was always trying to figure out how to acquire properties with no money down
  • How could he do more without finding the random seller who was willing to help him out?
  • He knew that he needed to raise money if he was going to grow
• He was in law enforcement, working nights and weekends and had Monday, Tuesday and Wednesdays off
  • He had most of the business week open to do his real estate business
  • He was financing with:
    • Private money loans
    • Lines of credit
    • Credit cards
  • After he had a few dozen deals under his belt, he realized it was too difficult to maintain his nights/weekends job
    • Put in his 2 week notice with the City
    • Told all his buddies in the police department that he was going into real estate investing and that, if they were interested, he rented out a room at the Community Center where he would be talking about what he’s doing.  So, if they were interested, to come by
      • He filled the room with his co-workers
      • Told them if they were interested and wanted to join him, they could contribute as little as $5,000 and that he would split the profits with them 50/50 on a pro-rata basis
      • By the end of the meeting. he had $500,000 in funding commitments from 28 cops who were carrying guys
        • He knew that he was now responsible for their life savings
        • Thinking that, if he screwed it up, his life was at stake (lol)
        • That was his introduction to the syndication world
        • That’s where he learned the two most important steps
          • Step #1 – Don’t lose anyone’s money
          • Step #2 – Don’t lose anyone’s money

What is a “Vertically Integrated Real Estate Private Equity Investment Firm”?

• That means, they are a firm that has all the disciplines of a real estate investment firm under one umbrella
  • They find the real estate
  • Acquire the real estate
  • Get it financed (the “private equity” part of the description)
    • Raise money from:
      • High net worth individuals
      • Family offices
      • Institutional investors
  • Do their own renovations
  • Manage the asset
  • Then, sells the property
  • They don’t hire third-party companies to do the above things – they do it all “in-house”

Why Write a Book on How to Invest in Real Estate Syndications?

• The idea for the book was first birthed when a friend of Brian’s lost her entire life savings in a passive real estate syndication
  • He didn’t want to see that happen to someone else
• He also learned from investors who had invested in his company’s projects that many were asking “all the wrong questions” or leaving all the right questions out
  • They were approaching how to “safe guard” their investments in the wrong ways
  • He saw that there really was no other source for people, who wanted to invest passively, that shows how the business works
• However, he also thought, “I’m on the other side of the fence as the guy offering the passive real estate syndications. I’m not the passive investor.  Shouldn’t the passive investor write the book?”
  • But after thing about it for a while, he saw that he was really the perfect person to write the book because:
    • He knows all the “inside information”
    • He knows what goes on “behind the scenes”
    • He can warn people on what to look out for, etc. – things a passive investor wouldn’t know
  • Plus the fact that he has been in the syndication business for 2 decades

Understanding the Risks

• Understand first, there is risk and uncertainty in any investment endeavor and real estate is no different
• If you are investing as an active real estate investor (i.e. buying a rental property) you still have a certain amount of risk
  • Having control doesn’t necessarily reduce your risk!
  • Being fully in control and making significant mistakes isn’t any better for you – it just means all you have to blame is yourself
  • Control isn’t the issue – risk mitigation is the issue!
• As an investor in a passive syndication you have all the same risks
  • The only difference is that there is is one “added risk” – the sponsors themselves
• When you’re investing in a passive syndication, you are “outsourcing your real estate investment pursuits”
  • Instead of spending your time…
    • going out and finding a house to buy
    • getting financing
    • managing tenants
  • You are finding an experienced investment sponsor/company (a private equity firm or real estate sponsor) who will go out and do all that stuff for you
    • They get fees
    • They get a split of the profits
    • You don’t have to worry about any of “the day-to-day stuff” because they do all that
    • They have, if they are experienced and savvy, already done all the “rookie mistakes” and remove that from the equation

Is Syndication Investing Really Passive?

• There is a bit of a misnomer with the term “passive” as it pertains to investing in a syndication
• Selecting “the right sponsor” is anything but passive
  • You need to be very active in doing due diligence on your potential sponsor
  • You need to understand:
    • Who they are
    • How they think
    • How they operate
    • How they’re capitalized
  • You need to make sure that they are a good steward of all your life savings
• For Old Dawgs
  • If you lose money, there’s really no time left to make all your money back
  • So, it’s a critical decision
  • You can’t just throw caution to the wind
  • If someone loses your money, you can’t just start over and hope to make it all back again
  • Your risk tolerance has to match the stage of your life that you’re in
  • The most important thing is mitigating your risk and making the right decisions

How to Get Started

• Some people start off with the wrong question – “How do I find a good deal to invest in?”
• They should be thinking, “How do I find a good firm to invest with?”
• They need to find the right investment sponsors first and then they can find the right deals
• That’s where the journey begins AND ends
• You need to do the required due diligence on those firms
• Learn about:
  • Their experience
  • Their track record
  • What they’re investing in
  • What their investment philosophy is
• Once you have found a few investment firms to invest with, then, sit back and wait for them to present deals
• When you get the deals, you will want to:
  • Analyze their prospectuses
  • Analyze their financials
  • Determine if the deal is any good

How to Analyze a Deal

• You need to go deep when analyzing a deal presented to you
  • In his book, The Hands-Off Real Estate Investor,” Brian goes line-item by line-item on the things you need to know when analyzing a property
    • What they should look like
    • What’s normal
    • What’s not normal
• It’s important to understand thoroughly each key number and aspect of a property
• Brian recommends that you don’t go with the first deal you are presented
• What to analyze first:
  • The financials
    • Financial projections
      • Do the financial projections make sense?
      • How do they compare to the property’s historical performance and where they differ?
      • Does the business plan to get to the projection make sense?
  • The real estate
  • The market
    • Does the sponsor know and have experience in the market?
      • Feel free to ask them questions on the market
      • Ask for third party market data from the sponsor if you want it to support their thesis
        • Reports that support what’s going on in the market
      • Why does the sponsor believe in that market?

 Investors’ Biggest Mistakes

• Failing to do good due diligence on the projects presented to them by sponsors
• Failing to properly diversify and use proper diversification as a defense mechanism
  • Different sponsors
  • Different geographies
  • Different property types
  • Diversification will help protect your principle
• Putting all of your free cash into one deal
• Brian knew one guy who puts $25K into every deal someone puts in front of him
  • Brian recommends investing a meaningful amount with proper diversification
  • It may not be the highest return but it is a good risk adjusted return
• Going for the highest projected return
  • Some syndicators finance the companies in a way to get the highest returns
  • The way they get those high returns is by using tons of leverage
    • A bridge loan that is 90% to cost
    • Financing the entire renovation
    • Capital stack
  • The loan to value ratio is pretty high and you’re really counting on…
    • appreciation
    • a continued perfect climate of low interest rates in order to refinance out of that bridge loan
  • You’re going to see people up get backed up against the wall with that kind of financing pretty soon
    • They could end up losing it all at some point

How to Find a Good Sponsor

• The business is kind of a secretive business
• Most people start out not knowing any sponsors
• Most sponsors don’t advertise because of SEC restrictions
• Finding good real estate sponsors takes a little bit of work
• Steps to finding a good sponsor:
  • Referrals from friends who are passive real estate investors
  • Listen to good podcasts (like The Old Dawg’s REI Network)
    • You can find out a lot about sponsors by listening to real estate podcasts
      • You’ll be able to “see behind the curtain” of sponsors and their companies
        • What they are about
        • How they think
  • Attend real estate investment conferences
    • Network with people there
    • BP Con (BiggerPockets) Conference
      • October 2-4
      • San Diego, CA
      • 2,500 people attend
  • Find Companies
    • Google “Real Estate Private Equity”
      • Look at company websites
  • Call/contact real estate brokers in cities where you’re interested in
    • Tell them you are a passive investor
    • Ask them who is their most active buyers
      • Those buyers are likely to be syndication sponsor firms
    • If they are a big real estate brokerage firm like Marcus and Millichap, CBRE Group, Cushman & Wakefiel;d, etc.
      • Check their websites
      • Often, they post big deals they have done
      • Syndication sponsor companies may be listed
  • Media
    • Globestreet.com
  • Look for sponsors who are conservatively financing deals

Getting Leverage as a Passive Investor

• Brian shared how passive investors can benefit from the type of leverage individual investors experience
• When an individual investor puts $100,000 down to buy a $500,000 property, he/she, in essence, buys something worth $500,000 for $100,000
  • They buy the property using their own money and “other people’s money” – most often from a bank or other lender
• Passive investors in a syndication can benefit from leverage but it’s a “different kind” of leverage
  • Instead of owning 100% of a $500,000 property, the $100,000 passive investor can own 10% of a $5 million property or 1% of a $50 million property
  • You own the same real estate when you think about it
  • But with larger real estate, you’re leveraging economies of scale
    • You get a larger property for the same money
    • But it operates more efficiently than smaller properties
  • Syndications are also using bank financing to purchase the property (with the investors money)
    • For example, a $50 million property would have $30 million from Freddie Mac (government sponsored funding) and $20 million from private investors (equity)
    • It’s the same thing you do when you buy a smaller property but with more money and people involved
  • Other leverage you get is with:
    • The Sponsor’s time
      • They are hunting down the great deals
      • They deal with all the financing
      • They work with contractors, property managers, etc.
    • The Sponsor’s team
    • The Sponsor’s contacts, networks and established relationships
    • The Sponsor’s broker contacts that gives access to exclusive deals
    • The Sponsor’s cash reserves and balance sheet

The Benefits of Passive Syndication Investing

• You get almost all of the benefits of individual real estate investors
• You’ll get:
  • Cashflow
  • Appreciation
  • Depreciation Tax Benefits
  • Amortization Tax benefits
• Plus, you get a benefit they don’t get – you don’t have to deal with the day-to-day management headaches

Investing During Tough Economic Times

• In light of the economy, Brain’s company has been selling fairly aggressively over the last 18 months
• They have done quite well, too
• They are, as prices are stabilizing and going down, gearing up to start buying again
• They are trying to stay in tune with the market and are looking for cycle opportunities
• They are looking at conservatively financing deals with a moderate to low level of debt
• They also want to have enough equity, safety and cash reserves to be able to weather a bit of a storm
• And the market will do what the market does until the next market cycle peak
• They are also investing in markets where people are moving to and avoiding markets where people are moving from
  • Use demographic cycles to your advantage which will help mitigate economic cycle shifts
• It’s also best to diversify:
  • Different sponsors
  • Different geographies
  • Different property types/asset classes
  • Diversification will help protect your principal

Income vs. Cashflow

• These are not the same
• They are like 2nd cousins but they are not the same
• You can have income in a syndication but the sponsor could be using the income to put on a new roof
  • You had income but no distribution
• You can also have no income but still have a distribution
  • You could have a refinance, pull cash out of the property, and issue that to investors as a return of capital, even though there’s no income that’s realized
  • You could have a $10 million loan and a $12 million loan and have $2 million left over that could be given back to the investors as a distribution

 Investing in Syndications for Cashflow

• It’s very common for retirees to invest in syndications for cashflow
• However, typically, in the early years of a syndication business model, the cashflow isn’t that great
• If the sponsors objective is to upgrade and rehab units to be able to increase rents, that process takes time
• Someone has to move out, then here’s the renovation time, then you need to market to new tenants at the increased rents, get new tenants in
• You are increasing the income of the property but that will take time
• What you’ll typically find in syndication plans is that, in the first couple of years, cashflow will be pretty light – maybe in the 2-4% range
• If you are investing in multiple deals, the older deals, over time, will be getting better cashflow, while the newer deals will be generating less
• Often, syndicators will say something like there will be an 8% “preferred return”
  • That means that the investor will get 100% of the cashflow distributed until it is all distributed until such time as they’ve met that return hurdle
  • In most cases, it’s a cumulative return
    • You need to read the words in the Operating Agreement to make sure that’s true because it’s not always the case
    • The most common industry standard is for that return to be cumulative
    • For example,
      • In year one, you got a 4% return
      • In year two, you get an 8% return
      • In year three, you’d get a 12% return (because the still owe you 4% from year one)
      • Sometimes you won’t get that 8% until the property sells

Current Business

• He’s looking forward to the company’s next phase of growth
• They have done their best when they can take advantage of some dislocation in the market
• He started out buying foreclosed real estate
• And when things weren’t going to so well, they had some of their best years
• Right now, they are seeing some rockiness – interest rate and debt stuff
• A lot of owners have been financing on some shaky debt
• This could mean there will be some opportunities coming up
• They are in a good position to gather up some of that real estate

Rap-It-Up

• Favorite real estate book: Deal Makers Guide to Commercial Real Estate by Ray Alcorn
• Favorite business book: The One Thing by Gary Keller and TedTalks by Chris Anderson
• Most valuable web site for success (other than your own) MLS, CoStar and Axiometrics
• Good Free Reports: Milken Institute Best Performing Cities Index and ULI and PWC Emerging Trends in Real Estate
• Favorite app: Google Maps
• Favorite quote: “Be fearful when everyone is greedy and greedy when everyone is fearful.” – Warren Buffett
• If you lost everything – all your assets – and had to start all over, knowing what you already know, and you only had $1,000, what would you do to re-launch your real estate investing business?  This was where I was at when I first started.  Having a $1,000 now would be like having a million bucks.  I had absolutely nothing when I first started.  But, knowing what I know now, I would have no problem re-starting my business.

How to Get Brian’s Book

• Get Brian’s book The Hands-Off Investor: An Insider’s Guide to Investing in Passive Real Estate Syndications on Amazon

How to Reach Brian

• Website: PraxCap.com

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